Hazards Faced When Giving Collateral (Coursework Sample)

INTERNATIONAL BANKING AND FINANCE
Institution Affiliation
Name
Date
Question 1
The statement "The more collateral there is a backing loan, the less the tender has to worry about adverse selection" is right. In case of a borrower defaults payments, adequate collateral security stands to provide the lender with security form, which the lender uses to recover the money lent to the debtor. The process of improving the cash entails selling the collateral security CITATION Abo14 \l 1033 (Abor, 2014). Hence, the higher the collateral security is backing a loan, the lesser the risk of defaults related to it. Therefore, a lender does not have to worry much about the loan. According to CITATION Her16 \l 1033 (Hertzberg, 2016), when an individual has a lot of collateral on investment, the more the individual will act in the lender's favor because the person has much at risk. Loans are assets or money borrowed by a person or an entity from a financial institution and act as supportive tools when the collateral is enormous. CITATION Gor10 \l 1033 (Gormley, 2010) suggests the borrower of any loan pays the interest, which is the additional amount for using the money. The goal of every commercial bank is to get a return on an investment after issuing several loans. The collateral against the amount the borrower obtains lets the bank decide whether to sell the collateral security to get back the principal and the interest or to declare the investment a lousy loan.
Adverse selection and moral hazards explain what happens when one party is representing another party financially CITATION Amb16 \l 1033 (Ambrose, 2016). Moral hazards are when one party has an incentive to take more risks because they don't take the risk. Adverse selection occurs when one party has more information about something than another; thus, adverse selection increases the degree of moral hazard. According to CITATION Yav00 \l 1033 (Yavas, 2000).Adverse selection happens before the transaction occurs, and the potential borrowers who are in positions to produce adverse outcomes are most likely to seek loans and be selected. In solving adverse selection, the lemon problem by George A. Akerlof, explains the way forward. George A. Akerlof's lemon problem provides asymmetrical information to lenders and borrowers.
Question 2
Activities involved in the line of business require capital for sustainability and growth. These activities may include starting a business, running a business, or expanding the business, CITATION Dua18 \l 1033 (Duarte, 2018). Firms may choose where to find finances for their actions. The sources may be from bank financing or issuance of bonds or stocks. Smaller firms in their initial stages of development and growth are more likely to use bank financing. These small firms are not well known, and thus they rely on financial banking to be in a position to capture all the people willing to join the banking business. Because it is harder for investors to acquire relevant information about these firms, it will be hard for them to sell securities in the financial markets. CITATION Hea10 \l 1033 (Hearn, 2010) elaborates that banks that specialize in collecting information about smaller firms will then be the only option these smaller firms can rely on financing their activities at grass root levels. Because bonds which are instruments of indebtedness are associated with higher risks than smaller firms cannot withstand, the uncertainty of the repayment of the debts is only guaranteed by more prominent financial institutions.
According to CITATION Ros16 \l 1033 (Rostamkalaei, 2016),Small and medium-sized enterprises, for example, will use bank financing rather than stocks and bonds. Banks find and perceive small businesses such as small, medium enterprises to be highly profitable in doing business. Banks are more exposed to small enterprises because they are in their process of growth. Small firms do not want to issue bonds to finance their activities because borrowing money can be risky to pay back the money if they don't operate to their full potential. These firms do not want to go in bankruptcy state and have painful terms of paying the loans in future.
References
Abor, J. Y., Agbloyor, E. K., & Kuipo, R. (2014). Bank finance and export activities of Small and Medium Enterprises. Review of Development Finance, 4(2), 97-103.
Alibhai, S., Buehren, N., Coleman, R., Goldstein, M., & Strobbe, F. (2018). Disruptive Finance: Using Psychometrics to Overcome Collateral Constraints in Ethiopia. World Bank.
Ambrose, B. W., Conklin, J., & Yoshida, J. (2016). Credit rationing, income exaggeration, and adverse selection in the mortgage market. The Journal of Finance, 71(6), 2637-2686.
Anand, K., van Lelyveld, I., Banai, Á., Friedrich, S., Garratt, R., Hałaj, G., ... & Molina-Borboa, J. L. (2018). The missing links: A global study on uncovering financial network structures from partial data. Journal of Fina