2. Consider the model where there are two types of firms; a proportion f are strategic firms who can choose either a 'good' project, G, or a 'bad' project, B, and a proportion 1-f are non-strategic firms who always choose project B. Project G pays G if suc- cessful and zero if not successful and has a probability of success ag. Project B pays B if successful and zero if not successful and has a probability of success B Suppose that parameters are such that ag = G = 5,7 },B = 2,f = 1 and the riskless rate of interest is zero (i.e. so that investors get their money back) and investors in the bond market are risk neutral and cannot distinguish between strategic and non-strategic firms. For all questions state any assumptions you are making in deriving your answers. B = - (a) In a one period model what is the critical level of interest rates above which strate- gic entrepreneurs will choose to invest in the bad project? (b) In a one period model what is the critical level for f above which all firms will be able to issue bonds directly i.e. for the bond market to exist ? (c) Now consider a two period model where in the first period all firms borrow from a bank that ensures that strategic firms choose project G, while non-strategic firms continue to choose B. What is the probability that a successful firm in the first period is a strategic firm? (d) Considering the two period model of part c) if the bond market can only observe whether a firm was successful in the first period or not, would a successful firm be able to sell bonds directly to the market in the second period? (e) Considering the two period model of part c) but now where f = { with all other aspects of the model being unchanged. If the bond market in the second period can only observe whether a firm was successful in the first period or not, would all firms be able to issue bonds in the second period? = 2. Consider the model where there are two types of firms; a proportion f are strategic firms who can choose either a 'good' project, G, or a 'bad' project, B, and a proportion 1-f are non-strategic firms who always choose project B. Project G pays G if suc- cessful and zero if not successful and has a probability of success ag. Project B pays B if successful and zero if not successful and has a probability of success B Suppose that parameters are such that ag = G = 5,7 },B = 2,f = 1 and the riskless rate of interest is zero (i.e. so that investors get their money back) and investors in the bond market are risk neutral and cannot distinguish between strategic and non-strategic firms. For all questions state any assumptions you are making in deriving your answers. B = - (a) In a one period model what is the critical level of interest rates above which strate- gic entrepreneurs will choose to invest in the bad project? (b) In a one period model what is the critical level for f above which all firms will be able to issue bonds directly i.e. for the bond market to exist ? (c) Now consider a two period model where in the first period all firms borrow from a bank that ensures that strategic firms choose project G, while non-strategic firms continue to choose B. What is the probability that a successful firm in the first period is a strategic firm? (d) Considering the two period model of part c) if the bond market can only observe whether a firm was successful in the first period or not, would a successful firm be able to sell bonds directly to the market in the second period? (e) Considering the two period model of part c) but now where f = { with all other aspects of the model being unchanged. If the bond market in the second period can only observe whether a firm was successful in the first period or not, would all firms be able to issue bonds in the second period? =