suppose two types of firms wish to borrow in the bond market. firm of type
A are good financial health and are relatively low risk. the appropriate
premium over the risk-free rate of lending to these firms is 2 percent.
firms of type B are in poor financial health and are relatively high risk.
the appropriate premium over the risk-free rate of lending to these firms
is 6 percent. as an investor, you have no other information about these
firms except that type A and type B firm exist in equal numbers.
A. at what interest rate would you be willing to lend if the risk free
rate were 5 percent?
B. Would this market function well? What type of asymmetric information
problem does this example illustrate?
simple answer
