Suppose a bank purchases $100 of an asset.To finance this purchase it uses $99 dollars of borrowed funds and $1 of bank capital.To what does this lead?
A)moral hazard
B)adverse selection
C)Ricardian equivalence
D)the Butterfly effect
E)irrational exuberance

Question

Quizplus · Accepted Answer

The situation described leads to moral hazard because the bank is highly leveraged, using mostly borrowed funds. This creates an incentive for the bank to take on excessive risk, knowing that losses will primarily affect the lenders rather than the bank's own capital.

Suppose a Bank Purchases $100 of an Asset