Moral hazard refers to the risk that a party might not have entered into an agreement in good faith. It also refers to a situation where one party will choose to take unusual risks since he or she will not have to bear the full cost of the risk. The hazard occurs due to asymmetric information.

The rationale behind government regulation is founded on the fact that borrowers and sellers might start acting in an immoral manner after an economic transaction. This risk (that a seller might alter behavior after finalizing a sale) is a good example of moral hazard.

The correct answer is, therefore, option C