Which of the following situations is similar to the externality effect?
A)Exercising an adverse material change in conditions clause as a last resort, thereby cancelling or repricing a loan commitment.
B)Increase in the cost of funds above normal levels while many FIs scramble for funds to meet their commitments to customers during a credit crunch.
C)In a loan commitment, the borrower takes down only part of the funds over the specified time period.
D)The buyer of a commercial letter of credit fails to perform as promised under a contractual obligation.

Question

Quizplus · Accepted Answer

The externality effect occurs when the actions of individuals or firms have an impact on third parties that is not reflected in market prices. Choice B, which describes a situation where the cost of funds increases for many financial institutions (FIs) as they scramble for funds to meet their commitments during a credit crunch, is similar to an externality. This is because the actions of some institutions in aggressively seeking funds can drive up the cost for others, impacting them without a direct transaction between the parties.

Which of the Following Situations Is Similar to the Externality