Consider an Individual Who Plans to Buy a New Home

question 44

Essay

Consider an individual who plans to buy a new home. He has two options: (i) pay for mortgage insurance (that insures the lender in case the borrower defaults), or (ii) pay the lender a higher interest rate for the mortgage. Describe how these two options are related to the concept
of risk premium and the lender's aversion to risk. Why does the interest rate on the mortgage differ in these two options?

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Definitions:

Confounding Variable

An outside influence that changes the effect of a dependent and independent variable being examined in an experimental or observational study.

Independent Variable

A variable in an experiment that is manipulated or changed by the researcher to observe its effects on the dependent variable.

Covaries

When two variables change in relation to each other, suggesting a potential relationship or correlation between the two.

Double-Blind Procedure

A research or testing method in which neither the participants nor the experimenters know who is receiving a particular treatment, to prevent bias.