Asymmetric Information.
Presentation Number 8 ROLL NO.26
ASYMMETRIC INFORMATION:
Asymmetric Information can be defined as "information that is known to one party in a transaction but no to the other party". The classified argument is that some sellers with inside information about the quality of an asset will be unwilling to accept the terms offered by a less informed buyer. This may cause the market breakdown or at a price lower than it would command if all buyers and sellers had full information. This is known as lemon market problem in valuation.
This concept has been applied to both equity and debt finance.
Equity Finance: For equity finance, shareholders demand a premium to purchase shares of relatively good firms to offset the losses arising from funding lemons. This premium raises the cost of new equity finance faced by managers of relatively high quality firms above the opportunity cost of internal finance faced by existing shareholders.
Debt Finance: In debt market, a borrower who takes out a loan usually has better information about the potential returns and risk associated with the investment projects for which the funds are earmarked. The lender on the other side does not have sufficient information concerning the borrower.
Lack of sufficient information creates problems before and after the transaction entered into, which is potentially a major problem with Islamic profit sharing financial contracts. The presence of asymmetric information normally leads to adverse selection and moral hazard problems.
1) Adverse Selection: Adverse selection refers to a situation in which sellers have relevant information that buyers lack or buyers have relevant information that sellers lack about some aspect of product quality. The term refers to the problem created by asymmetric information before the transaction occurs. It occurs when the potential borrowers are the one
ASYMMETRIC INFORMATION:
Asymmetric Information can be defined as "information that is known to one party in a transaction but no to the other party". The classified argument is that some sellers with inside information about the quality of an asset will be unwilling to accept the terms offered by a less informed buyer. This may cause the market breakdown or at a price lower than it would command if all buyers and sellers had full information. This is known as lemon market problem in valuation.
This concept has been applied to both equity and debt finance.
Equity Finance: For equity finance, shareholders demand a premium to purchase shares of relatively good firms to offset the losses arising from funding lemons. This premium raises the cost of new equity finance faced by managers of relatively high quality firms above the opportunity cost of internal finance faced by existing shareholders.
Debt Finance: In debt market, a borrower who takes out a loan usually has better information about the potential returns and risk associated with the investment projects for which the funds are earmarked. The lender on the other side does not have sufficient information concerning the borrower.
Lack of sufficient information creates problems before and after the transaction entered into, which is potentially a major problem with Islamic profit sharing financial contracts. The presence of asymmetric information normally leads to adverse selection and moral hazard problems.
1) Adverse Selection: Adverse selection refers to a situation in which sellers have relevant information that buyers lack or buyers have relevant information that sellers lack about some aspect of product quality. The term refers to the problem created by asymmetric information before the transaction occurs. It occurs when the potential borrowers are the one