Question 1

A financial bubble happens only because of irrational behaviors of investors, such as herding activities or outright foolishness.

Accepted Answer

A financial bubble can also occur even when investors are most rational. The expectation is put forward to explain bubbles where stock prices are governed by others' perception of other's perception of the stock price, rather than by the fundamentals. It is still rational behavior.
Key Takeaway: A financial bubble occurs when trades in products or assets happen in large volume at inflated prices. There are many causes of the bubble, but the most important one is speculation.

Question 2

A speculative bubble is usually caused by which of the following? Select all that apply:&#10;A)Exaggerated expectations of future growth.&#10;B)Price appreciation.&#10;C)An increase in asset values.&#10;D)Higher trading volumes.&#10;E)All of the above

Accepted Answer

All the factors cause a speculative bubble. As more investors jump into the market due to increasing expectations of future growth, buyers will outnumber sellers. Prices will increase rapidly beyond the reasonable level. Prices fall back down to normalized levels and most investors panic and sell out of their investments. The bubble will burst and most investments will lose their values.
Key Takeaway: The dot.com bubble in 2000 and the housing bubble in the U.S in 2007-2008 are a few examples of speculative bubbles.

Question 3

The main reason that led to the collapse of the oldest merchant bank in England, Barings Bank, in 1995 after 233 years of existence was...&#10;A)A bank run.&#10;B)A change in the board of directors, which caused a confidence crisis among the public.&#10;C)An unauthorized speculation by one employee on future contracts.&#10;D)The Kobe earthquake in Japan, which led to a financial crisis in Asia and hence, severely affected the bank's activities.

Accepted Answer

The main reason that led to the collapse of Barings Bank (1761-1995) was the speculation of one employee, Nick Leeson, on future contracts. After originally earning massive profits for Barings via several unauthorized trades in 1992, Leeson eventually lost over $1 billion in company capital while hiding the losses from his superiors.
Key Takeaway: This financial collapse illustrates how speculation plays a role in financial management. As the speculation led to false belief in the future growth, most of the rogue trades occurred in the future market and losses multiplied quickly.

Question 4

Which of the following events fueled the Asian Financial crisis in 1997?&#10;A)The war between Indonesia and West Timor.&#10;B)The Thai government decided to float its currency, the Baht.&#10;C)Brunei stopped selling its oil to neighboring countries.&#10;D)A political uproar in the Philippines.

Accepted Answer

The event that fueled the Asian Financial crisis in 1997 was the Thai government's decision to float its currency, the Baht, cutting its peg against the U.S. dollar. This led to the financial collapse of the Baht, a confidence crisis in the currency, and the collapse of the financial market in the country. As the crisis spread, most of Southeast Asia and Japan saw slumping currencies, devalued stock markets and other asset prices, and a precipitous rise in private debt.
Key Takeaway: Pegging the Thai baht against a strong currency like the U.S dollar gave stability to the currency. Discontinuing the peg led to macroeconomic instability, affecting investments of all types across Asia.

Question 5

The Dutch tulip bulb crisis (AKA &#34;Tulipmania&#34;) in February 1637, happened as the contract prices for Tulip bulbs soared from November 1636 to January 1637 and suddenly collapsed in February 1637. What does the case illustrate?&#10;A)Frenzy optimism about the growth in Tulip bulb prices.&#10;B)A speculative bubble.&#10;C)Irrational investing.&#10;D)A confidence crisis.

Accepted Answer

The Dutch Tulip bulb crisis is an example of a speculative bubble. At the peak of Tulipmania in February 1637, tulip contracts sold for more than 10 times the annual income of a skilled craftsman. After the collapse, they had fallen to 1/200th of the peak prices.
Key Takeaway: A speculative bubble happens when there is frenzied optimism about the value of an asset. This leads to an increase in the quantity demanded, which causes the price to rapidly increase and the buyers outnumber the sellers. However, when the bubble bursts, holders of the assets rush to exit and the price rapidly falls. This in turn causes a collapse in the asset prices, intense pessimism, and financial distress.

Deck 3: Bubble