A Moral Hazard Problem Arises When

question 24

Multiple Choice

A moral hazard problem arises when:

• A) An agent takes unobserved actions on his own behalf.
• B) A principal hires another individual to perform some service.
• C) Firms borrow money from bondholders.
• D) Stockholders have to incur costs to make managers act to maximize stock price.
• E) Managers are granted performance shares.

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Definitions:

CAPM

The Capital Asset Pricing Model is a theoretical framework that explains how the expected return on assets, especially stocks, is related to their systematic risk.

Measure of Return

A financial metric used to quantify the performance of an investment by assessing the gain or loss it generates.

Unit of Risk

A Unit of Risk quantifies the exposure to potential loss in an investment, typically measuring the volatility or variability of returns over a specified period.

Standard Deviation

A measure of the dispersion or variability of a set of values, indicating how much the values differ from the mean of the set.