There are two firms, A and B. Each firm needs $200 to finance a project. Firm A's project produces $250 with probability 0.9 and nothing with probability 0.1. Firm B's project produces $510 with probability 0.4 and nothing with probability 0.6. Neither firm has any funding. Each firm has to sell a bond for $200 to nance its project. The bond promises a payment in a year, when the project is complete. If the project produces nothing, the firm defaults. The savers have access to risk-free bond with the yield of 5%. The savers are risk neutral. a. Consider the symmetric information case. Will the bond be issued? b. Consider the asymmetric information case. The savers do not know which firm they are dealing with, A or B. They know that it is A with probability 0.6 and B with probability 0.4. Will the bond be issued?
There are two firms, A and B. Each firm needs $200 to finance a project. Firm A's project produces $250 with probability 0.9 and nothing with probability 0.1. Firm B's project produces $510 with probability 0.4 and nothing with probability 0.6. Neither firm has any funding. Each firm has to sell a bond for $200 to nance its project. The bond promises a payment in a year, when the project is complete. If the project produces nothing, the firm defaults. The savers have access to risk-free bond with the yield of 5%. The savers are risk neutral.
a. Consider the symmetric information case. Will the bond be issued?
b. Consider the asymmetric information case. The savers do not know which firm they are dealing with, A or B. They know that it is A with probability 0.6 and B with probability 0.4. Will the bond be issued?
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