Question

a) Would moral hazard and adverse selection still arise in financial markets if information were not Asymmetric? Explain.
Answer:


b) The more collateral there is backing a loan, the less the lender has to worry about adverse selection. Is this statement true, false, or uncertain? Explain your answer. (1.5 marks)
Answer:

Answer 1

Answer a:

If the information regarding stocks ,shares ,market price etc is asymmetric ie one trader or person has better knowledge than the other one then it may leads to adverse situation to one of the party having less knowledge.

Suppose a financial broker or a financial investor has more knowledge in how to dealing with butterly spread or purchasing power parity and have more information and correct information about a particular stock through insider trading then he or she can easily gain fianncial advantage the the other party

Sometimes acute market failure or market imbalance in certain situations can also leads to asymmetric risk.When an asymmetric information is exploited then the adverse selection may occurs..

Answer b:

Yes,the above statement is true.

Collateral or collateral security means the security based on which the lender advance money or give credit to the borrower subject to his good credit score.The lender apart from collateral security also verify the credit repayment history if any of the borrower..Suppose a borrower has a fixed deposit or term deposit of Rs10,00,000 with a bank then any credit advance of less than Rs10,00,000 to the borrower is matter of theoritically no risks on the part of the bank.