Faculty of Foreign Languages – Department of Business English Banking & Finance

Full Name: ..................................... Class: .................................. Student Code: .............................

Mark:

TEST 2

 TOPIC 2: ROLES OF FINANCIAL INTERMEDIARIES

SECTION 1 - Match the terms with the explanations

Terms Explanations
1 Financial intermediaries A The problem occurs when people do not pay for
information that others have to pay for.
2 Differences in preferences B A moral hazard problem that occurs when the
of lenders and borrowers managers in control act in their own interest rather
than in the interest of the owners due to differing
set of incentives.
3 Asset transformation C The inequality of knowledge that each party to a
transaction has about the other party.
4 Transaction costs D The time and money spent trying to exchange
financial assets, goods, or services.
5 Asymmetric information E Institutions that borrow funds from people who
have saved and then make loans to others

6 Adverse selection F The risk that one party to a transaction will engage
in behavior that is undesirable from the other
party’s point of view.
7 Moral hazard G Savings that can be achieved through increased
size.
8 Free-rider problem H The conflicting requirements of lenders (needs for a
high degree of liquidity in their asset holdings) and
borrowers (needs for permanent or long-term
capital).
9 Principle-agent problem I The problem created by asymmetric information
before a transaction occurs: the people who are the
most undesirable from the other party’s point of
view are the ones who are most likely to want to
engage in the financial transaction.
10 Economies of scale K The process by which the financial intermediaries
turn risky assets into sales assets for investors.
11 Economies of scope L Increased business that cab e achieved by offering
many products in one easy-to-reach location.
Faculty of Foreign Languages – Department of Business English Banking & Finance

SECTION 2 – Match the solutions with their problems. Some solutions are used more than
once.

Differences in Transaction Liquidity needs Asymmetric information

preferences of costs Adverse Moral hazard
lenders and selection Equity Debt
borrowers
markets markets

1. Screening loan applications 2. Economies of scale

3. Liquidity insurance 4. Diversifying risk
5. Debt contracts 6. Private production and sale of information
7. Expertise 8. Financial intermediaries
9. Economies of scope 10. Monitoring and enforcement of restrictive covenants
11. Government regulation 12. Pooling risks
13. Monitoring 14. Making debt contracts incentive-compatible

SECTION 3 – Choose the best answers for the questions below

Task 1:

1. The presence of transaction costs in financial markets explains, in part, why

(a) financial intermediaries and indirect finance play such an important role in financial markets.
(b) equity and bond financing play such an important role in financial markets.
(c)corporations get more funds through equity financing than they get from financial
intermediaries.
(d) direct financing is more important than indirect financing as a source of funds.

2. Financial intermediaries can substantially reduce transaction costs per dollar of

transactions because their large size allows them to take advantage of
(a) poorly informed consumers.
(b) standardization.
(c) economies of scale.
(d) their market power.
Faculty of Foreign Languages – Department of Business English Banking & Finance

3. Through risk-sharing activities, a financial intermediary _________ its own risk and
_________ the risks of its customers.
(a) reduces; increases
(b) increases; reduces
(c) reduces; reduces
(d) increases; increases

4. The presence of _________ in financial markets leads to adverse selection and moral
hazard problems that interfere with the efficient functioning of financial markets.
(a) noncollateralized risk
(b) free-riding
(c) asymmetric information
(d) costly state verification

5. When the lender and the borrower have different amounts of information regarding a
transaction, _________ is said to exist.
(a) asymmetric information
(b) adverse selection
(c) moral hazard
(d) fraud

6. When the potential borrowers who are the most likely to default are the ones most
actively seeking a loan, _________ is said to exist.
(a) asymmetric information
(b) adverse selection
(c) moral hazard
(d) fraud

7. When the borrower engages in activities that make it less likely that the loan will be
repaid, _________ is said to exist.
(a) asymmetric information
(b) adverse selection
(c) moral hazard
(d) fraud

8. 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.
Faculty of Foreign Languages – Department of Business English Banking & Finance

9. Adverse selection is a problem associated with equity and debt contracts arising from
(a) the lender’s relative lack of information about the borrower’s potential returns and risks of his
investment activities.
(b) the lender’s inability to legally require sufficient collateral to cover a 100 percent loss if the
borrower defaults.
(c) the borrower’s lack of incentive to seek a loan for highly risky investments.
(d) none of the above.

10. When the least desirable credit risks are the ones most likely to seek loans, lenders are
subject to the
(a) moral hazard problem.
(b) adverse selection problem.
(c) shirking problem.
(d) free-rider problem.
(e) principal-agent problem.

11. Financial institutions expect that

(a) moral hazard will occur, as the least desirable credit risks will be the ones most likely to seek
out loans.
(b) opportunistic behavior will occur, as the least desirable credit risks will be the ones most
likely to seek out loans.
(c) borrowers will commit moral hazard by taking on too much risk, and this is what drives
financial institutions to take steps to limit moral hazard.
(d) none of the above will occur.

12. Successful financial intermediaries have higher earnings on their investments because
they are better equipped than individuals to screen out good from bad risks, thereby
reducing losses due to
(a) moral hazard.
(b) adverse selection.
(c) bad luck.
(d) financial panics.

13. In financial markets, lenders typically have inferior information about potential returns
and risks associated with any investment project. This difference in information is called
(a) comparative informational disadvantage.
(b) asymmetric information.
(c) variant information.
(d) caveat venditor.

Task 2:
2.1. Read Chapter 7 in the textbook and circle the best option A, B, C or D.
1. What primary role do financial institutions play in the economy?
Faculty of Foreign Languages – Department of Business English Banking & Finance

A. Increase transaction costs

B. Facilitate indirect finance
C. Reduce information asymmetry
D. Both B and C
2. Which of the following best describes the concept of "adverse selection"?
A. Investors making decisions based on incomplete information
B. The risk that borrowers will engage in risky behavior after obtaining a loan
C. The phenomenon where high-risk borrowers are more likely to seek loans
D. None of the above
3. How do financial intermediaries primarily reduce transaction costs?64
A. By providing direct loans
B. By pooling resources and providing standardized products
C. By increasing regulatory oversight
D. By limiting the number of transactions
4. What is the "lemons problem" in the context of financial markets?
A. The inability to assess the quality of collateral
B. The challenge in distinguishing between high-quality and low-quality assets
C. The phenomenon of rising interest rates
D. None of the above
5. Which of the following is a direct consequence of moral hazard?
A. Increased risk-taking behavior by borrowers
B. Decreased lending to high-risk individuals
C. More stringent credit assessments
D. Increased transparency in financial reporting
6. What mechanism do financial institutions use to mitigate the impact of adverse
selection?
A. High interest rates
B. Diversification of loan portfolios
C. Rigorous screening processes
D. Government intervention
7. Why is it important for financial institutions to manage conflicts of interest?
A. To maximize profits for shareholders
B. To maintain trust and integrity in the financial system
C. To comply with regulatory requirements
D. Both B and C
8. Which of the following statements about the structure of financial institutions is true?
A. All financial institutions operate under the same regulatory framework.
B. Financial institutions have no impact on economic growth.
C. The structure of financial institutions can evolve due to financial innovation.65
D. Financial institutions are only concerned with traditional banking services.
9. What is the primary function of depository institutions?
A. Provide credit ratings
B. Accept deposits and provide loans
Faculty of Foreign Languages – Department of Business English Banking & Finance

C. Trade securities
D. Issue insurance policies
10. Which type of financial intermediary primarily focuses on risk pooling?
A. Investment banks
B. Commercial banks
C. Insurance companies
D. Hedge funds
11. How does financial regulation help mitigate moral hazard?
A. By reducing interest rates
B. Through transparency and accountability measures
C. By promoting competition among institutions
D. None of the above
12. What is one potential drawback of government deposit insurance?
A. It reduces the risk of bank runs.
B. It may encourage excessive risk-taking by banks.
C. It increases public confidence in financial institutions.
D. It ensures all deposits are fully backed.
13. What role do investment banks play in the financial system?
A. They primarily focus on retail banking.
B. They facilitate capital raising and mergers and acquisitions.
C. They provide savings accounts to consumers.
D. They only manage wealth for high-net-worth individuals.
14. Which of the following is true regarding the relationship between financial
institutions and economic growth?
A. Financial institutions have no significant impact on economic growth.66
B. Strong financial institutions can enhance economic stability and growth.
C. Economic growth leads to the decline of financial institutions.
D. Financial institutions solely focus on profit maximization.
15. What is the primary purpose of capital requirements for financial institutions?
A. To increase profitability
B. To ensure institutions have sufficient capital to cover risks
C. To limit the number of loans issued
D. To enhance competition in the market
16. Which factor is most likely to influence the demand for financial services?
A. Changes in interest rates
B. Regulations imposed by the government
C. Economic cycles
D. All the above
17. What is the significance of the principal-agent problem in finance?
A. It promotes better financial decisions.
B. It leads to conflicts of interest between stakeholders.
C. It ensures strict compliance with regulations.
D. None of the above
Faculty of Foreign Languages – Department of Business English Banking & Finance

18. How do financial institutions contribute to risk management for individuals and
businesses?
A. By providing loans without collateral
B. Through diversification of financial products
C. By increasing the costs of borrowing
D. By reducing regulatory oversight
19. What is one of the primary reasons for the existence of shadow banking systems?
A. To increase transparency in the financial system
B. To bypass traditional banking regulations
C. To reduce costs associated with financial intermediation
D. None of the above67
20. Which of the following best describes the relationship between financial innovation
and financial institutions?
A. Financial innovation leads to the obsolescence of financial institutions.
B. Financial institutions are the primary drivers of financial innovation.
C. Financial innovation has no impact on the structure of financial institutions.
D. Financial institutions must adapt to remain relevant amidst financial
innovation.

2.2. Read Chapter 8 and circle the best option A, B, C or D.

1. Which of the following best describes the relationship between asymmetric
information and financial crises?
A. Asymmetric information leads to better decision-making by investors.
B. Asymmetric information reduces the likelihood of financial crises.
C. Asymmetric information can lead to adverse selection and moral hazard,
contributing to financial crises.
D. Asymmetric information has no impact on financial stability.
2. In the context of agency theory, which stage of a financial crisis involves the
deterioration of asset values due to poor management decisions?
A. Initiation
B. Banking crisis
C. Debt deflation
D. Recovery
3. What is the primary reason that financial crises tend to escalate quickly?
A. Increased regulatory oversight
B. The interconnectedness of financial institutions
C. High liquidity in the market
D. Consumer confidence in the economy68
4. During the initiation phase of a financial crisis, which factor is most likely to trigger
panic among investors?
A. Strong economic indicators
B. Sudden drops in asset prices
C. Government intervention
Faculty of Foreign Languages – Department of Business English Banking & Finance

D. Low-interest rates
5. Which of the following is NOT a typical characteristic of financial crises?
A. Rapid decline in asset prices
B. Widespread bank failures
C. Increased consumer spending
D. Severe economic recession
6. The "leverage cycle" refers to:
A. The increasing risk of leveraging during economic downturns.
B.The tendency for financial institutions to increase leverage in booming periods
and reduce it during downturns.
C. The stabilization of asset prices through leverage.
D. The reduction in regulatory requirements for leveraged firms.
7. Which economic event is often cited as a classic example of a financial crisis due to
excessive risk-taking in the housing market?
A. The Great Depression
B. The dot-com bubble
C. The 2007-2009 financial crisis
D. The Asian Financial Crisis
8. What role do credit rating agencies play in the occurrence of financial crises?
A. They provide accurate assessments of risk.
B. They can contribute to crises by misrating financial products, leading to
excessive risk-taking.
C. They have no impact on financial markets.
D. They help stabilize the financial system through oversight.69
9. The term "debt deflation" refers to:
A. The decrease in the overall level of debt in an economy.
B. The decline in prices leading to increased real debt burdens.
C. The deflationary policies implemented by central banks.
D. The process of reducing government debt.
10. Moral hazard is most likely to occur when:
A. Borrowers have no stake in the outcome of their investments.
B. Lenders conduct thorough due diligence.
C. Markets are perfectly competitive.
D. Information is perfectly distributed among all parties.
11. Which of the following is a primary tool used by central banks to mitigate the effects
of a financial crisis?
A. Increasing interest rates
B. Providing liquidity to financial institutions
C. Reducing government spending
D. Imposing stricter regulations on lending
12. Which of the following can exacerbate a financial crisis once it has begun?
A. Enhanced transparency in financial markets
B. A sudden increase in consumer confidence
Faculty of Foreign Languages – Department of Business English Banking & Finance

C. A feedback loop of declining asset prices and tightening credit conditions

D. Government fiscal stimulus
13. The concept of "too big to fail" refers to:70
A. The idea that all financial institutions are equally important.
B. The belief that some institutions are so large that their failure would be
catastrophic for the economy.
C. The notion that all financial crises can be avoided through regulation.
D. The principle that government intervention is unnecessary in the financial
sector.
14. Which of the following best describes the impact of financial crises on economic
inequality?
A. Financial crises tend to reduce economic inequality.
B. Financial crises have no effect on economic inequality.
C. Financial crises typically exacerbate economic inequality.
D. Financial crises promote equitable wealth distribution.
15. What is the significance of the "financial accelerator" in the context of financial
crises?
A. It stabilizes the economy during downturns.
B. It amplifies the effects of economic shocks through the interaction of credit
and asset prices.
C. It minimizes the impact of leverage on financial institutions.
D. It ensures that all financial institutions follow the same lending practices.
16. Which of the following statements about the 2007-2009 financial crisis is true?
A. It was primarily caused by government overregulation of the mortgage
market.
B. It stemmed from a lack of risk management practices among financial
institutions.71
C. It had minimal impact on global financial markets.
D. It was solely due to international economic conditions.
17. Which factor is most likely to lead to the "contagion" effect during a financial crisis?
A. Isolated financial failures
B. The interconnectedness of global financial markets
C. Increased consumer savings
D. Strong regulatory frameworks
18. What does the term "financial liberalization" imply in the context of financial crises?
A. The imposition of stricter regulations on financial institutions.
B. The removal of restrictions on financial markets, which can lead to increased
risk-taking.
C. The stabilization of financial markets through government intervention.
D. The consolidation of financial institutions to reduce risk.
19. The impact of financial crises on economic output can be best characterized as:
A. Short-lived and easily recoverable.
B. Severe and long-lasting.
Faculty of Foreign Languages – Department of Business English Banking & Finance

C. Minimal in developed economies.

D. Nonexistent in emerging markets.
20. Which of the following actions is most effective in restoring confidence during a
financial crisis?
A. Increasing taxes on financial institutions
B. Providing transparent communication about the health of financial
institutions72
C. Reducing government intervention in financial markets
D. Allowing failed institutions to go bankrupt without support

SECTION 4: Fill in the gaps in the text below using the correct terms from the given table.
Each term can only be used once, and five terms will not be used.
Task 1:
regulations production moral hazard transaction costs financial intermediaries
underwriting monitoring net worth adverse selection asymmetric information
consulting enforcement credit assessment conflicts of interest free-rider problem
restrictions financing securities markets agencies Global Legal Settlement
auditing collateral debt contracts economies of scale principal–agent problem

Financial intermediaries are essential for the U.S. financial structure, with a higher significance
than (1) ____ for corporate (2) ____. Financial markets are heavily regulated, with access
limited to large, established corporations. (3) ____ is crucial in debt contracts, which are intricate
legal agreements placing significant (4) ____ on borrowers.
(5) ____ hinder many small savers and borrowers from engaging directly in financial markets.
However, financial intermediaries leverage (6) ____ and expertise to reduce these costs,
benefiting their savers and borrowers. (7) ____ causes two main problems: (8) ____, occurring
before a transaction, and (9) ____, occurring after. Adverse selection means that those with high
credit risks are more likely to seek loans, while moral hazard involves borrowers possibly
undertaking actions unfavorable to lenders.
Adverse selection disrupts the smooth functioning of financial markets. Measures to mitigate this
include private (10) ____ and sale of information, government (11) ____ to enhance information,
financial intermediation, and the use of (12) ____ and (13) ____. The (14) ____ shows why
banks and other financial intermediaries are more pivotal in financing businesses than securities
markets.
Moral hazard in equity contracts is referred to as the (15) ____, because managers (agents) have
less motivation to maximize profits compared to stockholders (principals). Tools to reduce this
problem include (16) ____, government regulations, and financial intermediation.
To lessen moral hazard in debt contracts, tools like collateral, (17) ____, and financial
intermediation are used. (18) ____ arise when financial service providers or their employees
have multiple interests, potentially misusing or hiding information necessary for financial
markets to function efficiently.
The three financial service activities most prone to conflicts of interest are (19) ____ and
research in investment banking, auditing and consulting in accounting firms, and credit
assessment and consulting in credit rating (20) ____.
Faculty of Foreign Languages – Department of Business English Banking & Finance

Task 2:
currency crisis Great Depression fiscal imbalances uncertainty asymmetric information
causing financial system banking crisis lending investment opportunities
debt deflation economic activity adverse selection inflation financial liberalization
moral hazard asset-price booms shadow banking interest rates subprime mortgages
financial crises housing bubble speculative attack net worth economic downturn

A financial crisis occurs when a disruption in the (1) ____ leads to increased (2) ____ problems,
making (3) ____ and (4) ____ more severe. This situation prevents financial markets from
effectively channeling funds to households and firms with productive (5) ____, causing a
significant reduction in (6) ____.
Financial crises can begin in several ways in countries like the U.S.: mismanagement of (7) ____
or innovation, (8) ____ and busts, or a general increase in (9) ____ due to the failures of major
financial institutions. These factors lead to heightened adverse selection and moral hazard issues,
resulting in reduced (10) ____ and a decline in economic activity.
As business conditions worsen and bank balance sheets deteriorate, the crisis enters the second
stage, leading to a (11) ____. The decline in the number of banks results in the loss of their
information capital, further reducing lending and causing the economy to spiral downwards. In
some cases, this economic decline leads to a sharp drop in prices, increasing the real liabilities of
firms and reducing their (12) ____, resulting in a (13) ____.
The most significant financial crisis in U.S. history, which led to the (14) ____, involved several
stages: a stock market crash, bank panics, worsening of asymmetric information problems, and
finally debt deflation. The financial crisis that began in 2007 was triggered by the
mismanagement of financial innovations involving (15) ____ and the bursting of a (16) ____.
This crisis spread globally, causing significant deterioration in the balance sheets of banks and
other financial institutions, a run on the (17) ____, and the failure of many high-profile firms.
Financial crises in emerging market countries follow two basic paths: mismanagement of
financial liberalization or globalization, which weakens bank balance sheets, and severe (18)
____. Both paths lead to a (19) ____ on the domestic currency, (20) ____ its value to plummet.

Financial intermediaries are essential for the U.S. financial structure, with a higher significance
than (1) securities markets for corporate (2) financing. Financial markets are heavily regulated,
with access limited to large, established corporations. (3) Collateral is crucial in debt contracts,
which are intricate legal agreements placing significant (4) restrictions on borrowers.
(5) Transaction costs hinder many small savers and borrowers from engaging directly in
financial markets. However, financial intermediaries leverage (6) economies of scale and
expertise to reduce these costs, benefiting their savers and borrowers. (7) Asymmetric
information causes two main problems: (8) adverse selection, occurring before a transaction,
and (9) moral hazard, occurring after. Adverse selection means that those with high credit risks
are more likely to seek loans, while moral hazard involves borrowers possibly undertaking
actions unfavorable to lenders.
Adverse selection disrupts the smooth functioning of financial markets. Measures to mitigate this
include private (10) production and sale of information, government (11) regulations to
Faculty of Foreign Languages – Department of Business English Banking & Finance

enhance information, financial intermediation, and the use of (12) collateral and (13) net worth
. The (14) free-rider problem shows why banks and other financial intermediaries are more
pivotal in financing businesses than securities markets.
Moral hazard in equity contracts is referred to as the (15) principal–agent problem, because
managers (agents) have less motivation to maximize profits compared to stockholders
(principals). Tools to reduce this problem include (16) monitoring, government regulations, and
financial intermediation.
To lessen moral hazard in debt contracts, tools like collateral, (17) enforcement , and financial
intermediation are used. (18) Conflicts of interest arise when financial service providers or their
employees have multiple interests, potentially misusing or hiding information necessary for
financial markets to function efficiently.
The three financial service activities most prone to conflicts of interest are (19) underwriting
and research in investment banking, auditing and consulting in accounting firms, and credit
assessment and consulting in credit rating (20) agencies.
Task 2:
A financial crisis occurs when a disruption in the (1) financial system leads to increased (2)
asymmetric information problems, making (3) adverse selection and (4) moral hazard more
severe. This situation prevents financial markets from effectively channeling funds to households
and firms with productive (5) investment opportunities, causing a significant reduction in (6)
economic activity.
Financial crises can begin in several ways in countries like the U.S.: mismanagement of (7)
financial liberalization or innovation, (8) asset-price booms and busts, or a general increase in
(9) uncertainty due to the failures of major financial institutions. These factors lead to
heightened adverse selection and moral hazard issues, resulting in reduced (10) lending and a
decline in economic activity.
As business conditions worsen and bank balance sheets deteriorate, the crisis enters the second
stage, leading to a (11) banking crisis. The decline in the number of banks results in the loss of
their information capital, further reducing lending and causing the economy to spiral downwards.
In some cases, this economic decline leads to a sharp drop in prices, increasing the real liabilities
of firms and reducing their (12) net worth, resulting in a (13) debt deflation.
The most significant financial crisis in U.S. history, which led to the (14) Great Depression,
involved several stages: a stock market crash, bank panics, worsening of asymmetric information
problems, and finally debt deflation. The financial crisis that began in 2007 was triggered by the
mismanagement of financial innovations involving (15) subprime mortgages and the bursting
of a (16) housing bubble. This crisis spread globally, causing significant deterioration in the
balance sheets of banks and other financial institutions, a run on the (17) shadow banking
system, and the failure of many high-profile firms.
Financial crises in emerging market countries follow two basic paths: mismanagement of
financial liberalization or globalization, which weakens bank balance sheets, and severe (18)
fiscal imbalances. Both paths lead to a (19) speculative attack on the domestic currency, (20)
causing its value to plummet.
Faculty of Foreign Languages – Department of Business English Banking & Finance

SECTION 5: Decide if the statements are True or False. If false, correct them.

1. Financial markets channel funds from savers to borrowers, promoting economic efficiency.

2. Commercial banks are the most important financial intermediaries in the economy.

3. Investment banks assist in the initial sale of securities in the primary market.

4. The primary market is where previously issued securities are traded.

5. Insurance companies primarily deal with short-term financial instruments.

6. Money markets are for long-term debt instruments.

7. The secondary market increases the liquidity of financial instruments.

8. Financial institutions reduce transaction costs through economies of scale.

9. Mutual funds pool resources from many investors to buy diversified portfolios of securities.

10. Moral hazard occurs before the transaction.

11. Higher inflation typically leads to lower nominal interest rates to maintain real returns.

12. A diversified portfolio eliminates all types of risk.

13. The Federal Reserve System is the central bank of the United States.

14. Adverse selection occurs before a transaction takes place.

15. A well-functioning financial system is essential for economic growth.

16. A financial intermediary increases the direct connection between savers and borrowers.

17. The primary purpose of venture capital is to provide loans to large corporations.

18. High transaction costs typically increase market efficiency.

19. Financial innovation can improve the efficiency of financial markets.

20. Financial intermediaries help reduce transaction costs.

21. Financial markets facilitate the transfer of risk.

22. Principal-agent problems are a form of moral hazard where agents may act in the best
interests of principals.

23. Only borrowers face moral hazard in financial transactions.

24. Transaction costs are always fixed and do not vary with the size of the transaction.

25. Economies of scale can reduce transaction costs in financial markets.

Faculty of Foreign Languages – Department of Business English Banking & Finance

26. Moral hazard occurs after a transaction has taken place.

27. Monitoring is a tool used to mitigate moral hazard.

28. Transaction costs only include monetary fees.

29. Adverse selection is not an issue in well-regulated financial markets.

30. Only buyers incur transaction costs.

31. Government guarantees can increase moral hazard in the banking sector.

SECTION 6: Answer the following questions

Task 1:
Question 1 (Lecture 2, Chapter 7): “The more collateral there is backing a loan, the less the
lender has to worry about adverse selection.” Is this statement true, false, or uncertain? Explain
your answer.
Question 2 (Lecture 2, Chapter 7): How can economies of scale help explain the existence of
financial intermediaries?
Question 3 (Lecture 2, Chapter 7): Describe two ways in which financial intermediaries help
lower transaction costs in the economy.
Question 4 (Lecture 2, Chapter 7): Would moral hazard and adverse selection still arise in
financial markets if information were not asymmetric? Explain.
Question 5 (Lecture 2, Chapter 8): What are the two ways that spikes in interest rates lead to an
increase in adverse selection and moral hazard problems?
Question 6 (Lecture 2, Chapter 8): True, false, or uncertain: Financial engineering always leads
to a more efficient financial system.
Question 7 (Lecture 2, Chapter 8): How can a currency crisis lead to higher interest rates?

Task 2:
Question 1 (Lecture 2, Chapter 7): Which firms are most likely to use bank financing rather than
to issue bonds or stocks to finance their activities? Why?
Question 2 (Lecture 2, Chapter 7): How can the existence of asymmetric information provide a
rationale for government regulation of financial markets?
Question 3 (Lecture 2, Chapter 7): How does the free-rider problem aggravate adverse selection
and moral hazard problems in financial markets?
Question 4 (Lecture 2, Chapter 8): When can a decline in the value of a country’s currency
exacerbate adverse selection and moral hazard problems? Why?
Question 5 (Lecture 2, Chapter 8): How does a general increase in uncertainty as a result of a
failure of a major financial institution lead to an increase in adverse selection and moral hazard
problems?

Task 3:
Question 1 (Lecture 2, Chapter 7): Would you be more willing to lend to a friend if she put all of
her life savings into her business than you would if she had not done so? Why?
Faculty of Foreign Languages – Department of Business English Banking & Finance

Question 2 (Lecture 2, Chapter 7): Rich people often worry that others will seek to marry them
only for their money. Is this a problem of adverse selection?
Question 3 (Lecture 2, Chapter 7): Manulife insurance company is concerned about adverse
selection when offering health insurance policies. How can Manulife mitigate the risk of
attracting predominantly high-risk individuals?
Question 4 (Lecture 2, Chapter 7): BIDV is considering providing a large loan to a new startup.
However, the bank is concerned that once the loan is granted, the startup might engage in riskier
business activities than initially promised. What measures can BIDV take to prevent moral
hazard?
Question 5 (Lecture 2, Chapter 7): LET, a small business, is looking to raise funds through
issuing bonds. However, the costs associated with issuing the bonds are substantial. How do
these transaction costs affect the small business, and what can it do to mitigate these costs?

Homework
Summary
Financial intermediaries

Why – exist

- To solve or reduce………………………………………………………………………………...

………………………………………………………………………………………………………

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What – types

- Def: ……………………………………………………………………………………………….

………………………………………………………………………………………………………

- Types: …………………………………………………………………………………………….

………………………………………………………………………………………………………

………………………………………………………………………………………………………

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How – solve/reduce (Explain solutions used by financial intermediaries in details)

………………………………………………………………………………………………………

………………………………………………………………………………………………………

………………………………………………………………………………………………………
Faculty of Foreign Languages – Department of Business English Banking & Finance

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