Question

Identify whether each of the following events poses an adverse selection problem or a moral hazard problem in financial markets.

a. A manager of a savings and loan association responds to reports of a likely increase in federal deposit insurance coverage. She directs loan officers to extend mortgage loans to less creditworthy borrowers.

b. A loan applicant does not mention that a legal judgment in his divorce case will require him to make alimony payments to his ex-wife.

c. An individual who was recently approved for a loan to start a new business decides to use some of the funds to take a Hawaiian vacation.

Short answer

a. A probability that its borrowing would employ their resources in some kind of a dangerous method.

b. The granting substantial divorce proceedings toward the disabled would making servicing of the mortgage particularly challenging.

c. The objective to just get finances modified once he was released. Thus, increases risk after borrowing.

Step-by-step solution

High-risk projects

• Any modification in either a customers preferences concerning debt repayment amount for any business will obviously have a moral hazard impact on the fiat currency.
• Here, as you recognize that an adverse selection is that the tendency for high-risk projects and clients to be overrepresented among borrowers.
• In addition, moral hazards defined because the possibility that a borrower might engage in riskier behavior after a loan has been obtained.

Hazard problem (a)

a) In regard to the proposition, an undesirable selection condition has recently been introduced. this is often because, though choice is created among creditworthy borrowers. Additionally, the lender really does have the capacity to bungle the wealth.

High risk (b)

b. Given the statement identified as an adverse selection problem.this can be because; this involves borrowing funds for projects with a high risk of failure. Moreover, making alimony payments to his ex-wife would make the repayment of loan difficult.

Borrowing funds (c)

c. Given the statement identified asan ethical hazard problem.this can be why because; the intention for borrowing funds has changed after the approval. Thus, increases risk after borrowing.