Question 1

Because of the adverse selection problem

Accepted Answer

The answer of Because of the adverse selection problem
...

Question 2

That only large,well-established corporations have access to securities markets

Accepted Answer

Indirect finance is crucial for businesses, especially smaller ones, because direct access to securities markets is often limited to larger, well-established corporations. This makes banks and other financial intermediaries key sources of external funds for these smaller entities.

Question 3

How does collateral help to reduce the adverse selection problem in credit market?

Accepted Answer

The answer of How does collateral help to reduce the...

Question 4

As information technology improves,the lending role of financial institutions such as banks should

Accepted Answer

As information technology improves, financial institutions are faced with increased competition from digital lenders which offer fast, convenient and low-cost lending options. Therefore, the lending role of banks is expected to decrease as more customers prefer using digital banks and lenders who offer better online experience and faster loan approvals.

Question 5

In the United States,the government agency requiring that firms that sell securities in public markets adhere to standard accounting principles and disclose information about their sales,assets,and earnings is the

Accepted Answer

The agency responsible for regulating the sale of securities in public markets and ensuring that companies adhere to standard accounting principles is the Securities and Exchange Commission (SEC). The Federal Communications Commission (FCC) regulates communications industries like television and radio, the Federal Trade Commission (FTC) works to protect consumers by enforcing antitrust laws and preventing fraudulent business practices, and the Federal Reserve System oversees monetary policy and regulates the banking industry.

Question 6

External financing by ________ should be more important in developing countries than in industrialized countries because information about private firms is more difficult to collect in developing countries.

Accepted Answer

Developing countries have less developed financial markets and less information about private firms compared to industrialized countries. As a result, external financing by financial intermediaries, such as banks or microfinance institutions, and direct lending by governments or international organizations may be more important in providing necessary funding for small businesses and individuals in developing countries. Bonds and stock markets may not be as accessible or well-developed in these countries.

Question 7

The problem of adverse selection helps to explain

Accepted Answer

Adverse selection refers to the problem of asymmetric information where one party has more information than the other, leading to the selection of less desirable options. In the case of financial markets, adverse selection can occur when borrowers who are more likely to default are the ones who seek out loans, while lower-risk borrowers do not apply for loans. This leads to lenders having a higher risk of default and therefore requiring higher interest rates. Banks and other financial intermediaries are better equipped to handle adverse selection by screening borrowers and gathering information, which makes them a more attractive option for firms seeking funds. Securities markets, on the other hand, are more vulnerable to adverse selection because they rely on the public to purchase securities, and individuals may not have the resources or knowledge to evaluate the risks of different securities.

Question 8

Government regulations require publicly traded firms to provide information,reducing

Accepted Answer

The adverse selection problem refers to the issue of asymmetrical information where the seller knows more about the product or service than the buyer. Government regulations requiring publicly traded firms to provide information aim to address this problem by ensuring that investors have access to relevant and accurate information about the company's financial performance and operations. This can help to reduce the information asymmetry between investors and companies, ultimately improving market efficiency and reducing the potential for adverse selection problems.

Question 9

The concept of adverse selection helps to explain all of the following EXCEPT

Accepted Answer

Adverse selection generally leads to a preference for indirect finance over direct finance, as intermediaries can screen and mitigate risk better than individual investors or lenders. Therefore, option C is not supported by the concept of adverse selection. The other options are explanations that can be linked to adverse selection.

Question 10

Analysis of adverse selection indicates that financial intermediaries,especially banks

Accepted Answer

Financial intermediaries, especially banks, have advantages in overcoming the free-rider problem, which is one reason why indirect finance is more important than direct finance for businesses. This is because intermediaries can pool resources and conduct in-depth analyses that individual investors might not undertake due to the costs involved, thus mitigating adverse selection issues.

Question 11

That most used cars are sold by intermediaries (i.e.,used car dealers)provides evidence that these intermediaries

Accepted Answer

The answer of That most used cars are sold by...

Question 12

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

Accepted Answer

Adverse selection occurs when the lender lacks information about the borrower's potential returns and risks of their investment activities. This information asymmetry creates a situation where the borrower is more likely to take out a loan if they have a high risk/high reward investment opportunity, leaving the lender with a potentially risky investment. This problem is more common in equity and debt contracts where the lender is not able to legally require sufficient collateral to cover a 100% loss if the borrower defaults. Therefore, the best answer is A.

Question 13

A lesson of the Enron collapse is that government regulation

Accepted Answer

The collapse of Enron was due to a lack of transparency and asymmetric information. While government regulation cannot completely eliminate this problem, it can reduce it by requiring companies to disclose information to the public. Therefore, option B is the best choice as it acknowledges the limitations of regulation while recognizing its potential to mitigate asymmetric information.

Question 14

A problem for equity contracts is a particular type of ________ called the ________ problem.

Accepted Answer

The correct answer is moral hazard; principal-agent problem. This problem arises when there is a conflict of interest between a principal (e.g., a shareholder) and an agent (e.g., a company's executive), where the agent has an incentive to act in their own best interests rather than those of the principal, especially when the principal cannot perfectly monitor the agent's actions.

Question 15

The free-rider problem occurs because

Accepted Answer

The free-rider problem occurs because people who do not pay for information use it, causing a lack of incentive for others to produce and provide the information.

Question 16

The ________ problem helps to explain why the private production and sale of information cannot eliminate ________.

Accepted Answer

The free-rider problem occurs when individuals can enjoy the benefits of a good or service without paying for it, which leads to underproduction and potentially market failure. Private production and sale of information would not eliminate free-riders as it is costly to exclude non-payers from the use of information. Adverse selection, on the other hand, refers to a situation where one party in a transaction has more information than the other, leading to potential market failure. While adverse selection is a related issue in information markets, it is not directly addressed by the free-rider problem. Therefore, the correct answer is A, as the free-rider problem helps to explain why private production and sale of information cannot eliminate the issue of free-riders.

Question 17

Equity contracts

Accepted Answer

Equity contracts represent ownership in the company and entitle the holder to a share in the profits and assets of the business. This is in contrast to debt contracts where the holder only receives a fixed interest payment and does not have a claim to the profits or assets of the business. Option B is incorrect as state verification is typically lower for debt contracts since they have more defined terms and are less complex than equity contracts. Option C is incorrect since debt contracts are typically used more frequently to raise capital than equity contracts. Option D is incorrect as moral hazard can exist with equity contracts since owners may take excessive risks if they are not personally liable for the losses of the business.

Question 18

The concept of adverse selection helps to explain

Accepted Answer

Adverse selection refers to a situation where one party to a transaction has better information than the other party, leading to an imbalance of information that can result in unfavorable outcomes. In financial markets, adverse selection can lead to problems such as moral hazard and asymmetric information, which are major concerns for regulators. Therefore, financial markets are heavily regulated to prevent adverse selection and maintain transparency for investors. None of the other options relate to adverse selection.

Question 19

Net worth can perform a similar role to

Accepted Answer

Net worth can serve as collateral for loans or investments, as it represents the value of assets minus liabilities that can be used to secure financing.

Question 20

Tools to help solve the adverse selection problem in financial markets include all of the following EXCEPT

Accepted Answer

Diversification is a strategy used to reduce risk by allocating investments among various financial instruments, industries, and other categories. It does not directly address the adverse selection problem, which involves asymmetric information between buyers and sellers. Government regulations, financial intermediaries, and the private production and sale of information all aim to reduce information asymmetry, thereby mitigating adverse selection.

Quiz 8: An Economic Analysis of Financial Structure