The problem of adverse selection helps to explain ________.
A) which firms are more likely to obtain funds from banks and other financial intermediaries, rather than from securities markets
B) why direct finance is more important than indirect finance as a source of business finance
C) why collateral is not an important feature of debt contracts
D) why banks prefer to make loans unsecured

Question

Quizplus · Accepted Answer

Adverse selection refers to the problem of high-risk borrowers being more likely to seek out loans, which can make it difficult for lenders to determine the creditworthiness of potential borrowers. This makes it more likely that firms with poor credit histories will seek out funds from banks and other financial intermediaries rather than from securities markets, as intermediaries have more expertise and resources to evaluate borrowers' creditworthiness.

The Problem of Adverse Selection Helps to Explain ________