Adverse selection is a problem associated with equity and debt contracts arising from
A)the lender's relative lack of information about the borrower's potential returns and risks of his investment activities.
B)the lender's inability to legally require sufficient collateral to cover a 100% loss if the borrower defaults.
C)the borrower's lack of incentive to seek a loan for highly risky investments.
D)the borrower's lack of good options for obtaining funds.

Question

Quizplus · Accepted Answer

Adverse selection occurs when the lender has less information than the borrower about the potential returns and risks of investment activities, leading to the borrower taking on risky investments that may result in default or underperformance. This can result in lenders offering higher interest rates to compensate for the increased risk or choosing not to lend at all.

Adverse Selection Is a Problem Associated with Equity and Debt