Answer the following statements true (T) or false (F)

Question

1. Collateral means something valuable—often property or equipment—that a lender would have a right to seize and sell if the loan is not repaid.
2. Insurance companies price their premiums based on what each customer can afford to pay.
3. Adverse selection is a type of asymmetric information in which the seller has more information than the buyer, making it hard for the buyer to know how much to pay.
4. In many cases of asymmetric information, the seller has more information than the buyer. When the buyer has more information, the problem is known as “adverse selection.”
5. Firms can raise the financial capital they need in four main ways: (1) from early-stage investors; (2) by reinvesting profits; (3) by borrowing through banks or bonds; and (4) by selling stock.

Answer 1

1. True
This statement is true. Collateral means something valuable—often property or equipment—that a lender would have a right to seize and sell if the loan is not repaid.
2. False
This statement is false. Insurance companies price their premiums based on the probability of certain events occurring among a pool of people.
3. False
This statement is false. Adverse selection is a type of asymmetric information in which the buyer has more information than the seller, making it difficult to decide on appropriate prices or fees.
4. True
This statement is true. Adverse selection refers to the problem in which the buyers of insurance (for example) have more information about whether they are high risk or low risk than the insurance company does. This creates an asymmetric information problem for the insurance company.
5. True
This statement is true. Firms can raise the financial capital they need in four main ways: (1) from early-stage investors; (2) by reinvesting profits; (3) by borrowing through banks or bonds; and (4) by selling stock.