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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?