Deck 9: Financial Crises

Question 1

A financial crisis occurs when an increase in asymmetric information from a disruption in the financial system ________.

A)causes severe adverse selection and moral hazard problems that make financial markets incapable of channelling funds efficiently
B)allows for a more efficient use of funds
C)increases economic activity
D)reduces uncertainty in the economy and increases market efficiency

Answer 1

A

Question 2

Financial crises ________.

A)are major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms
B)occur when adverse selection and moral hazard problems in financial markets become less significant
C)frequently lead to sharp expansions in economic activity
D)are a free-rider problem

Answer 2

A

Question 3

A decline in asset prices can lead to ________.

A)worsening adverse selection and moral hazard problems
B)declining uncertainty
C)increased economic activity
D)anticipated increase in the price level

Answer 3

A

Question 4

A major disruption in financial markets characterized by sharp declines in asset prices and firm failures is called a ________.

A)financial crisis
B)fiscal imbalance
C)free-rider problem
D)"lemons" problem

Question 5

Government safety nets ________.

A)weaken market discipline
B)reduce moral hazard
C)incent banks to take less risk
D)require banks to loan less funds

Question 6

Asymmetric information problems that act as a barrier to efficient allocation of capital are often described as ________.

A)financial treason
B)financial markets
C)financial frictions
D)financial allocations

Question 7

Share prices are a valuation of a corporation's ________.

A)collateral
B)net worth
C)current capital
D)net earnings

Question 8

When the value of loans begins to drop, the net worth of financial institutions falls causing them to cut back on lending in a process called ________.

A)deflation
B)releveraging
C)capitulation
D)deleveraging

Question 9

When there is a deterioration in financial institutions' balance sheets ________.

A)economic activity contracts
B)asset prices increase
C)financial engineering takes place
D)financial globalization increases its pace

Question 10

In a bank panic ________.

A)free-rider increase
B)bond prices increase
C)transactions costs increase
D)multiple banks fail

Question 11

Factors that lead to worsening conditions in financial system include ________.

A)increases in net worth
B)stock market increases
C)decreases in interest rates
D)stock market declines

Question 12

The dark side of financial liberalization is ________.

A)market allocations
B)credit booms
C)currency appreciation
D)financial innovation

Question 13

In a bank panic, the source of contagion is the ________.

A)free-rider problem
B)too-big-to-fail problem
C)transactions cost problem
D)asymmetric information problem

Question 14

Factors that lead to worsening conditions in financial system include ________.

A)declining interest rates
B)unanticipated increases in the price level
C)the deterioration in banks' balance sheets
D)increases in bond prices

Question 15

When financial intermediaries deleverage, firms cannot fund investment opportunities resulting in ________.

A)a contraction of economic activity
B)an economic boom
C)an increased opportunity for growth
D)a call for government regulation

Question 16

A sharp decline in the stock market means that the ________ of corporations has fallen making lenders ________ willing to lend.

A)net worth; less
B)net worth; more
C)liability; less
D)liability; more

Question 17

When financial institutions go on a lending spree and expand their lending at a rapid pace they are participating in a ________.

A)credit bust
B)credit boom
C)deleveraging
D)market race

Question 18

The elimination of restrictions on financial markets and institutions is also known as ________.

A)financial engineering
B)financial lending
C)financial liberalization
D)financial deleveraging

Question 19

Factors that lead to worsening conditions in financial system include ________.

A)increases in net worth
B)unanticipated increases in the price level
C)unanticipated increases in the value of the domestic currency
D)unanticipated declines in the value of the domestic currency

Question 20

A sharp decline in the stock market means that the ________ of corporations has fallen.

A)net worth
B)interest rates
C)liabilities
D)payrolls

Question 21

A substantial decrease in the aggregate price level that reduces firms' net worth may stall a recovery from a recession. This process is called ________.

A)debt deflation
B)moral hazard
C)insolvency
D)illiquidity

Question 22

If the anatomy of a financial crisis is thought of as a sequence of events, which of the following events would be least likely to be the initiating cause of the financial crisis?

A)Increase in interest rates
B)Bank panic
C)Stock market decline
D)Increase in uncertainty

Question 23

An economic downturn which causes the price level to fall and a deterioration in firms' net worth because of the increased burden of indebtedness results in ________.

A)asset bubbles
B)rising interest rates
C)debt deflation
D)financial recovery

Question 24

Factors that lead to worsening conditions in financial system include ________.

A)increases in net worth
B)unanticipated increases in the price level
C)decreases in interest rates
D)unanticipated declines in the price level

Question 25

If debt contracts are of fairly long maturity, then an unanticipated decline in the aggregate price level results in ________.

A)a decline in a firm's net worth
B)an increase in a firm's net worth
C)a decrease in adverse selection and moral hazard
D)an increase in willingness to lend

Question 26

A(n)________ is an increase in prices of assets above their fundamental economic values.

A)decrease in moral hazard
B)asset-price bubble
C)decline in lending
D)liability war

Question 27

Most financial crises have started during periods of ________ either after the start of a recession or a stock market crash.

A)high uncertainty
B)low interest rates
C)low asset prices
D)high financial regulation

Question 28

An unanticipated decline in the price level increases the burden of debt on borrowing firms but does not raise the real value of borrowing firms' assets. The result is ________.

A)that net worth in real terms declines
B)that adverse selection and moral hazard problems are reduced
C)an increase in the real net worth of the borrowing firm
D)an increase in lending

Question 29

Debt deflation occurs when ________.

A)an economic downturn causes the price level to fall and a deterioration in firms' net worth because of the increased burden of indebtedness
B)rising interest rates worsen adverse selection and moral hazard problems
C)lenders reduce their lending due to declining stock prices (equity deflation) that lowers the value of collateral
D)corporations pay back their loans before the scheduled maturity date

Question 30

A possible sequence for the three stages of a financial crisis in Canada might be ________ leads to ________ leads to ________.

A)asset price declines; banking crises; unanticipated decline in price level
B)unanticipated decline in price level; banking crises; increase in interest rates
C)banking crises; increase in interest rates; unanticipated decline in price level
D)banking crises; increase in uncertainty; increase in interest rates

Question 31

The start of a recession or a stock market crash can result in ________.

A)high financial regulation
B)low interest rates
C)low asset prices
D)high uncertainty

Question 32

The government bailout of troubled financial institutions occurred in the U.S. and many other countries. Which country saw their banking system collapse requiring the government to take over its three largest banks?

A)Iceland
B)England
C)Germany
D)Belgium

Question 33

The economy recovers quickly from most recessions, but the increase in adverse selection and moral hazard problems in the credit markets caused by ________ led to the severe economic contraction known as The Great Depression.

A)debt deflation
B)illiquidity
C)an improvement in banks' balance sheets
D)increases in bond prices

Question 34

If uncertainty about banks' health causes depositors to begin to withdraw their funds from banks, the country experiences a(n)________.

A)banking crisis
B)financial recovery
C)reduction of the adverse selection and moral hazard problems
D)increase in information available to investors

Question 35

A bank panic can lead to a severe contraction in economic activity due to ________.

A)a decline in international trade
B)the losses of bank shareholders
C)the losses of bank depositors
D)a decline in lending for productive investment

Question 36

A sharp stock market decline increases moral hazard incentives ________.

A)since borrowing firms have less to lose if their investments fail
B)because it is immoral to profit from someone's loss
C)since lenders are more willing to make loans
D)reducing uncertainty in the economy and increasing market efficiency

Question 37

If the anatomy of a financial crisis is thought of as a sequence of events, which of the following events would be least likely to be the initiating cause of the financial crisis?

A)Increase in interest rates
B)Stock market decline
C)Unanticipated decline in price level
D)Increase in uncertainty

Question 38

Like a CDO, a structured investment vehicle pays off cash flows from pools of assets, however, rather than long-term debt the structured investment vehicle backs ________.

A)commercial paper
B)Treasury notes
C)corporate bonds
D)municipal bonds

Question 39

The Irish government helped mitigate the financial crisis by ________.

A)guaranteeing all deposits
B)privatizing the banking system
C)increasing short term borrowing
D)refusing to inject more capital into the failing system

Question 40

Banking crises or bank panics have started when ________.

A)there is a reduction of the adverse selection and moral hazard problems
B)there have been periods of low interest rates
C)depositors withdraw their funds from banks
D)when information is made available to investors

Question 41

Credit market problems of adverse selection and moral hazard increased as a result of all of the following except ________.

A)increase in housing market prices
B)increased uncertainty from the failures of financial institutions
C)deterioration in financial institutions' balance sheets
D)decline in the stock market of over 40 percent from its peak

Question 42

________ is the development of new, sophisticated financial instruments.

A)Discounting
B)Origination
C)Financial engineering
D)Distribution

Question 43

What is debt deflation?

Question 44

A bank loan to a household or business was not a security because ________.

A)it could not be bought or sold in a financial market
B)it was not a debt instrument
C)there was no market for them
D)they increased the asymmetric information problem

Question 45

________ is a process of bundling together smaller loans (like mortgages)into standard debt securities.

A)Securitization
B)Origination
C)Debt deflation
D)Distribution

Question 46

The originate-to-distribute business model has a serious ________ problem since the mortgage broker has little incentive to make sure that the mortgagee is a good credit risk.

A)principal-agent
B)debt deflation
C)democratization of credit
D)collateralized debt

Question 47

The agency problem in the mortgage markets was due to the ________ business model.

A)originate-to-distribute
B)business-as-usual
C)securitization
D)"pass-through"

Question 48

Credit default swaps ________.

A)provide payments to holders of bonds if they default
B)decrease asymmetric information in the mortgage markets
C)had strong incentives to make sure CDO holders would be paid off
D)were only a small part of insurance companies portfolios

Question 49

Typically, the economy recovers fairly quickly from a recession. Why did this not happen in the United States during the Great Depression?

Question 50

A ________ pays out cash flows from subprime mortgage-backed securities in different tranches, with the highest-rated tranch paying out first, while lower ones paid out less if there were losses on the mortgage-backed securities.

A)collateralized debt obligation (CDO)
B)adjustable-rate mortgage
C)negotiable CD
D)discount bond

Question 51

The housing boom in the United States was aided by ________.

A)liquidity from China and India
B)higher interest rates
C)tariffs reducing global trade
D)weak balance sheets in the banking industry

Question 52

Describe an asset-price bubble.

Question 53

Mortgage brokers often did not make a strong effort to evaluate whether the borrower could pay off the loan. This created a ________.

A)severe adverse selection problem
B)decline in mortgage applications
C)call to deregulate the industry
D)decrease in the demand for houses

Question 54

How do increases in interest rates play a role in promoting financial crises?

Question 55

The "democratization of credit" was attributed to ________.

A)the subprime mortgage market
B)the 2000-2001 recession
C)growth of prime mortgages
D)asset-price gaps

Question 56

The housing price bubble ________.

A)was aided by low interest rates on residential mortgages
B)only occurred in the emerging economies
C)was not a contributing factor to the 2007-2008 recession
D)cannot be explained

Question 57

The originate-to-distribute business model is when ________.

A)mortgage originators made sure that the mortgage was a good credit risk
B)mortgage originators distributed the mortgage to an investor as an underlying asset in a security
C)homeowners could refinance their houses with larger loans when their homes appreciated in value
D)mortgage originators were the credit rating agencies

Question 58

Agency problems in the subprime mortgage market included all of the following except ________.

A)homeowners could refinance their houses with larger loans when their homes appreciated in value
B)mortgage originators had little incentives to make sure that the mortgage is a good credit risk
C)underwriters of mortgage-backed securities had weak incentives to make sure that the holders of the securities would be paid back
D)the evaluators of securities, the credit rating agencies, were subject to conflicts of interest

Question 59

Agency problems in the subprime mortgage market included all of the following except ________.

A)homeowners could refinance their houses with larger loans when their homes appreciated in value
B)mortgage originators had little incentives to make sure that the mortgage is a good credit risk
C)underwriters of mortgage-backed securities had weak incentives to make sure that the holders of the securities would be paid back
D)the evaluators of securities, the credit rating agencies, were subject to conflicts of interest

Question 60

Financial innovations that emerged after 2000 in the mortgage markets included all of the following except ________.

A)adjustable-rate mortgages
B)subprime mortgages
C)Alt-A mortgages
D)mortgage-backed securities

Question 61

During the ABCP saga, The Bank of Canada ________.

A)shut down all non-bank sponsored conduits
B)refused to accept ABCPs as collateral for loans to banks
C)provided liquidity as a lender to the market
D)was bailed out by the CDIC

Question 62

Which investment bank filed for bankruptcy on September 15, 2008 making it the largest bankruptcy filing in U.S. history?

A)Lehman Brothers
B)Merrill Lynch
C)Bear Stearns
D)Goldman Sachs

Question 63

The risk of asset-backed commercial paper depends on ________.

A)unsecured promissory notes
B)the underlying securities
C)commercial paper
D)Treasury bills

Question 64

Under the Montreal Accord, investors ________.

A)froze losses to $200 million
B)agreed to a standstill period
C)were bailed out by the Bank of Canada
D)were bailed out by the CDIC

Question 65

As housing prices rose, many subprime borrowers were able to ________.

A)default on their mortgage
B)reduce their loan-to-value ratio
C)get piggyback mortgages
D)walk away from their houses

Question 66

By 2012, the debt to GDP ratio for Greece had climbed to ________.

A)60%
B)100%
C)160%
D)200%

Question 67

Between October 2007 and March 2009, asset prices in the stock market fell by ________.

A)over 50 percent
B)10 percent
C)around 16 percent
D)less than 30 percent

Question 68

What triggered the 2007-2008 financial crises ?

Question 69

Fitch and Standard & Poor announced downgrades on ________ of mortgage-backed securities and CDOs.

A)more than $10 billion
B)more than $100 billion
C)$50 billion
D)more than $10 million

Question 70

Although the subprime mortgage market problem began in the United States, the first indication of the seriousness of the crisis began in ________.

A)Europe
B)Australia
C)China
D)South America

Question 71

When housing prices began to decline after their peak in 2006, many subprime borrowers found that their mortgages were "underwater." This meant that ________.

A)the value of the house fell below the amount of the mortgage
B)the basement flooded since they could not afford to fix the leaky plumbing
C)the roof leaked during a rainstorm
D)the amount that they owed on their mortgage was less than the value of their house

Question 72

In Canada, an early symptom of the U.S. subprime mortgage market problem was the ________.

A)financial engineering of the asset-backed commercial paper market
B)freezing of the asset-backed commercial paper market
C)increase of the asset-backed commercial paper market
D)restructuring of the asset-backed commercial paper market

Question 73

Asset-backed commercial paper is backed by all of the following except ________.

A)unsecured promissory notes
B)mortgages
C)car loans
D)credit card receivables

Question 74

U.S. firms affected by the financial crisis included ________.

A)Bear Stearns and Merrill Lynch
B)AIG and JP Morgan
C)Manulife and RBC
D)Capital One and BNP Paribas

Question 75

"Plain vanilla" assets are ________.

A)unsecured promissory notes
B)residential mortgages
C)subprime mortgages
D)CDOs

Question 76

Credit rating agencies were subject to conflicts of interest in the subprime mortgage market because ________.

A)banks were earning large fees by underwriting the mortgage-backed securities
B)they had little incentives to make sure that the mortgage was a good credit risk
C)they had weak incentives to make sure that the holders of the securities would be paid back
D)they were earning fees from rating the mortgage-backed securities and from advising clients on how to structure the securities to get the highest ratings

Question 77

During the 2007-2009 financial crisis in the U.S. the credit spreads peaked at ________ in December 2008.

A)nearly 6 percent
B)nearly 5 percent
C)nearly 4 percent
D)3 percent

Question 78

What triggered the ABCP saga in Canada?

Question 79

Increased complexity of structured products can ________.

A)destroy information and improve adverse selection problems
B)increase information and worsen adverse selection problems
C)make asymmetric information better in the financial system
D)make asymmetric information worse in the financial system

Question 80

How can asymmetric information lead to a bank panic?