Question : 8.6   How Moral Hazard Influences Financial Structure in Debt Markets 1) : 1373703

 

8.6   How Moral Hazard Influences Financial Structure in Debt Markets

 

1) Although debt contracts require less monitoring than equity contracts, debt contracts are still subject to ________ since borrowers have an incentive to take on more risk than the lender would like.

A) moral hazard

B) agency theory

C) diversification

D) the “lemons” problem

 

2) A debt contract is incentive compatible

A) if the borrower has the incentive to behave in the way that the lender expects and desires, since doing otherwise jeopardizes the borrower’s net worth in the business.

B) if the borrower’s net worth is sufficiently low so that the lender’s risk of moral hazard is significantly reduced.

C) if the debt contract is treated like an equity.

D) if the lender has the incentive to behave in the way that the borrower expects and desires.

 

3) High net worth helps to diminish the problem of moral hazard problem by

A) requiring the state to verify the debt contract.

B) collateralizing the debt contract.

C) making the debt contract incentive compatible.

D) giving the debt contract characteristics of equity contracts.

 

4) One way of describing the solution that high net worth provides to the moral hazard problem is to say that it

A) collateralizes the debt contract.

B) makes the debt contract incentive compatible.

C) state verifies the debt contract.

D) removes all of the risk in the debt contract.

5) A clause in a debt contract requiring that the borrower purchase insurance against loss of the asset financed with the loan is called a

A) collateral-insurance clause.

B) prescription covenant.

C) restrictive covenant.

D) proscription covenant.

 

6) Professional athletes often have contract clauses prohibiting risky activities such as skiing and motorcycle riding. These clauses are

A) limited-liability clauses.

B) risk insurance.

C) restrictive covenants.

D) illegal.

 

7) For restrictive covenants to help reduce the moral hazard problem they must be ________ by the lender.

A) monitored and enforced

B) written in all capitals

C) easily changed

D) impossible to remove

 

8) Although restrictive covenants can potentially reduce moral hazard, a problem with restrictive covenants is that

A) borrowers may find loopholes that make the covenants ineffective.

B) they are inexpensive to monitor and enforce.

C) too many resources may be devoted to monitoring and enforcing them, as debtholders duplicate others’ monitoring and enforcement efforts.

D) they reduce the value of the debt contract.

 

9) Solutions to the moral hazard problem include

A) low net worth.

B) monitoring and enforcement of restrictive covenants.

C) greater reliance on equity contracts and less on debt contracts.

D) greater reliance on debt contracts than financial intermediaries.

10) A key finding of the economic analysis of financial structure is that

A) the existence of the free-rider problem for traded securities helps to explain why banks play a predominant role in financing the activities of businesses.

B) while free-rider problems limit the extent to which securities markets finance some business activities, nevertheless the majority of funds going to businesses are channeled through securities markets.

C) given the great extent to which securities markets are regulated, free-rider problems are not of significant economic consequence in these markets.

D) economists do not have a very good explanation for why securities markets are so heavily regulated.

 

 

11) One reason financial systems in developing and transition countries are underdeveloped is

A) they have weak links to their governments.

B) they make loans only to nonprofit entities.

C) the legal system may be poor making it difficult to enforce restrictive covenants.

D) the accounting standards are too stringent for the banks to meet.

 

12) One reason China has been able to grow so rapidly even though its financial development is still in its early stages is

A) the high savings rate of around 40%.

B) the shift of labor to the agricultural sector.

C) the stringent enforcement of financial contracts.

D) the ease of obtaining high-quality information about creditors.

 

13) Why does the free-rider problem occur in the debt market?