Question

1. The two ways financial intermediaries can reduce transactions costs are ________ and ________.

a) economies of scale; expertise

b) moral hazard; adverse selection

c) direct finance; indirect finance

d) stocks; bonds

2. If bad credit risks are the ones who most actively seek loans, then financial intermediaries face the problem of ________.

a) moral hazard

b) adverse selection

c) free-riding

d) costly state verification

3. An example of the ________ problem would be if Brian borrowed money from Sean in order to purchase a used car and instead took a trip to Atlantic City using those funds.

a) adverse selection

b) costly state verification

c) agency

d) moral hazard

4. The solution to the adverse selection problem in financial markets is to ________.

a) supply borrowers with full details on the lenders

b) supply governmental agencies with financial information

c) supply lenders with full details on the borrowers

d) produce more free riders

5. Analysis of adverse selection indicates that financial intermediaries, especially banks, ________.

a) have advantages in overcoming the free-rider problem, helping to explain why indirect finance is a more important source of business finance than is direct finance

b) despite their success in overcoming free-rider problems, nevertheless play a minor role in moving funds to corporations

c) provide better-known and larger corporations a higher percentage of their external funds than they do to newer and smaller corporations which rely to a greater extent on the new issues market for funds

d) must buy securities from corporations to diversify the risk that results from holding non-tradable loans

Answer 1

1. The two ways financial intermediaries can reduce transactions costs are economies of scale and expertise

2.If bad credit risks are the ones who most actively seek loans, then financial intermediaries face the problem of Adverse selection

3. An example of the Moral hazard problem would be if Brian borrowed money from Sean in order to purchase a used car and instead took a trip to Atlantic City using those funds.

4.  The solution to the adverse selection problem in financial markets is to supply lenders with full details on the borrowers

5. Analysis of adverse selection indicates that financial intermediaries, especially banks, have advantages in overcoming the free-rider problem, helping to explain why indirect finance is a more important source of business finance than is direct finance