1. For the information asymmetry case, show calculations to determine the selling price and which cars remain in the market. Description Peaches

. peaches Lemons

Buyer's Value $11,200 , / $9,400

Seller's Value $10,300, / $7,500

Proportion 4 / 3

2. A lender is willing to make a loan as long as 11% expected rate of return is received. Borrowers having no wealth, but access to two projects that require $1.5 million of initial financing, apply for a loan. The expected pay-offs for each project are:

Project A pays: $2.2 million with probability of 0.75 $1.6 million with probability of 0.25

Project B pays: $2.5 million with probability of 0.6 $1.1 million with probability of 0.4.

(a) Calculate the fair rate for project A.

(b) Calculate the fair rate for project B.

(c) Calculate the maximum rate that can be charged.

(HINT: Borrowers will participate in the loan if they can obtain at least $0.2 million in the 'high' state.)

The market is made up of 45% of project A's and 55% of project B's and the bank can't distinguish between the projects.

(d) Given the maximum rate you calculated in

(c), will the lender obtain their 11% expected rate of return, given the loan market composition?