1 1. What are the eight basic facts about the financial structure in the U.S. ec
ID: 1180447 • Letter: 1
Question
1
1. What are the eight basic facts about the financial structure in the U.S. economy? How do
some of these facts compare with other developed economies such as Germany, Japan,
and Canada?
2. How do transactions costs influence financial structure?
3. How do financial intermediaries reduce transactions costs?
4. Explain how adverse selection (the lemons problem) affects the stock and bond markets.
5. What tools are available from the private sector, the government, and financial
intermediaries to reduce the asymmetric information and the resulting adverse selection
problems in the financial system?
6. Explain how the principal-agent problem (i.e., moral hazard problem in equity contracts)
affects the choice between debt and equity contracts.
7. What tools are available from the private sector, the government, and financial
intermediaries to reduce the asymmetric information and the resulting principal-agent
problem?
8. Explain how the moral hazard problem affects debt markets.
9. What tools are available to reduce the asymmetric information and the resulting moral
hazard problem in debt contracts (such as bonds, loans)?
10. Explain how underdeveloped financial systems in developing and transition economies
can lead to low economic development and growth. Discuss in terms of the unavailability
of tools used by advanced economies to lower adverse selection and moral hazard
problems.
2
1. What is a financial crisis?
2. Explain the dynamics of financial crises in advanced economies in terms of the three stages:
initiation of the crisis, banking crisis, and debt deflation.
3. For advanced economies, explain the three ways in which financial crises are likely to begin (i.e.,
the first stage of the crisis): mismanagement of financial innovation/liberalization, asset price
boom and bust, and increase in uncertainty
4. What were the causes of the 2007-2009 financial crisis?
5. What are the five key areas of the U.S. economy where the 2007-2009 crisis had a major impact?
6. List the government interventions at the peak of the 2007-2009 financial crisis that were aimed at
propping up financial markets and stimulating the economy.
7. Explain the dynamics of financial crises in developing economies in terms of the three stages:
initiation of the crisis, currency crisis, and full-fledged financial crisis.
8. For Stage 1, explain the two major paths along which financial crises are likely to develop in
developing economies: mismanagement of financial liberalization/globalization and severe fiscal
imbalances
9. Besides the two paths explained in question #5, what additional factors can play a role in the first
stage in crises in developing economies? 10. In developing economies, explain how the deterioration of bank balance sheets and severe
imbalances in stage 1 lead to a currency crisis in stage 2.
11. In developing economies, explain how the currency crisis in stage 2 leads to full-fledged financial
and banking crisis in stage 3.
12. Outline the main features of the financial crises in Mexico, East Asia, and Argentina in the 1990s.
3
1. Explain the following characteristic about a bank
Explanation / Answer
Adverse Selection (before) and Moral Hazard (after)
One party in the transaction knows less than the other.
The Lemons Problem by George Akerlof:
How Adverse Selection Influences Financial Structure
Not knowing the true condition of a used car, buyer offers an average price (higher than what a bad car is worth but lower than the value of a good car). Hence, few good cars are sold, buyer becomes wary and few sales take place.
Lemons in the Stock and Bond Markets:
The same logic will work in the financial market as well. Adverse selection makes the market inefficient and stocks and bonds account for only 31.9% of external financing.
Tools to Help Solve Adverse Selection Problems
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