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THEORY OF FINANCIAL STRUCTURE (Tools solve adverse selection problem…
THEORY OF FINANCIAL STRUCTURE
Asymmetric information
One party has more infomation
Financial institutions
Insurance, Takaful, Unit trust
Financial markets
Moral Hazard
Arises after the transaction occurs
Tools solve adverse selection problem
Financial intermediation
Sort good & bad credit
Government regulation
increase info
Collateral & net worth
Reduce lender's loss of default
Private production & sale of info
Free-rider problem
Transaction costs
Cost for economic exchange
Banks, Investment banks
Effects
Hinder flows of funds
Increase costs
How to reduce
Economic of scale
Develop expertise
Adverse selection
Risk occurs before transaction
Peach vs Lemon
Peach
Happy situation
Lemon
Unhappy / Sour situation
Tools of solve debt contract
Monitoring & enforcement of restrictive covenants
encourage desirable behavior
keep collateral valuable
discourage undesirable behavior
provide info
Financial intermediation
Net worth &collateral
Moral hazard of debt contract
Pay at fixed amounts at periodic intervals
Tools of solve agency problem
Government regulation
Increase info
Financial intermediation
Venture capital firm
Production of info
Monitoring
Agency Problem
Conflict of interest
The lemon problem
Market of used cars
All cars are lemon