Part 1Would you be more willing to lend to a friend if she put all of her life savings into her business than you would if she had not done so? Part 2
A. You would be more willing because putting her life savings into her business provides you protection against the problem of moral hazard B. Whether or not she puts her life savings into her business has no bearing on whether she repays the loan or not. Therefore, it should have no effect on your decision to loan her money C. You would be less willing because putting her life savings into a business that can potentially fail makes it more risky for you to loan her money. If the business fails, she will protect her investment before she considers repaying you D. You would be more willing because putting her life savings into her business provides you protection against the problem of adverse selection

Question

Part 1Would you be more willing to lend to a friend if she put all of her life savings into her business than you would if she had not done​ so? Part 2
A. You would be more willing because putting her life savings into her business provides you protection against the problem of moral hazard B. Whether or not she puts her life savings into her business has no bearing on whether she repays the loan or not.​ Therefore, it should have no effect on your decision to loan her money C. You would be less willing because putting her life savings into a business that can potentially fail makes it more risky for you to loan her money. If the business​ fails, she will protect her investment before she considers repaying you D. You would be more willing because putting her life savings into her business provides you protection against the problem of adverse selection

BlackTom AI · Accepted Answer

Question restatement: You’re asked to evaluate how willing you would be to lend to a friend under two-part scenario, with four answer choices.
Option A: You would be more willing because putting her life savings into her business provides you protection against the problem of moral hazard.
Option B: Whether or not she puts her life savings into her business has no bearing on whether she repays the loan or not. Therefore, it should have no effect on your decision to loan her money.
Option C: You would be less willing because putting her life savings into a business that can potentially fail makes it more risky for you to loan her money. If the business fails, she will protect her investment before she considers repaying you.
Option D: You would be more willing because putting her life savings into her business provides you protection against the problem of adverse selection.

Analysis of each option:
Option A — Why it might be correct: The idea here is that when the borrower has substantial personal funds at stake, she has ‘skin in the game.’ This reduces moral hazard because she bears personal risk if the venture fails, which should incentivize prudent behavior and timely loan repayment. In other words, lenders worry less about risky actions by the borrower once the borrower’s own money is invested. 
Why it is plausible: It aligns incentives between lender and borrower and is a standard microeconomic intuition about moral hazard mitigation when borrowers have equity at stake. 
Option B — Why this is incorrect: The borrower’s personal investment can affect her incentives and behavior, which in turn influences repayment likelihood. Dismissing any effect ignores the incentive-alignment role of ownership and risk-sharing, so this option overlooks a key channel through which moral hazard operates. 
Option C — Why this is incorrect: The argument suggests increased risk from her personal investment elevates the lender’s risk, implying the borrower would delay repayment to safeguard her own funds. This misreads moral hazard: personally invested funds typically reduce, not increase, the borrower’s tendency to take unsustainable risks or default, since she has more to lose. The statement reverses the standard logic about skin in the game. 
Option D — Why this is incorrect: Adverse selection concerns the lender’s difficulty in distinguishing creditworthy from uncreditworthy borrowers before the transaction, not primarily about post-transaction incentives or moral hazard. While personal investment may influence some screening considerations, the claimed protection specifically against adverse selection is not the typical mechanism; it addresses different conceptually risk (pre-transaction information asymmetry) than moral hazard (post-agreement behavior).

Putting it all together, you evaluate incentives: the presence of the borrower’s own substantial funds in the business tends to align her incentives with repayment and prudent operation, reducing moral hazard more directly than it addresses adverse selection or the unconditional claim that personal investment has no effect.

Homework:Chapter 8 Homework

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