| Course | FIN-3310 Financial Institutions and Markets |
|---|---|
| Module | Module 2 |
| Paper type | Written assignment 2: fundamentals of financial institutions |
| Length | About 566 words, 5 pages |
| Format | APA 7 student paper |
| School | Thomas Edison State University |
| Program | B.S.B.A. in Finance |
| Updated | October 2026 |
Free sample paper for FIN 3310 Module 2
Lemons, Collateral and a Loan Committee: Why a Credit Union Lends Where Markets Will Not
Student Name
B.S.B.A. in Finance, Thomas Edison State University
FIN-3310: Financial Institutions and Markets
Mentor Name
Month Day, Year
Lemons, Collateral and a Loan Committee: Why a Credit Union Lends Where Markets Will Not
Transaction Costs and Economies of Scale
A teacher who wanted to lend $20,000 directly to a neighbor buying a car would need to draft a contract, check the borrower's credit and collect payments, costs that would consume much of the interest. A credit union spreads those costs over thousands of loans, uses standard documents and automated payment systems and pools members' deposits so each saver has a small stake in many loans. Mishkin and Eakins (2018) describe these economies of scale as one reason intermediaries exist; they also give savers liquidity, since a member can withdraw deposits at any time even though the loans run for years.
Asymmetric Information
The deeper reason is that borrowers know more about their own prospects than lenders do. That gap causes two problems.
Adverse selection occurs before the loan. Akerlof (1970) showed with used cars that when buyers cannot tell good cars from bad, they offer an average price, which drives owners of good cars out of the market until mostly "lemons" remain. In credit markets, borrowers most eager for loans at high rates are often the riskiest, so raising the rate can worsen the pool of applicants.
Moral hazard occurs after the loan. A borrower may use the funds for riskier purposes than promised or work less hard to repay, because the lender bears part of the loss.
Two Applications
Application A carries little asymmetric information: the credit union sees the member's paycheck deposited every month, a long repayment history and the car as collateral. Application B is the textbook case of both problems. The committee cannot easily judge whether the bakery will succeed, and once funded, the owner could expand too fast or divert funds.
| Application A | Application B | |
|---|---|---|
| Purpose | $22,000 used-car loan | $60,000 to open a bakery |
| Borrower | Member teacher with ten years of employment and a credit score of 742 | Member's spouse, first business, no operating history |
| Collateral | The car | Ovens and fixtures, worth about half the loan |
| Information the credit union has | Payroll deposits, payment history, credit report | A business plan and personal credit report |
Tools Against Asymmetric Information
Diamond (1984) explained why intermediaries are efficient monitors: a single lender monitoring a borrower on behalf of many depositors avoids the duplicated effort of each saver monitoring separately. The credit union's relationship with its members, seeing their deposits and payments over years, is information no bond buyer would have.
| Tool | Problem addressed | Use in the applications |
|---|---|---|
| Screening and credit scoring | Adverse selection | Credit report and payroll history for A; business plan review for B |
| Collateral | Both | The car secures A; equipment partly secures B |
| Net worth or owner's equity requirements | Both | Require the bakery owner to invest $20,000 of her own |
| Restrictive covenants | Moral hazard | Limit B's additional borrowing and require insurance |
| Monitoring | Moral hazard | Quarterly financial statements and site visits for B |
| Long-term relationship | Both | Members' accounts give continuing information |
The Decision
Application A should be approved at a standard rate. Application B should be approved only with conditions: a $20,000 owner contribution that gives the borrower a large stake in success, a lien on the equipment, an SBA guarantee if available and covenants requiring quarterly statements. These tools do not eliminate risk, but they reduce both problems enough to make a loan possible that no market would make directly.
References
Akerlof, G. A. (1970). The market for "lemons": Quality uncertainty and the market mechanism. Quarterly Journal of Economics, 84(3), 488-500. https://doi.org/10.2307/1879431
Diamond, D. W. (1984). Financial intermediation and delegated monitoring. Review of Economic Studies, 51(3), 393-414. https://doi.org/10.2307/2297430
Mishkin, F. S., & Eakins, S. G. (2018). Financial markets and institutions (9th ed.). Pearson.
What the FIN 3310 Module 2 instructions ask for
The second module asks why financial institutions exist at all. Expect to explain why financial intermediaries exist, covering transaction costs, economies of scale and liquidity, and the problems of asymmetric information, adverse selection and moral hazard, with the tools lenders use to address them. Applying the concepts to specific lending situations is a common format. The credit union and the two applications here are composites. Expect to explain adverse selection and moral hazard and why financial intermediaries reduce them. Some versions ask why banks remain important even as capital markets grow. Expect questions on why financial intermediaries exist, including transaction costs, adverse selection and moral hazard, and on how those problems shape loan contracts.
How the FIN 3310 Module 2 example is put together
The paper begins with transaction costs and economies of scale, using a direct loan between neighbors as the contrast. It then defines adverse selection with Akerlof's lemons example and moral hazard. A table sets out two loan applications side by side, and the analysis explains why one carries far more asymmetric information. A second table matches each remedy to the problem it addresses and to the applications, with Diamond's explanation of delegated monitoring, and the paper closes with a decision on each application. Each information problem is paired with the institution or contract feature that addresses it. A closing paragraph explains why indirect finance still dominates for small borrowers.
Where the marks sit in the FIN 3310 Module 2 rubric
The intermediation paper is graded on how well information problems explain the credit union's loan practices. Mentors look for accurate explanations of transaction costs, adverse selection and moral hazard, a clear account of how intermediaries reduce each and application to concrete situations. Distinguishing problems that arise before a loan from those after it, and matching each remedy to the problem it solves, shows the understanding this module is designed to build and the midterm essays will test. Answers that use concrete examples, such as collateral, covenants and credit scoring, show understanding beyond definitions. Mentors also credit answers that link information problems to regulation, such as disclosure rules. Clear structure helps the mentor follow the argument from problem to solution.
Common FIN 3310 Module 2 mistakes, and how to avoid them
Papers in this module lose credit for treating adverse selection and moral hazard as the same thing, for listing remedies without saying which problem each addresses and for explaining intermediaries only through convenience. Define each problem by when it occurs. Match each tool to a problem. Apply them to a real or realistic loan. Explain why an intermediary can do what a market cannot. A free first sample of your own FIN-3310 Module 2 assignment is available on request. Keep adverse selection, which arises before a transaction, separate from moral hazard, which arises after it. Give one real example for each problem. Close by naming the institution best placed to solve each problem.
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FIN 3310 Module 2 questions, answered
Where can I find a free FIN 3310 Module 2 sample paper?
The credit union paper above uses two loan applications to explain transaction costs, adverse selection, moral hazard and the tools lenders use against them.
What is the difference between adverse selection and moral hazard?
Adverse selection arises before a transaction, when riskier parties are more likely to seek it; moral hazard arises after, when one party takes risks the other bears.
What is the lemons problem?
Akerlof's insight that when buyers cannot judge quality, they offer an average price that drives good products out of the market.
Why does collateral reduce lending risk?
It lowers the lender's loss if the borrower defaults and gives the borrower a reason to repay.
Why do financial intermediaries exist?
They lower transaction costs through economies of scale, provide liquidity and reduce the problems of asymmetric information.