Question 1

How did information asymmetries in the home mortgage market contribute to the financial crisis of 2007-2009?

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Question 2

Provide an example of how a bank achieves lower cost in making a large loan to a company than could be achieved without the bank.

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Question 3

Explain the difference between a secured and an unsecured loan, and the interest rate you would expect to see charged on each (all other factors equal).

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Question 4

A friend who is taking her first class in investments asks you why the regulatory bodies place so much emphasis on minimizing insider information if many of the potential problems associated with financial transactions stem from information asymmetry or a lack of information.How would you respond?

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Question 5

The United States, the United Kingdom, Germany and Japan are all developed countries with highly developed and efficient financial markets.However, in all four countries the main source of business finance is internal funding.Why is this so?

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Question 6

You have a friend that has run up a pretty large balance on his credit card.He mentions to you that he has missed a few payments but doesn't think it is that big of a deal since all it cost him is a little more interest on his balance.You tell him it may end up costing him a lot more that.He presses you for an explanation.Explain to him how his handling of this debt can impact what he pays for future debt.

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Question 7

A bank advertises a very competitive loan interest rate.Explain how this strategy can avoid the problem of adverse selection.

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Question 8

Prosper.com is a San Francisco-based web site that facilitates peer-to-peer micro lending.If you were going to consider making a loan through Prosper would you be more concerned about adverse selection or moral hazard, and why?

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Question 9

Private Mortgage Insurance (PMI) is often required by mortgage lenders when the borrowers have less than a 20% down payment.Link the requirement of PMI to the concepts of net worth, moral hazard, and transfer of risk.

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Question 10

Explain how mutual funds offer small investors a low-cost way to achieve diversification.

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Question 11

Respond to the following: "If it takes a significant period of time to uncover accounting manipulations by individuals in a major corporation, honesty may be the best policy but dishonesty can be a lot more profitable!"

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Question 12

Discuss the role that companies like Standard & Poor's, Dun & Bradstreet, and Moody's play in solving the problem of adverse selection.

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Question 13

Explain how the threat of a leveraged buyout or a takeover can actually treat the problem of moral hazard.

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Question 14

It is not uncommon to read about highly successful mutual fund managers that spend considerable amounts of time visiting the companies that they have placed their clients' funds with.What might be the motive(s) behind these visits?

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Question 15

Life insurance companies usually offer a lower premium to non-smokers than the premium charged to smokers.Discuss first the potential for adverse selection and moral hazard and then ways the company can seek to reduce or eliminate these problems.

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Question 16

If diversification is such a good idea for a saver, why do so many people put a lot of their savings in the same bank?

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Question 17

Explain why deflation can be so troubling to borrowers and lenders.

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Question 18

Most credit cards charge a relatively high rate of interest, yet many people carry them, including people who would be considered low-risk borrowers.Our discussion of adverse selection said that low-risk borrowers should have been discouraged from these What gives?

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Question 19

Explain what is likely to happen to the rate of mortgage loan default given the following: "For years home values across the country have increased on average 3 to 4% percent each year.Mortgage lenders have come to expect this to always be the case and so begin to offer mortgages with little to nothing down and not requiring PMI insurance.An economic slowdown occurs hitting a few areas of the country harder than others.Home values across the country begin to decrease with some areas seeing decreases of as much as 10%."

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Question 20

If buyers cannot distinguish quality, and on average, people value a good used car at $15,000 and a "lemon" at $5,000, explain why an average price of $10,000 for used cars will not bring the average of quality used cars to the market.

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Quiz 11: The Economics of Financial Intermediation