Answer to Question 1
C
Answer to Question 2
If it were possible for saver-lenders to know the true value of financial assets, they would never be tempted to pay more than the asset is truly worth. In reality, though, savers know too little and must make the best of the available information. When the prices of certain assets are rising, savers may interpret this as a signal that the assets' fundamental value is rising. Because savers know that they and other savers don't know for sure whether the fundamental value is rising nor how high the price might go, they may expect to profit from the price increase. Asymmetric information forces lenders to extend credit on the basis of creditworthiness, rather than unobservable and/or unverifiable aspects of the specific purpose of the loan. An increase in asset prices, regardless the cause, enhances the creditworthiness of holders of such assets. Moreover, the belief shared by lender and borrower alike that possession of high-value assets reduces the probability of default may inspire the latter to choose risky behaviors and the latter to remain ignorant or complacent. So long as financial markets reward holders of rising-price assets, the price will continue to rise.
A graphical representation of the marginal value theorem.
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