you are to consider the impact of adverse selection and moral hazard on capital markets and explore the various mechanisms that exist to mitigate these problems.

Capital markets are where savers and entrepreneurs (or corporate managers) come together to do business. Savers have money left over after consumption spending while entrepreneurs and corporate managers need money to start businesses and fund investment projects. A host of institutions exists to facilitate the channeling of money from savers to investors, including commercial banks.

Consider the following stylized scenario: In the country of Edmundia, savers and entrepreneurs come together in the local capital market to do business. Suppose further that Edmundia is populated with some entrepreneurs having "good" business ideas and others that have "bad" business ideas. Regardless of the quality of their idea, entrepreneurs will try to convince savers that they have an excellent idea. Since bad ideas are disguised as good ideas, savers have a difficult time discerning between the two, even though they know both types of ideas exist. Consequently, savers value all ideas the same, as the average value of good ideas and bad ideas.

1. What sorts of mechanisms, institutions, and corporate practices exist to mitigate the impact of adverse selection in capital markets? Hint: Think about the root cause above and how savers might gain equal footing with entrepreneurs.