Firms with safe and risky projects exist in equal numbers. A safe investment of $100 turns into $110 with certainty. A risky investment is equally likely to turn $100 into $216 or $0. Everyone is risk-neutral and the risk-free rate is 7 percent. Start by assuming symmetric information.
Now assume asymmetric information.
1) How much face value do bonds have to offer in order to sell $100 worth of bonds from a pool of safe and risky bonds?
2) In the equilibrium with asymmetric information, do safe projects receive funding? How about risky projects? Explain.
3) There are 60 safe and 60 risky projects, and each project costs $800,000. Compute the deadweight loss.