1. The structure of financial markets is influenced by the problems relating to asymmetric information. For each of the market characteristics below, indicate whether the problem arises because of Adverse Selection or Moral Hazard. (1=Adverse Selection, 2=Moral Hazard) The SEC requires disclosure of annual operations to current shareholders. The most used sources of exterm funds for a company are loans, not stocks c bonds. JCPenney will find it easier to iss stock than the Charlie's Store in downtownVermillion. Loan contracts include language restricting the borrower's actions

1. The structure of financial markets is influenced by the problems relating to asymmetric information. For each of the market characteristics below, indicate whether the problem arises because of Adverse Selection or Moral Hazard. (1=Adverse Selection, 2=Moral Hazard) The SEC requires disclosure of annual operations to current shareholders. The most used sources of exterm funds for a company are loans, not stocks c bonds. JCPenney will find it easier to iss stock than the Charlie's Store in downtownVermillion. Loan contracts include language restricting the borrower's actions

Principles of Economics 2e

2nd Edition

ISBN:9781947172364

Author:Steven A. Greenlaw; David Shapiro

Publisher:Steven A. Greenlaw; David Shapiro

Chapter17: Financial Markets

Section: Chapter Questions

Problem 1SCQ: Answer these three questions about early-stage corporate finance: Why do very small companies tend...

See similar textbooks

Similar questions

Answer these three questions about early-stage corporate finance: Why do very small companies tend to raise money from private investors instead of through an IPO? Why do small, young companies often prefer an IPO to borrowing from a bank or issuing bonds? Who has better information about whether a small firm is likely to earn profits, a venture capitalist or a potential bondholder, and why?
QUESTION ONE (1) Assume that an officer of ZED Bank wants to execute a transaction with the following characteristics using the risk-adjusted return on capital (RAROC) model: ▪ Probability of default (PD) = 45 basis points ▪ Loss given default (LGD) = 50% ▪ Exposure at default (EAD) = US$ 2.0 million ▪ The risk-free rate of return is 6% This is a loan to an agricultural company and the bank’s economic capital (EC) model delivers the following charge for the firm:EC of exposure = 5% of EAD, which is US$ 100,000. Assume that the bank has set a RAROC hurdle rate of 15% and this transaction has a net profit of US$ 12,000 before other adjustments. Required: Compute the bank’s risk-adjusted rate of return on the loan to an agricultural company? Now assume that the bank could also have made a loan for the same amount and net profit of US$ 12,000 before other adjustments to a chemical manufacturing firm, and that the EC = 2.5% in this case. Which loan between the two should the bank…
5 2.Asymmetric Information. Now let’s examine the impact of asymmetric information on thecreditmarket equilibrium. Specifically, in this question we assume that Anderson is not able toobserveor enforce the project that the borrower chooses. As a result, the loan contract can onlyspecifythe interest rate (not the project). Everything else remains as in problem 1.a.What type of asymmetric information problem does Anderson face? Write a shortexplanation justifying your answer.
Suppose that in a given bond market, there is currentlyno information that can help potential bond buyers todistinguish between bonds. Which bond issuers havean incentive to disclose information about their companies? Explain why
As and example of a possible investment restriction, an insurer mah only be allowed to invest up to 20 percent of its assets in common stock. What penalty is imposed upon the insurer that invests 30 percent of available assets in common stock?A. The additional 10 percent must be disposed of by year endB. The state regulators would impose a 10 percent fine on the insurer.C. The additional 10 percent would be a nonadmitted asset.D. The additional 10 percent would only be listed at cost.
Explore the assertion regarding the state ofFinancial Markets, both globally and within the Caribbean region, evaluating whether they arecharacterized by market perfection or imperfection. Argue in favorthat markets are perfect , allowing for a comprehensive examination ofthe topic. To enhance the analysis of key points in the subject argument, it is imperative to employrelevant finance theories or concepts which either validate or refute the EMH. These concepts serveas a robust framework for understanding financial phenomena. By leveraging established concepts,one can systematically evaluate the evidence presented, thereby bolstering the argument'scredibility and depth.
B. Richard's nickname is "No-Risk Rick" because he is an extremely risk-averse individual. His utility function is given by U(W) = √W. where W represents his current wealth in dollars. He currently has $100 worth of property, but there is a 50% chance that all of it will be stolen. What is Richard's expect wealth and expected utility of wealth? An insurance company offers to reimburse Richard for his loss if the money is stolen. What is the most that Richard would pay for such a policy? Explain. Please solve this with in 1 hour
You are in the market for a used car. At a used carlot, you know that the Blue Book value of the car youare looking at is between $15,000 and $19,000. Ifyou believe the dealer knows as much about the caras you do, how much are you willing to pay? Why?Assume that you care only about the expected valueof the car you will buy and that the car values aresymmetrically distributed.23. Refer to Problem 22. Now you believe the dealerknows more about the car than you do. How muchare you willing to pay? Why? How can this asymmetric information problem be resolved in a competitivemarket?
6. Risk-averse people will choose different asset portfolios than people who are not risk averse. Over a long period of time, we would expect thatA.every risk-averse person will earn a higher rate of return than every non-risk averse person.B.every risk-averse person will earn a lower rate of return than every non-risk averse person.C.the average risk-averse person will earn a higher rate of return than the average non-risk averse person.D.the average risk-averse person will earn a lower rate of return than the average non-risk averse person. 7.The real exchange rate equals the relative A.price of domestic and foreign currency.B.price of domestic and foreign goods.C.rate of domestic and foreign interest. D.None of the above is correct. 8.According to the theory of liquidity preference, an increase in the price level causes theA.interest rate and investment to rise.B.interest rate and investment to fall.C.interest rate to rise and investment to fall.D.interest rate to fall and…
First, explain the concept of risk-return trade off. How do you define return? How do you define risk? What does the trade-off says, in you own words? show the application of the risk-return trade-off for pensions choice. Does the existence of a risk-return trade-off means that all the investors select the same type of pension? show how the selection of the adequate risk-return trade-off is dependant on the investor’s risk-aversion. Detail the influence of other objective factors such as age, economic situation and personal wealth. As you can see, understanding the risk-return trade-off is essential in finance. A popular phrase in Finance is “there is no such thing as a free lunch”. Try to explain this expression based on your new understanding of the risk-return trade off. Last, reflect on how the risk-return trade-off can be applied to your own life. Identify an area in your professional life where you can apply the risk-return trade-off approach. Then find an area in your personal…
a) You are a senior financial analyst and have been asked to examine whether the global financial crisis and the COVID-19 affect financial and non-financial firms to the same extent? For the period beginning in 2006, plot the interest rates on threemonth nonfinancial commercial paper (FRED code: CPN3M), three-month financial commercial paper (FRED code: CPF3M) and Treasury bills (FRED code: TB3MS). Compare the evolution of these interest rates. b)Market participants, including financial institutions, fund managers and corporations, must understand monetary policy setting impacts on economic activity and business cycle. A central bank will typically implement monetary policy settings in order to achieve certain economic outcomes over a business cycle. In order to forecast future economic conditions and business activity, business managers therefore need to understand the business cycle. Briefly describe the principal monetary policy objective of the Reserve Bank of Australia and give…
4. Ted Baxter runs a small, very stable newspaper company insouthern Oregon. The paper has been in business for 25 years.The total value of the firm’s capital stock is $1 million, which Tedowns outright. This year the firm earned a total of $250,000after out-of-pocket expenses. Without taking the opportunitycost of capital into account, this means that Ted is earning a25 percent return on his capital. Suppose that risk-free bondsare currently paying a rate of 10 percent to those who buy them.d. How much excess profit is Ted earning?