When the borrower has an incentive to use the proceeds of a loan for a more risky venture after the loan is funded, lenders are faced with a/an
A)adverse selection problem.
B)asymmetric information problem.
C)moral hazard problem.
D)None of the above are correct.

Question

Quizplus · Accepted Answer

This is a classic case of moral hazard, where the borrower has an incentive to take more risks with the loan proceeds because they are not fully bearing the consequences of their actions. Lenders may be hesitant to provide the loan because they cannot fully trust the borrower's actions and may have to raise the interest rate to compensate for the higher perceived risk.

When the Borrower Has an Incentive to Use the Proceeds