Suppose two types of firms wish to borrow in the bond market. Firms of type A are in good financial health and are relatively low risk. The appropriate premium over the risk-free rate of lending to these firms in 1%. 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 5%. As an investor, you know that type A and B firms exist in equal numbers, but you cannot identify which firms are which.