Intenational finance Assignment Example | Topics and Well Written Essays - 500 words

Intenational finance - Assignment Example management) is tasked to handle the resources of another (i.e, the investor). In financial undertakings, the existence of moral hazard comes in many forms, such as where management pays itself excessive compensation out of the funds it manages on behalf of its investor, or where it makes decisions to take on risks that the other has to bear. Where interests of management and investor are not aligned, then there is a potential for moral hazard. From its very definition, moral hazards are inevitable; the key is to keep them under reasonable control, which is the major objective of institutional design. The link between risk-taking and moral hazards runs according to this rationale: if I am faced with the option to take risks that may be potentially rewarding for us both, but you bear the burden of the risk, then I have the incentive to take them. However, if I were to bear the potential loss, then I will act more responsibly and cautiously (Dowd, 2009). The moral hazard lies in taking the risk for which another has to bear the consequence. The recent subprime crisis was replete with instances of moral hazards gone uncontrolled. One was the creation of mortgages to subprime borrowers who had little or no capacity to repay the loan (Brummer, 2008), and then selling this loan to Fannie Mae (the Federal National Mortgage Association) which then securitizes the risk and sells it out as mortgage backed securities (MBS).