Financial Choice test 3

Through risk-sharing activities, a financial intermediary _________ its own risk and _________ the risks of its customers.

• (a) reduces; increases

• (b) increases; reduces

• (c) reduces; reduces

• (d) increases; increases

Financial institutions expect that

• moral hazard will occur, as the least desirable credit risks will be the ones most likely to seek out loans.

• opportunistic behavior will occur, as the least desirable credit risks will be the ones most likely to seek out loans.

• borrowers will commit moral hazard by taking on too much risk, and this is what drives financial institutions to take steps to limit moral hazard.

• none of the above will occur.

When the lender and the borrower have different amounts of information regarding a transaction, _________ is said to exist.

• asymmetric information

• adverse selection

• moral hazard

• fraud

When the borrower engages in activities that make it less likely that the loan will be repaid, _________ is said to exist.

• asymmetric information

• adverse selection

• moral hazard

• fraud

When the least desirable credit risks are the ones most likely to seek loans, lenders are subject to the

• moral hazard problem.

• adverse selection problem.

• shirking problem.

• free-rider problem.

• principal-agent problem.

When the potential borrowers who are the most likely to  are the ones most actively seeking a loan, _________ is said to exist.

• asymmetric information

• adverse selection

• moral hazard

• fraud

Financial intermediaries can substantially reduce transaction costs per dollar of transactions because their large size allows them to take advantage of

• poorly informed consumers.

• standardization.

• economies of scale.

• their market power.

In financial markets, lenders typically have inferior information about potential returns and risks associated with any investment project. This difference in information is called

• comparative informational disadvantage.

• asymmetric information.

• variant information.

• caveat venditor.

Adverse selection is a problem associated with equity and debt contracts arising from

• the lender's relative lack of information about the borrower's potential returns and risks of his investment activities.

• the lender's inability to legally require sufficient collateral to cover a 100 percent loss if the borrower s.

• the borrower's lack of incentive to seek a loan for highly risky investments.

• none of the above.

The presence of _________ in financial markets leads to adverse selection and moral hazard problems that interfere with the efficient functioning of financial markets.

• noncollateralized risk

• free-riding

• asymmetric information

• costly state verification