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© 2014 Pearson Canada Inc.#
Debt contracts ____.
A) are agreements by the borrowers to pay the lenders fixed dollar amounts at periodic intervals
B) have a higher cost of state verification than equity contracts
C) are used less frequently to raise capital than are equity contracts
D) never result in a loss for the lender
Answer: A
Diff: 1 Type: MC Page Ref: 172 - 173
Skill: Recall
Objective List: 8.1 Depict how asymmetric information results in adverse selection and moral
hazard
Since they require less monitoring of firms, ____ contracts are used more frequently
than ____ contracts to raise capital.
A) debt; equity
B) equity; debt
C) debt; loan
D) equity; stock
Answer: A
Diff: 1 Type: MC Page Ref: 173
Skill: Recall
Objective List: 8.1 Depict how asymmetric information results in adverse selection and moral
hazard
Explain the principal-agent problem as it pertains to equity contracts.
Answer: The principals are the stockholders who own most of the equity. The agents are the
managers of the firm who generally own only a small portion of the firm. The problem occurs
because the agents may not have as much incentive to profit maximize as the stockholders.
Diff: 1 Type: SA Page Ref: 171
Skill: Recall
Objective List: 8.1 Depict how asymmetric information results in adverse selection and moral
hazard
Explain the four tools that can help solve the principal-agent problem.
Answer: These are: production of information monitoring, government regulation to increase
information, financial intermediation and debt contracts.
Diff: 1 Type: SA Page Ref: 171 - 172
Skill: Recall
Objective List: 8.1 Depict how asymmetric information results in adverse selection and moral
hazard