Question

Describe Information Asymmetry, Adverse Selectin, and Moral Hazard as they relate to Financial Institutions.

Answer 1

Asymmetric information means a party has more information about particular transaction than the other party . The problems that arise are moral hazard or adverse selection. That means wrong selection by on party or loss for only one party.
When a retail investor invests through the help of a financial advisor or specialist they might face asymmetric information. The retail investor's goal might not match with the financial advisor. Hence, due to information asymmetry the retail investor might stand to lose due to self-interest of the financial advisor.
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Adverse selection is the wrong selection or potential losses faced due to decision taken for lack of information. Thus the business becomes less profitable.
Example: The buyer of car has less information about performance or quality of car than a seller of car. The buyer might buy an accidental car at a higher price due to lack of information leading to adverse selection.


Moral hazard   means risk for one  party or loss for only one party even though there has been an exchange by two parties. It occurs due to asymmetric information which means a party has more information about particular transaction than the other party. Ex A company get loans by manipulating its balance sheet and other financial statements and hence transferring all risks to banks.