Week 1 -- Investment Finance and the Selection Problem: Standard debt market

An increase in the market interest rate (r) will cause ... to Pi - qualified answersa decrease in Pi, probability of success This leads to the adverse selection effect Any other Investment Market considerations? - qualified answersParties are self interested. Agents can lie about the information they have. Agent chooses the best action for themselves (selfish). Principal understand the agent can lie so plan the design accordingly. Asymmetric Information examples - qualified answersCustomers know more about their tastes than firms Firms know more about their costs than the government Agents take actions that are partly unobservable Briefly describe the Principal-Agent model - qualified answers1. A leader (Principal) who proposed the contract, they are normally uniformed. 2. A follower (Agent) who accepts or rejects the contract, they are informed One party does not work for the other Example of Principal Agent problem in Investment Funds - qualified answers1. Principal = Investor or a Bank 2. Agents = Entrepreneur who has a project i, needs to borrow amount K. K is observable by all parties. Project i offers a random return Ri Examples of Principal-Agent mode