Expected Utility Theory in Finance

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Questions and Answers

What is one of the causes of agency problems?

  • The agent never receiving any bonuses
  • The principal not communicating with the agent
  • The principal always agreeing with the agent's decisions
  • The agent acting independently from the principal for personal gain (correct)

How can transparency help reduce agency problems?

  • By keeping transactions confidential between the agent and principal
  • By making the decisions without consulting the principal
  • By allowing the agent to act independently
  • By ensuring decisions are agreed upon by both parties and are fair (correct)

What is one way to motivate an agent according to the text?

  • Implementing restrictions on the agent's power
  • Introducing bonuses for the agent (correct)
  • Keeping the agent in the dark about important information
  • Confidentiality breaches regarding the principal's information

What might cause a conflict of interest between a principal and an agent?

<p>The agent acting in their own best interest rather than the principal's (B)</p> Signup and view all the answers

How can setting specific restrictions on agency power help reduce agency problems?

<p>By increasing the principal's confidence in their agent (D)</p> Signup and view all the answers

What action by an agent might lead to a confidentiality breach?

<p>Engaging in insider trading using principal's information (B)</p> Signup and view all the answers

How does introducing bonuses affect an agent's decision-making according to the text?

<p>It motivates agents to make decisions that benefit the principal (A)</p> Signup and view all the answers

Why might an agent act against the recommendations provided by the principal?

<p>'The agent wants to obtain previously agreed upon incentives or bonuses' (C)</p> Signup and view all the answers

Flashcards

Cause of agency problem

Agent acting independently for personal gain.

Transparency's role

Ensures decisions are fair and agreed upon by both parties.

Motivating agent

Offering bonuses for desired actions.

Conflict of interest

Agent prioritizes own benefit over principal's.

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Restrictions on power

Increases principal's trust in agent by setting limits on their actions.

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Confidentiality breach

Agent using principal's inside information for personal gain.

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Bonus effect on agent

Motivates agent to act in the principal's best interest.

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Agent's actions against principal

An agent might act against a recommendation to obtain promised incentives/bonuses.

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