In evaluating credit risk, discuss the statement: "An increase in collateral is a direct substitute for an increase in default risk." In your discussion, evaluate the credit risk premium on a one-year loan with and without collateral using the following formula and values:
Risk Premium: k-i = [(1+i) / (y+p - py)] - (1+i)
where, k = required yield on a risky loan, i = 0.1 (default risk free interest rate), (1-p) = 0.1 (probability of default over the year), and γ = 0.9 (the portion of the loan collateralized).