Adverse Selection Is a Problem Associated with Equity and Debt

question 79

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% loss if the borrower defaults.
• C)the borrower's lack of incentive to seek a loan for highly risky investments.
• D)the borrower's lack of good options for obtaining funds.

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Definitions:

Consumer Surplus

The gap in the total amount consumers are willing to invest in a product or service and the amount they end up paying.

Producer Surplus

The difference between what producers are willing to accept for a good or service versus what they actually receive, measuring their benefit.

Total Surplus

The sum of consumer surplus and producer surplus, representing the total benefit to society from the production and consumption of a good or service.

Tax

A financial charge or levy imposed by a government on individuals, corporations, or transactions to fund public expenditures.