Explain why asymmetry of information creates the problem of adverse selection and moral hazard, and what effect these problems have on the financial markets.

GIVEN THAT,

Asymmetric information occurs when lender or borrower have more information about financial market than other party. It leads to two problems:

Adverse selection: It occurs when a person with high probability of dying in next few months buys a life insurance without knowing thr insurance company that his death is near. In this case, insurance company will charge normal premium to that person and liable to pay huge amount in next few months if he die.
In financial market, if lender is not able to figure out the investment plan for which borrower needs money or not able to figure out the genuine borrower who will pay his money back on time. Borrower will spend the money borrowed in a high risky project as he knows that even if investment fails, he turns out to be bankrupt and do not pay money back.

Moral Hazard: It occurs when someone with health insurance pays no attention to his health as he knows that insurance company will bear all the cost if he fall sick.
In financial market, moral hazard occurs when borrower know that someone else will pay back money to lender if his investment fails. If any startup have raised 100% funding, even if the idea does not work, investors will loose their money.