The problem of adverse selection helps to explain
A)why firms are more likely to obtain funds from banks and other financial intermediaries,rather than from securities markets.
B)why collateral is an important feature of consumer,but not business,debt contracts.
C)why direct finance is more important than indirect finance as a source of business finance.
D)why lenders refuse loans to individuals with high net worth.

Question

Quizplus · Accepted Answer

Adverse selection is a situation where borrowers with high-risk profiles are more likely to seek loans than those with low-risk profiles. This can lead to lenders offering only high-interest rates to compensate for the risk. Financial intermediaries can mitigate this problem by gathering and analyzing information on potential borrowers, which helps to reduce adverse selection. Therefore, firms are more likely to obtain funds from banks and other financial intermediaries rather than from securities markets.

The Problem of Adverse Selection Helps to Explain