Adverse Selection

question 47

Multiple Choice

Adverse selection:

• A)relates to unobserved characteristics of people or goods and occurs before the parties have entered into an agreement.
• B)is about actions and occurs after the parties have voluntarily entered into an agreement.
• C)is always present when moral hazard arises.
• D)All of these statements are true.

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Definitions:

Call Contract

A financial contract that gives the holder the right, but not the obligation, to buy a specified amount of an underlying asset at a predetermined price within a specified time period.

Put Contract

A financial agreement that grants the holder permission, but not the requirement, to sell a certain amount of an underlying asset at a predetermined price before a certain deadline.

Call Premium

The additional cost over the par value that an investor must pay to purchase a callable security before its maturity date.

Strike Price

The predetermined price at which the holder of an option can buy (call) or sell (put) the underlying asset, until the option expires.