Question

36. For a mortgage lender that makes mortgage loans to borrowers, which one of the following would be an example of adverse selection?

a) After the loan has been made, individuals become careless with their finances

b) Individuals most likely to default are the ones most likely to apply for the loan

c) Borrowers investing their loan proceeds differently than the bank requires

d) None of these

38. Information gathering for a moral hazard problem happens

a.) Before the agent is hired

b.) After the agent is hired

c.) After the agent is fired

d.) None of these

39. The ways to address agency costs include

a.) Gathering information about the agent's characteristics before hiring

b.) Gathering information about the agent's actions once hired

c.) Incentivizing agents to work on behalf of principals

d.) All of these

Answer 1

a) After the loan has been made, individuals become careless with their finances

Since the bank made the loan based on assuming a certain level of fiduciary responsiblity on behalf of the loanee and them not living upto it makes it an example of adverse selection

b) After the agent is hired

A principal-agent problem arises when there is a conflict of interest between the agent and the principal, whi legally appoints the agent to make decisions and take actions on its behalf. Therefore close monitoring and information gathering is required.

d.) All of these

Gathering information before hiring allows the agency to male better informed decisions.

Gathering the information after the hiring ensures that the agent does not slack off.

Incentivizing agents better creates an effective system for solving the principal agent problem by making the agent likelier to act on behalf of the principal.