a customer has approached a bank for a $100,000 one-year loan at an 8% interest rate. if the bank does not approve this loan application, the $100,000 will be invested in bonds that earn a 6% annual return. without additional information, the bank believes that there is a 4% chance that this customer will default on the loan, assuming that the loan is approved. if the customer defaults on the loan, the bank will lose $100,000. at a cost of $1000, the bank can thoroughly investigate the customer’s credit record and supply a favorable or unfavorable recommendation. experience indicates that the probability of a favorable recommendation for a customer who will eventually not default is 0.80, and the chance of a favorable recommendation for a customer who will eventually default is 0.15.
