require paying interest. The major difference is who must be persuaded to lend money: a bank loan

requires persuading the bank, while issuing bonds requires persuading a number of separate

bondholders. Since a bank often knows a great deal about a firm (especially if the firm has its accounts

with that bank), bank loans are more common where imperfect information would otherwise be a

problem.

3. a. Remember, equity is the market value of the house minus what is still owed to the bank. Thus: the

value of the house is $200,000, Fred owes $180,000 to the bank, and his equity is $20,000.

b. The value of Freda’s house is $250,000. It does not matter what price she bought it for. She owes zero

to the bank, so her equity is the whole $250,000.

c. The value of Frank’s house is $160,000. He owes $60,000 to the bank (the original $80,000 minus the

$20,000 he has paid off the loan). His equity is $100,000.
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