Question 1

The price for private information is likely higher than it should be due to the problem of:

Accepted Answer

The answer of The price for private information is likely...

Question 2

The scandals involving Enron, World Com, Global Crossing and other large firms:

Accepted Answer

The scandals involving Enron, World Com, Global Crossing and other large firms are examples of asymmetric information where the firms had access to more information than the public, leading to a less well functioning stock market. This has led to a call for increased transparency and regulation in financial reporting.

Question 3

The principal-agent problem is:

Accepted Answer

The principal-agent problem is a form of moral hazard, where the principal (such as a shareholder or owner) hires an agent (such as a manager) to act on their behalf, but the agent may not act in the best interest of the principal due to their own incentives or interests. This can lead to a divergence of goals and potential conflicts between the principal and agent. Adverse selection refers to the process of asymmetric information before the contract is made, while the principal-agent problem occurs after the contract is made. Stockholders not acting in the best interest of managers would be the opposite scenario, where the agents (managers) are not acting in the best interest of the principal (stockholders). Managers may be able to monitor stockholder behavior, but this is not the main cause of the principal-agent problem.

Question 4

Requiring a large net worth on the part of an applicant is one way lenders treat the problem of:

Accepted Answer

The answer of Requiring a large net worth on the...

Question 5

Deflation compounds information problems because it:

Accepted Answer

Deflation increases the real value of money over time, which means the real value of liabilities remains constant or increases as the nominal value of assets decreases. This can make debts more burdensome to repay, as the purchasing power of the money used to repay the debt increases.

Question 6

Moody's, Value Line, and Dun and Bradstreet are examples of companies that:

Accepted Answer

Moody's, Value Line, and Dun and Bradstreet are all companies that provide financial information services to investors for a fee. They do not provide information for free, nor do they rely on advertising from companies being rated to recoup expenses. While some of the information they provide may be available elsewhere for free, they offer analysis and insights that may not be available elsewhere.

Question 7

Private mortgage insurance is usually required in situations where:

Accepted Answer

Private mortgage insurance (PMI) is typically required when the homebuyer has a down payment that is less than 20 percent of the purchase price. This insurance protects the lender in case the borrower defaults on the loan. It is not related to the buyer's income or if they have overpaid for the house.

Question 8

Requiring a home buyer to have a large down payment reduces the risk to a mortgage lender because:

Accepted Answer

Requiring a large down payment means that the buyer has more equity in the property, which reduces the risk for the lender. If the price of the house falls, the owner will suffer the loss rather than the lender.

Question 9

Which of the following statements is true?

Accepted Answer

Unsecured loans are loans that are not backed by collateral such as a home or car. Lenders face a higher risk of default on unsecured loans because they have no collateral to seize if the borrower defaults. This risk is compounded by adverse selection, which is the tendency for borrowers who are more likely to default to apply for and receive unsecured loans. To compensate for this risk, lenders charge higher interest rates on unsecured loans. The free-rider problem, which occurs when borrowers take out loans with no intention of repaying them, may also contribute to higher interest rates but is not the primary reason. Option C is false because unsecured loans are still widely used, especially for personal or business loans. Option D is also false because lenders do not only make unsecured loans to individuals with very high net worth.

Question 10

A home mortgage is a good example of:

Accepted Answer

A home mortgage is a secured loan, as the borrower uses their home as collateral to secure the loan. This means that if the borrower defaults on the loan, the lender can seize the home to recoup their losses.

Question 11

The principal-agent problem is quite common in large public corporations due to:

Accepted Answer

The principal-agent problem occurs when the individuals making decisions, the agents, may not act in the best interest of the owners, the principals. In large public corporations, the owners are often dispersed among many shareholders, while the agents making operational decisions are upper management. This separation of ownership and management can create conflicts of interest and information asymmetry leading to the principal-agent problem. The other options, such as large sales volumes or employment rates, do not directly relate to this issue. Regulation by the government may help mitigate the problem, but it is not the cause of it.

Question 12

The fact that many companies employ supervisors to oversee the actions of workers is a way to treat:

Accepted Answer

Employing supervisors to oversee workers is a way to mitigate moral hazard, which is the risk that a worker will act in their own self-interest and not in the best interest of the company. By having a supervisor oversee their actions, workers are less likely to engage in such behavior. Adverse selection refers to the problem of attracting low-quality workers to a job, the law of diminishing returns is a concept related to productivity, and the free-rider problem is the risk that some workers will benefit from the efforts of others without contributing themselves.

Question 13

Which of the following could the lemons problem, applied to financial markets, explain?

Accepted Answer

The answer of Which of the following could the lemons...

Question 14

Requiring that borrowers put up collateral to obtain a loan is a tool designed to treat:

Accepted Answer

Collateral is used to mitigate the problem of moral hazard by ensuring that borrowers have a financial stake in repaying the loan, thus aligning their incentives with those of the lender.

Question 15

Credit may dry up at the start of an economic downturn because of all of the following except:

Accepted Answer

The other options all relate to the increased uncertainty and risk associated with lending during an economic downturn, but the free-rider problem (when people benefit from a public good or service without contributing to its production) is not directly related to credit availability.

Question 16

An unsecured loan is:

Accepted Answer

An unsecured loan is a type of loan where the borrower does not have to provide any collateral or security for the loan. This means that the lender relies solely on the borrower's creditworthiness and ability to repay the loan, which makes it a higher-risk loan for the lender. However, the borrower does not have to risk any of their assets as collateral, making it a good option for those who may not have any assets to use as security.

Question 17

A borrower who obtains funds from a lender to purchase additional inventory but uses the funds to finance a trip to Las Vegas for a weekend of gambling at the opening of a new casino is an example of:

Accepted Answer

This situation is an example of moral hazard because the borrower used the funds for a purpose other than the intended use, taking advantage of the lender's trust. The borrower may be incentivized to take risks or engage in irresponsible behavior knowing that the lender will bear the financial consequences.

Question 18

Which of the following statements is not true?

Accepted Answer

Credit card loans are unsecured loans, meaning they are not backed by collateral. The lender relies on the borrower's creditworthiness to determine whether or not to grant the loan.

Question 19

A bank usually treats the moral hazard problem by using all of the following, except:

Accepted Answer

Not making loans is not a practical solution for a bank, as it would prevent the bank from making a profit. Therefore, banks typically use other methods such as requiring collateral, down payments, and restrictive covenants to manage the risk of moral hazard.

Question 20

Tom borrows $100,000 from his local bank to purchase inventory for his store for the upcoming holiday season.Tom's neighbor tells him about a get-rich-quick scheme that can take this $100,000 and triple it in a month.Tom decides to buy into this scheme figuring he can repay the bank and still have plenty left for inventory.This is an example of:

Accepted Answer

Tom taking on additional risk of investing in a get-rich-quick scheme after borrowing a large amount from the bank shows moral hazard, as he may be more willing to take risks now that he has borrowed the money rather than if it was his own personal funds at stake. This behavior can be detrimental to the bank's interests as it increases the likelihood of default.

Quiz 11: The Economics of Financial Intermediation