In Each Case Identify Whether the Situation Is a Case

question 83

Essay

In each case identify whether the situation is a case of adverse selection or moral hazard. Explain. a. Jasper knows, but the car rental company does not know when he is trying to rent a car during a blizzard in Wisconsin, that Jasper grew up in a tropical climate and has no idea how to drive in cold weather and snowy conditions.
b. Joan has received a loan from the bank to finance the purchase of more inventory for her quilt shop, but she intends to use the money (without telling the bank) to take a safari in Africa.
c. Some companies sell annuities, which are policies that make periodic payments as long as the purchaser lives. Jane is trying to buy an annuity. Jane knows, but the annuity issuers do not know, that people in Jane's family routinely live to age 100 .

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Definitions:

Interest Expense

A financial charge for borrowing money or the cost incurred on debt.

Net Income

The total profit of a company after all expenses and taxes have been subtracted from total revenue.

Financial Leverage

A difference between the rate of return on assets and the rate paid to creditors.

Common Stock

A type of security that represents ownership in a corporation, granting holders voting rights and a share in the company's profitability through dividends and/or capital appreciation.