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Chapter 2: Q.11 (page 97)

How can the adverse selection problem explain why you are more likely to make a loan to a family member than to a stranger?

Short Answer

Expert verified

The trust factor is the only variable that makes people to give loan to family rather than a stranger.

Step by step solution

01

Step 1. Introduction

Adeverse selection problem refers to the situation where the lack of proper information causes an economic agent to make a decision that otherwise would not have been made with perfect information.

02

Step 2. Explanation

In any financial transactions, both parties may not have equal level of information. This may lead to one party making a decision which is otherwise not considered rational. When makign a loan to a family member, the lender is more likely to be aware of their ability to pay back. This is not the case with a stranger. So, any lender is more likely to give out a loan to a family member.

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Most popular questions from this chapter

Go to the St. Louis Federal Reserve FRED database, and find data on the total assets of all commercial banks (TLAACBM027SBOG) and the total assets of money market mutual funds (MMMFFAQ027S). Transform the commercial bank assets series to quarterly by adjusting the Frequency setting to “Quarterly.” Calculate the percent increase in growth of assets for each series, from January 2000 to the most recent quarter available. Which of the two financial intermediaries has experienced the most percentage growth?

Suppose that Toyota sells yen-denominated bonds in Tokyo. Is this debt instrument considered a Eurobond? How would your answer change if the bond were sold in New York?

One of the single best sources of information about financial institutions is the U.S. Flow of Funds report, produced by the Federal Reserve. This document contains data on most financial intermediaries. Go to http:// www.federalreserve.gov/releases/Z1/ and find the most current release. You may have to get Acrobat Reader if your computer does not already have it; the site has a link for a free download. Go to the Level Tables and answer the following questions.

a. What percentage of assets do commercial banks hold in loans? What percentage of assets is held in mortgage loans?

b. What percentage of assets do savings and loans hold in mortgage loans?

c. What percentage of assets do credit unions hold in mortgage loans and in consumer loans?

Why would a life insurance company be concerned about the financial stability of major corporations or the health of the housing market?

A significant number of European banks held large amounts of assets as mortgage-backed securities derived from the U.S. housing market, which crashed after 2006. How does this demonstrate both a benefit and a cost to the internationalization of financial markets?
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