Deck 13: Financial Crises: Causes and Consequences

Question 1

The Federal Reserve is the most common lender of last resort.

Answer 1

True

Question 2

Islamic banks perform worse than conventional ones during financial crises.

Answer 2

False

Question 3

The financial panic of 2007-2009 was a systemic crisis.

Answer 3

True

Question 4

Loan calls are more likely during a panic.

Question 5

MBS stands for mortgage backed securities.

Question 6

Lower levels of leverage can make a financial panic more severe.

Question 7

Higher leverage can give investors higher returns during a bubble.

Question 8

Bailouts often involve taxpayer money.

Question 9

Higher expected future stock prices can lead to increasing prices without any change in the profitability of the firms.

Question 10

Bubbles always end due to mistaken government intervention.

Question 11

Asymmetric information problems are more severe during a financial panic.

Question 12

Higher leverage can protect investors against large losses when asset prices fall.

Question 13

A financial panic causes a lack of liquidity.

Question 14

Changes in stock prices are the result of changes in fundamentals.

Question 15

The popping of the dot-com bubble in 2000 turned into a systemic crisis.

Question 16

The primary argument for bailouts is they help crises to remain systemic.

Question 17

The stock market crash of 1929 turned into a systemic crisis.

Question 18

A corporate bond is an example of a securitized asset.

Question 19

CMO stands for credit managed offering.

Question 20

During the 2007-2009 financial crisis, the government engaged in bailouts but did not act as a lender of last resort.

Question 21

When companies cannot plan for the future and when investors feel they cannot estimate future corporate earnings or interest, inflation, or default rates, they tend to hold cash instead of investing in a new factory or equipment.

Question 22

By allowing Lehman to fail, the Federal Reserve worsened the moral hazard problem between regulators and financial institutions.

Question 23

"Under water" means an investor has negative equity.

Question 24

In Islamic insurance, or , participants contribute to a common fund, and settlements are settled from that fund.

Question 25

A stock market bubble can start due to

A) low interest rates.
B) high expected dividends.
C) high levels of lending.
D) all of the above.

Question 26

High interest rates increase lenders desire to lend.

Question 27

A cause of the financial crisis of 2007-2009 was the general belief that housing prices would rise indefinitely.

Question 28

During the 2007-2009 financial crisis, the government acted as a lender of last resort but did not use bailouts.

Question 29

IBs:

A) invest in assets that do not pay interest.
B) purchase assets and lease them to customers for a fixed price and time period.
C) do not pay interest.
D) all of the above.

Question 30

Islamic banks invest in assets that do not play explicit interest.

Question 31

High interest rates can be both the cause of a bubble and the result of a burst.

Question 32

The collapse of the housing bubbles ends when all homeowners are "under water."

Question 33

The Federal Reserve was forced to take over AIG to alleviate the panic in 2008.

Question 34

A stock market bubble can start due to

A) high interest rates.
B) low expected dividends.
C) high levels of lending.
D) all of the above.

Question 35

A stock market bubble can arise

A) due to a technological advance.
B) due to lowering of lending standards.
C) due to self-fulfilling expectations.
D) all of the above.

Question 36

A technological advance can lead to an increase in stock prices primarily through

A) lower interest rates.
B) higher expected earnings.
C) higher levels of lending.
D) none of the above.

Question 37

Leverage increases both risk and return for investors.

Question 38

Only a leveraged investor can end up with negative equity when a stock market bubble bursts.

Question 39

A lender of last resort is always a government agency.

Question 40

Ignoring borrowing costs, an investor who borrows half the funds to invest in an asset that rises from $200 to $300 makes an effective rate of return of

A) 30%.
B) 50%.
C) 100%.
D) 300%.

Question 41

Which of the following institutions was allowed to fail?

A) AIG
B) Lehman Brothers
C) Bear Stearns
D) none of the above

Question 42

Riba is

A) prohibited under the Quran.
B) allowed under the Quran.
C) permitted only in very specific circumstances under the Quran.
D) all of the above.

Question 43

To help minimize the financial crisis of 2007-2009, the government

A) lent money to replace private sector funds.
B) lowered tariffs
C) raised interest rates.
D) all of the above.

Question 44

An investor borrows half the funds to buy a stock at a price of $100. If the price falls to $80, his or her effective rate of return is

A) -20% + borrowing costs.
B) -40% + borrowing costs.
C) -70% + borrowing costs.
D) none of the above.

Question 45

To help minimize the financial crisis of 2007-2009, the government

A) lent money to replace private sector funds.
B) bailed out failing financial institutions.
C) lowered interest rates.
D) all of the above.

Question 46

When the Treasury Department recapitalized some banks, they were

A) engaged in a bailout.
B) operating as a lender of last resort.
C) decreasing the money supply.
D) all of the above.

Question 47

Bailouts are intended to

A) increase the capital in financial institutions.
B) restore confidence in financial markets.
C) prevent insolvencies.
D) all of the above.

Question 48

An investor borrows 20% of the funds to buy a stock at a price of $100. If the price falls to 50, his or her effective rate of return is

A) -20% + borrowing costs.
B) -50% + borrowing costs.
C) -62.5% + borrowing costs.
D) -66.6% + borrowing costs.

Question 49

Lenders of last resort intend to

A) increase the capital in financial institutions.
B) restore confidence in financial markets.
C) restrain money supply growth.
D) all of the above.

Question 50

During a housing bubble, people continue to buy houses because

A) they expect house price to continue to rise.
B) they are able to get loans at high interest rates.
C) the government guarantees house value won't fall.
D) all of the above.

Question 51

IBs perform _______ conventional banks during financial crises.

A) better than
B) worse than
C) the same as
D) none of the above

Question 52

The housing bubble leading up to the financial crisis of 2007-2009 was exacerbated by

A) easy monetary policy.
B) Fannie and Freddie's purchase of MBS.
C) loose private sector lending standards.
D) all of the above.

Question 53

Ignoring borrowing costs, an investor who borrows three-quarters of the funds to invest in an asset that rises from $100 to $175 makes an effective rate of return of

A) 75%.
B) 400%.
C) 700%.
D) none of the above.

Question 54

Bailouts are intended to

A) increase the liquidity in financial institutions.
B) prevent insolvencies.
C) restrain money supply growth.
D) all of the above.

Question 55

The housing bubble leading up to the financial crisis of 2007-2009 was exacerbated by

A) rising mortgage rates.
B) Treasury Department purchase of CDOs.
C) NINJA loans.
D) all of the above.

Question 56

Lenders of last resort intend to

A) add liquidity to financial markets.
B) restore confidence in financial markets.
C) lower interest rates.
D) all of the above.

Question 57

When the Fed bought commercial paper (short term loans to established firms), they were

A) engaged in a bailout.
B) operating as a lender of last resort.
C) decreasing the money supply.
D) all of the above.

Question 58

The way the government dealt with which of these institutions may have mitigated the asymmetric information problem between regulators and financial firms?

A) AIG
B) Fannie Mae
C) Lehman Brothers
D) none of the above

Question 59

Which government action is usually tried first in a financial crisis?

A) changing the reserve requirement
B) bailout
C) lender of last resort
D) none of the above

Question 60

Subprime mortgages refer to home loans

A) to high risk borrowers.
B) for real estate with rising prices.
C) at below market interest rates.
D) all of the above.

Question 61

How do short term interest rates act during a financial panic? Why?

Question 62

What meant by deleveraging? What role does it play in a credit crunch?

Question 63

What does MBS stand for?

Question 64

Musharakah are:

A) joint ventures.
B) based on equity-ownership and a partnership relationship loans.
C) both a and b.
D) none of the above.

Question 65

An investor borrows half the funds to invest in an asset whose price falls from $200 to $150. Ignoring the cost of borrowing, what is the effective rate of return?

Question 66

An investor borrows half the funds to invest in an asset whose price rises from $100 to $120. Ignoring the cost of borrowing, what is the effective rate of return?

Question 67

Some would argue that the government should not engage in most bailouts due to moral hazard. Explain their reasoning and the nature of the asymmetric information problem.

Question 68

Explain why securitization led to an erosion of lending standards.

Question 69

What are the costs and benefits in the way the government dealt with Lehman Brothers during the financial crisis in 2008?

Question 70

All of the following EXCEPT one would have a strong propensity to initiate a financial crisis. Which is the exception?

A) increases in uncertainty
B) increases in interest rates
C) balance sheet deterioration
D) exchange rate appreciation

Question 71

Samantha and Jamaal both invest in a stock whose price goes from $40 to $50 after one year and $60 the next. Samantha borrowed 25% of the money to invest while Jamaal borrowed none. Find their effective rates of return on the initial price, ignoring the cost of borrowing.

Question 72

Samantha and Jamaal both invest in a stock whose price goes from $100 to $60 after one year and $40 the next. Samantha borrowed 20% of the money to invest while Jamaal borrowed none. Find their effective rates of return on the initial price ignoring the cost of borrowing.

Question 73

Which government action involves putting taxpayer money at risk?

A) lowering interest rates
B) bailout
C) lender of last resort
D) none of the above

Question 74

What classifies a financial instrument as ?

Question 75

Which government action does NOT necessarily involve putting taxpayer money at risk?

A) fiscal stimulus
B) bailout
C) lender of last resort
D) none of the above

Question 76

Explain why an increase in stock prices is not necessarily a bubble.

Question 77

Was the Black Friday stock market crash in 1987 a systemic crisis? Why or why not?

Question 78

How do IBs stop depositor runs?

Question 79

What is the primary reason a financial panic can spread to the rest of the economy?