When One Party to a Transaction Has Incentives to Engage

question 23

Multiple Choice

When one party to a transaction has incentives to engage in activities detrimental to the other party,there exists a problem of

• A)moral hazard.
• B)split incentives.
• C)ex ante shirking.
• D)pre-contractual opportunism.

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Definitions:

Risk Premium

The extra return expected by an investor for holding a risky asset instead of a risk-free asset, serving as compensation for bearing additional risk.

Arbitrage Opportunity

An arbitrage opportunity is the chance to buy an asset at a low price in one market and sell it at a higher price in another, taking advantage of the price difference for profit.

Expected Return

The anticipated amount of returns an investment is expected to generate, calculated as a weighted average of possible returns, based on their probabilities.

Risk-free Rate

The theoretical return on an investment with zero risk, often represented by the yield on government securities like U.S. Treasury bills.