The purpose of collateral and restrictive covenants is to reduce ________ in debt contracts.
A) adverse selection
B) transactions costs
C) moral hazard
D) loan amounts

Question

Quizplus · Accepted Answer

Collateral and restrictive covenants are designed to reduce moral hazard in debt contracts. Moral hazard refers to the risk that a borrower will take actions that benefit themselves but harm the lender, such as taking on too much risk or failing to repay the loan. Collateral provides the lender with a form of security that can be seized if the borrower defaults, while restrictive covenants limit the borrower's ability to take certain actions that could increase their risk of default. Together, these mechanisms help to reduce the risk of moral hazard and protect the lender's interests. Adverse selection, transactions costs, and loan amounts are not directly addressed by collateral and restrictive covenants.

The Purpose of Collateral and Restrictive Covenants Is to Reduce