Financial intermediaries typically require mortgage borrowers to have homeowner's insurance and do credit checks before making the loan.
A)The insurance requirement and the credit check are both designed primarily to reduce adverse selection.
B)The insurance requirement and the credit check are both designed primarily to reduce the risk of moral hazard.
C)The insurance requirement is designed primarily to reduce adverse selection;the credit check is designed primarily to reduce the risk of moral hazard.
D)The insurance requirement is designed primarily to reduce the risk of moral hazard;the credit check is designed primarily to reduce adverse selection.

Question

Quizplus · Accepted Answer

Homeowner's insurance is designed to protect the financial intermediary from losses due to the borrower's default or damage to the property. This mitigates the risk of moral hazard. On the other hand, credit checks are designed to ensure that the borrower has a good credit history and is likely to fulfill their obligation to repay the loan. This reduces the risk of adverse selection, as financially stable borrowers are more likely to be approved for the loan. Therefore, the insurance requirement is primarily designed to reduce the risk of moral hazard, while the credit check is primarily designed to reduce adverse selection.

Financial Intermediaries Typically Require Mortgage Borrowers to Have Homeowner's Insurance