Short Notes on Friday Online Class

Date: 24th February 2023.

 If the information level is not the same or asymmetric then the information cost will be
much.
 There are substantial transaction and information cost in any financial market.
 Financial System’s structure consists of direct and indirect mode of Finance.
 Indirect mode of Finance is benefitted by economies of scale as they have a lot of deposit
from their depositors – Average cost will be lower. Enjoying this benefit comparing to
individual investor.
 Expertise – Comparing to individual investor Mutual Fund Management companies are
much more expert.
 Due to information gap, there can be two consequences. They are: (1) Adverse Selection
and (2) Moral Hazard.
 Adverse selection – Lack or gap of information- Possibility of selecting a bad borrower
or company.
 Asymmetric information is known as lemon problem.
 Solution to Adverse Selection Problem: Private production and sale of information. But
this is not the ultimate solution because of free rider problem.
 Another solution is Government regulations. It also doesn’t solve the Adverse selection
problem because of corruption. Audit and Accounting firms are also involved in
corruption.
 Moral Hazard – Lender will be subjected to hazard because of the immoral activities of
the borrower.
 Equity and debt finance – different resolving
 Costly state verification
 Monitoring cost is high.
 Corporate culture- Separation between owner and management
 This separation of ownership and control involves moral hazard in that the managers in
control (the agents) may act in their own interest rather than in the interest of the
 stockholder-owners (the principals) because the managers have less incentive to
maximize profits than the stock-holder-owners do.
 Debt contract: Debt financial instruments like, bonds. It is less risky because monitoring
is not needed. If we want to do good in this, we need to increase the network of borrower
to make the incentive compatible.