Acme Widget tells investors it wants to build a new widget factory and sell investors $10,000,000 in bonds to finance it. Once they have raised the $10,000,000 the owners of Acme Widget use the funds to finance a trip to Atlantic City to try out a new scheme they have devised to win at blackjack. This is an example of
A)the adverse selection problem in financial markets.
B)the moral hazard problem in financial markets.
C)the difficulty lenders have in distinguishing good from lemon firms.
D)the problems with using rational expectations in financial markets.

Question

Quizplus · Accepted Answer

This is an example of moral hazard in financial markets, as the owners of Acme Widget have used the funds raised through selling bonds for personal gain instead of for the stated purpose of building a new factory. This behavior is likely due to the expectation that they will not be held fully accountable for their actions and that the bondholders will ultimately bear the risk of their irresponsible behavior.

Acme Widget Tells Investors It Wants to Build a New