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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?

Short Answer

Expert verified

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.

Step by step solution

01

Step 1. Introduction

Moral hazard can also refer to a party's desire to take extraordinary risks in order to profit before the contract's expiration date. When two parties form an agreement with one another, moral risks can occur at any time. Each contracting party may have a vested interest in acting contrary to the agreement's principles.

02

Step 2. Explanation

In case when there is no asymmetric information between lender and borrower but the risk of moral hazard continues because, there can be some conditions under which a borrower will become insufficient in repaying debt. Thus, it will be good if we prevent borrower to lend money.

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Most popular questions from this chapter

Assume that a carpenter borrowed \(2,000 to be paid off in a year to finance a machine that would make him work faster. As a result, she is able to take on more projects and collect \)400 more earnings in the first year, after paying off the principal of $2,000. However, there is a 15% rental fee (interest) on her loan, which she also has to pay off. What is the carpenter鈥檚 net earnings for the first y

Why do loan sharks worry less about moral hazard in connection with their borrowers than some other lenders do?

鈥淚n a world without information costs and transaction costs, financial intermediaries would not exist.鈥� Is this statement true, false, or uncertain? Explain your answer.

One of the single best sources of information about financial institutions is the U.S. Flow of Funds report, produced by the Federal Reserve. This document contains data on most financial intermediaries. Go to http:// www.federalreserve.gov/releases/Z1/ and find the most current release. You may have to get Acrobat Reader if your computer does not already have it; the site has a link for a free download. Go to the Level Tables and answer the following questions.

a. What percentage of assets do commercial banks hold in loans? What percentage of assets is held in mortgage loans?

b. What percentage of assets do savings and loans hold in mortgage loans?

c. What percentage of assets do credit unions hold in mortgage loans and in consumer loans?

Suppose a few investors are looking for an investment opportunity that will yield high returns. They are willing to invest in private securities instead of government bonds. However, their analyst found that currently most companies listed on the market and are actively trading in securities are in trouble, which would make them risky investments. What can you conclude from this situation? How would you advise the investors?
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