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Chapter 2: Q.15 (page 97)
If there were no asymmetry in the information that a borrower and a lender had, could a moral hazard problem still exist?
Yes, since even if you are aware that a borrower is putting the loan in jeopardy, you must intervene to prevent the borrower from doing so.
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Suppose you have just inherited \(10,400 and are considering the following options for investing the money to maximize your return:
Option 1: Put the money in an interest-bearing checking account that earns 3%. The FDIC insures the account against bank failure.
Option 2: Invest the money in a corporate bond with a stated return of 6%, although there is a 10% chance the company could go bankrupt.
Option 3: Loan the money to one of your friend鈥檚 roommates, Ayesha, at an agreed-upon interest rate of 7%, but you believe there is a 7% chance that she will leave town without repaying you.
Option 4: Hold the money in cash and earn zero return.
a. If you are risk-neutral (that is, neither seek out nor shy away from risk), which of the four options should you choose to maximize your expected return? (Hint: To calculate the expected return of an outcome, multiply the probability that an event will occur by the outcome of that event and then add them up.)
b. Assume that Option 3 and Option 4 are your only choices. If you could pay your friend \)50 to find out extra information about Ayesha that would indicate with certainty whether she will leave town without paying, would you pay the $50? What does this say about the value of better information regarding risk?
Go to the St. Louis Federal Reserve FRED database, and find data on federal debt held by the Federal Reserve (FDHBFRBN), by private investors (FDHBPIN), and by international and foreign investors (FDHBFIN). Using these series, calculate the total amount held and the percentage held in each of the three categories for the most recent quarter available. Repeat for the first quarter of 2000, and compare the results.
If you suspect that a company will go bankrupt next year, which would you rather hold, bonds issued by the company or equities issued by the company? Why?
Suppose that Toyota sells yen-denominated bonds in Tokyo. Is this debt instrument considered a Eurobond? How would your answer change if the bond were sold in New York?
A significant number of European banks held large amounts of assets as mortgage-backed securities derived from the U.S. housing market, which crashed after 2006. How does this demonstrate both a benefit and a cost to the internationalization of financial markets?
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