Question

State the basic facts about financial structure. Which facts are explained by transaction costs and which are explained by asymmetric information problems?

Answer 1

Stocks are not the company's most important source of external funding.
2. The issuance of marketable debt and equity securities is not the primary way for companies to finance their operations.
3. Indirect financing, involving financial intermediaries ' operations, is many times more relevant than direct finance, where businesses raise funds directly from financial market lenders.
4. The most important source of external funds used to finance businesses are financial intermediaries, especially banks.
5. The financial system is one of the economy's most heavily regulated industries.

7. To fund their operations, only big, well-established companies have easy access to the securities market.
7. Collateral is a common feature of both household and company debt contracts.
8. Typically, debt contracts are extremely complicated legal documents that place significant restrictions on the borrower's behaviour.

Asymmetric knowledge is the incarnate demon, second only to scarcity, a scourge of humanity. Really, if you want to understand why the financial system exists and why it is heavily regulated for the most part, it is a vital concept to grasp. Asymmetric information makes our economies, financial and otherwise, less effective than they would otherwise be by allowing the superior information party to benefit from the inferior information party. Where asymmetric data is high, assets are not put to their most valuable uses, and by exploiting others, it is possible to make outsized profits.

Adverse selection is an economic concept that often appears in the insurance and risk management literature. The main idea is that buyers and sellers will have different or asymmetric information about goods, financial instruments or products, and those traders with better product quality information will participate selectively in trades that will most benefit them — at the expense of their counterparts. The definition also occurs in a more general sense of imperfect information in any communication and in any human action being done between the parties.