The Concept of Adverse Selection Helps to Explain

question 14

Multiple Choice

The concept of adverse selection helps to explain

• A) which firms are more likely to obtain funds from banks and other financial intermediaries, rather than from the securities markets.
• B) why indirect finance is more important than direct finance as a source of business finance.
• C) why direct finance is more important than indirect finance as a source of business finance.
• D) only A and B of the above.
• E) only A and C of the above.

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Definitions:

ROE

Return On Equity represents a financial performance metric that is obtained by dividing a company's net income by its shareholders' equity, demonstrating the company's effectiveness in using investor funds to grow earnings.

EPS

Earnings Per Share, a key indicator of a company's profitability, calculated by dividing the company's net income by its total number of outstanding shares.

DFL

Degree of Financial Leverage, a ratio measuring the sensitivity of a company's earnings per share to fluctuations in its operating income, due to changes in its capital structure.

Optimal Capital Structure

The most favorable blend of debt and equity financing that minimizes a company's cost of capital while maximizing its market value.