Adverse Selection Is a Problem Associated with Equity and Debt

question 29

Multiple Choice

Adverse selection is a problem associated with equity and debt contracts arising from ________.

• A) the lender's relative lack of information about the borrower's potential returns and risks of his investment activities
• B) the lender's inability to legally require sufficient collateral to cover a 100 percent loss if the borrower defaults
• C) the borrower's lack of incentive to seek a loan for highly risky investments
• D) the lender's inability to restrict the borrower from changing his behavior once given a loan

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Definitions:

Accumulated Depreciation

The total amount of depreciation expense that has been recorded against a fixed asset since it was put into use.

Investing Activities

Part of a company's cash flow statement that reports the purchase and sale of long-term investments and property, plant, and equipment.

Gain

Gain refers to an increase in economic benefits or inflow of assets that result in an increase in equity, not related to contributions from equity participants.

Office Equipment

Assets like computers, desks, and chairs used in an office to carry out operations, not immediately consumed in the production process.