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

This leads to moral hazard because the bank is using borrowed funds to finance the majority of the purchase, meaning it has limited liability, and therefore may take on more risk than it would if it had used its own funds.

Suppose a Bank Purchases $100 of an Asset