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Cards In This Set
| Front | Back |
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Exists when one party to a transaction knows more than the other party
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Asymmetric information
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What does asymmetric information lead to?
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Adverse selection
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Those most eager to make a deal are the least desirable to the other party
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Adverse selection
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Poor-quality used cars
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Lemons
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What markets does adverse selection affect?
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Stock and bond markets
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Is overvalued or undervalued stock considered a lemon?
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Overvalued
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In bond markets, what type of default risk is common for adverse selection?
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High default risk
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The hazard of harmful behavior during adverse selection
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Moral hazard
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When does moral hazard arise in financial markets?
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When savers cannot observe the actions of firms that issue securities
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When does moral hazard in stock markets occur?
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When managers behave in ways that benefit themselves at the expense of the owners
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How can savers reduce moral hazard and adverse selection?
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By gathering information and monitoring firms
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Who reduces moral hazard by monitoring managers?
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Board of directors
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A financial institution that owns large shares in private companies
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Private equity firms
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What are the two types of private equity firms?
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Takeover firms and venture capital firms
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Private equity firms that buy entire companies and try to increase the companies' profits
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Takeover firms
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