FINANCIAL MARKETS AND INSTITUTIONS
COMPREHENSIVE EXAM 2026 WITH FULL
SOLUTIONS.
◉ Why are financial intermediaries more effective than securities
markets? Answer: They reduce asymmetric information, thus
minimizing adverse selection and moral hazard.
◉ What is asymmetric information? Answer: A situation where one
party lacks sufficient knowledge about the other party in a
transaction, hindering accurate decision-making.
◉ What is adverse selection? Answer: An asymmetric information
problem occurring before a transaction, where over-valued equity
and bad credit risks seek new capital.
◉ What is moral hazard? Answer: The risk that a borrower will
engage in undesirable activities after a transaction, making loan
repayment less likely.
◉ What are economies of scale in financial transactions? Answer:
The ability to reduce per unit costs of transactions, influencing the
structure of financial intermediaries and securities markets.
,◉ What role does private production and sale of information play in
finance? Answer: It helps solve the adverse selection problem by
providing investment analysis products that evaluate credit and
investment worthiness.
◉ How does government regulation help increase information in
finance? Answer: The SEC requires independent audits to promote
accurate disclosure of a firm's financial performance and health.
◉ How do banks mitigate adverse selection? Answer: By becoming
experts in producing information about firms to differentiate good
credit risks from bad ones.
◉ What is the significance of collateral and net worth in financial
transactions? Answer: They reduce adverse selection and moral
hazard by aligning the interests of borrowers and lenders.
◉ What is the principal-agent problem? Answer: A situation where
firm management (agent) may act in their own self-interest rather
than in the interest of stockholders (principal).
◉ What is costly state verification? Answer: The process by which
stockholders incur costs to monitor the firm's activities to prevent
wasteful expenditures or fraud.
, ◉ What are restrictive covenants? Answer: Contractual clauses
aimed at reducing moral hazard by discouraging undesirable
behavior or encouraging desirable behavior.
◉ What is one type of covenant that discourages undesirable
behavior? Answer: Covenants that prevent investment in risky
projects.
◉ What is a covenant that encourages desirable behavior? Answer:
Covenants that require maintenance of minimum levels of liquidity
and financial leverage.
◉ What type of covenant keeps collateral valuable? Answer:
Covenants requiring firms to carry insurance and maintenance
contracts on collateralized assets.
◉ What is a covenant that provides information? Answer: Covenants
that require firms to provide quarterly financial information and
allow lenders to audit records.
◉ How do financial intermediaries monitor borrower behavior?
Answer: They maintain ongoing customer relations and have
expertise in assessing firm health.
COMPREHENSIVE EXAM 2026 WITH FULL
SOLUTIONS.
◉ Why are financial intermediaries more effective than securities
markets? Answer: They reduce asymmetric information, thus
minimizing adverse selection and moral hazard.
◉ What is asymmetric information? Answer: A situation where one
party lacks sufficient knowledge about the other party in a
transaction, hindering accurate decision-making.
◉ What is adverse selection? Answer: An asymmetric information
problem occurring before a transaction, where over-valued equity
and bad credit risks seek new capital.
◉ What is moral hazard? Answer: The risk that a borrower will
engage in undesirable activities after a transaction, making loan
repayment less likely.
◉ What are economies of scale in financial transactions? Answer:
The ability to reduce per unit costs of transactions, influencing the
structure of financial intermediaries and securities markets.
,◉ What role does private production and sale of information play in
finance? Answer: It helps solve the adverse selection problem by
providing investment analysis products that evaluate credit and
investment worthiness.
◉ How does government regulation help increase information in
finance? Answer: The SEC requires independent audits to promote
accurate disclosure of a firm's financial performance and health.
◉ How do banks mitigate adverse selection? Answer: By becoming
experts in producing information about firms to differentiate good
credit risks from bad ones.
◉ What is the significance of collateral and net worth in financial
transactions? Answer: They reduce adverse selection and moral
hazard by aligning the interests of borrowers and lenders.
◉ What is the principal-agent problem? Answer: A situation where
firm management (agent) may act in their own self-interest rather
than in the interest of stockholders (principal).
◉ What is costly state verification? Answer: The process by which
stockholders incur costs to monitor the firm's activities to prevent
wasteful expenditures or fraud.
, ◉ What are restrictive covenants? Answer: Contractual clauses
aimed at reducing moral hazard by discouraging undesirable
behavior or encouraging desirable behavior.
◉ What is one type of covenant that discourages undesirable
behavior? Answer: Covenants that prevent investment in risky
projects.
◉ What is a covenant that encourages desirable behavior? Answer:
Covenants that require maintenance of minimum levels of liquidity
and financial leverage.
◉ What type of covenant keeps collateral valuable? Answer:
Covenants requiring firms to carry insurance and maintenance
contracts on collateralized assets.
◉ What is a covenant that provides information? Answer: Covenants
that require firms to provide quarterly financial information and
allow lenders to audit records.
◉ How do financial intermediaries monitor borrower behavior?
Answer: They maintain ongoing customer relations and have
expertise in assessing firm health.
