Question 1

Prior to the U.S. financial crisis of 2008-2009, financial regulation in the United States consisted of a _____ system of regulators, which the Dodd-Frank Act sought to improve upon by _____ the number of regulatory bodies.

Accepted Answer

The answer of Prior to the U.S. financial crisis of...

Question 2

How do deposit insurance and the "too big to fail" policy increase moral hazard?

Accepted Answer

The answer of How do deposit insurance and the "too...

Question 3

The benefit of stricter capital requirements for shadow banks is _____, while the cost is _____.

Accepted Answer

Stricter capital requirements for shadow banks enhance financial stability by ensuring they have enough capital to absorb losses, but they may also impede financial intermediation by limiting the banks' ability to lend and invest.

Question 4

The Volcker rule restricts excessive risk-taking by commercial banks by:

Accepted Answer

The Volcker Rule, part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, specifically prohibits banks from engaging in proprietary trading and from owning or investing in hedge funds or private equity funds, which are considered speculative investments. This is aimed at reducing the risk of financial institutions engaging in excessively risky activities that could threaten the overall financial system.

Question 5

The government making loans that are secured by collateral of dubious value to prop up the financial system is an example of:

Accepted Answer

Risky lending refers to providing loans with high credit risk, which increases the likelihood of loan defaults. Making loans secured by collateral of dubious value is a type of risky lending where the collateral may not be sufficient to cover the loan if the borrower defaults. This is not a capital injection or conventional monetary policy as those involve injecting funds into the financial system or adjusting interest rates, respectively. It is also not necessarily a giveaway of public funds as the loans may be intended to be repaid.

Question 6

Identify whether each of the following situations is a case of adverse selection or moral hazard. Explain.
a.Jasper knows, but the car rental company does not know when he is trying to rent a car during a blizzard in Winnipeg, that Jasper grew up in a tropical climate and has no idea how to drive in cold weather and snowy conditions.
b.Joan has received a loan from the bank to finance the purchase of more inventory for her quilt shop, but she intends to use the money (without telling the bank) to go on a safari in Africa.
c.Some companies sell annuities, which are policies that make periodic payments as long as the purchaser lives. Jane is trying to buy an annuity. Jane knows, but the annuity issuers do not know, that people in Jane's family routinely live to age 100.

Accepted Answer

The answer of Identify whether each of the following situations...

Question 7

What are the problems that hinder any direct transaction between the lender and borrower? What role do banks play in mitigating those issues?

Accepted Answer

The answer of What are the problems that hinder any...

Question 8

Two policies that are intended to make the financial system more stable by restricting the size of financial institutions are:

Accepted Answer

Restricting mergers among large banks and requiring higher capital requirements for large banks can help make the financial system more stable by preventing consolidation of risk and ensuring that large institutions have enough capital to weather any financial shocks. The other options (A, B, and D) could potentially exacerbate the problem of "too-big-to-fail" and increase the risk of taxpayer-funded bailouts.

Question 9

Proponents of restricting the size of financial institutions believe this policy will _____, while opponents believe this policy will _____.

Accepted Answer

Proponents argue that smaller financial institutions would lead to a more stable financial system by reducing the risk posed by "too big to fail" entities. Opponents argue that restrictions could increase operational costs due to the loss of economies of scale and other efficiencies.

Question 10

The phrase _____ describes a financial institution so central to that financial system that policymakers will not allow it to enter bankruptcy.

Accepted Answer

The phrase "too big to fail" refers to financial institutions that are so large and interconnected that their failure would be disastrous to the economy, prompting government intervention to prevent bankruptcy.

Question 11

Which of the following policies are intended to reduce the likelihood of future financial crises?

Accepted Answer

All of the policies mentioned (restricting the size of financial firms, limiting excessive risk taking, and reforming regulatory agencies) are intended to reduce the likelihood of future financial crises. By limiting the size of financial firms, the concentration of risk is reduced, while limiting excessive risk taking helps prevent a buildup of financial imbalances. Additionally, reforming regulatory agencies helps ensure that they have the necessary tools and mandates to oversee the financial system effectively. Therefore, all of these policies are crucial in preventing future financial crises.

Question 12

There are systematic risks and idiosyncratic risks. Which risks can be mitigated by whom and how?

Accepted Answer

The answer of There are systematic risks and idiosyncratic risks....

Question 13

Deposit insurance is an example of _____ used to prop up the financial system.

Accepted Answer

The answer of Deposit insurance is an example of _____...

Question 14

"The less healthy a person is, the more likely he or she is to purchase insurance." This is a fact stated by an employee of a health insurance company. Is this issue related to adverse selection? If yes, how?

Accepted Answer

The answer of "The less healthy a person is, the...

Question 15

Sovereign debt refers to debt issued:

Accepted Answer

Sovereign debt refers to debt issued by governments, so option C is the correct choice. Options A, B, and D are not accurate definitions of sovereign debt.

Question 16

Provide one example from the 2008-2009 U.S. financial crisis of how the following types of policies were used to respond to the crisis:
a.conventional monetary and fiscal policy
b.lender of last resort
c.injections of government funds

Accepted Answer

The answer of Provide one example from the 2008-2009 U.S....

Question 17

All of the following are examples of U.S. shadow banks except:

Accepted Answer

Bank of America is a traditional commercial bank, not a shadow bank. Shadow banks include financial institutions like Bear Stearns, AIG, and Lehman Brothers that engage in banking activities outside traditional banking regulations.

Question 18

The government purchasing ownership stakes in a faltering financial institution in order to prop up the financial system is an example of:

Accepted Answer

This is an example of a capital injection, where the government injects capital into a financial institution to improve its financial position and prevent it from collapsing. This is typically done to prevent systemic risks to the financial system as a whole.

Question 19

The purpose of the U.S. Financial Services Oversight Council, which was created by the Dodd-Frank Act, is to:

Accepted Answer

The U.S. Financial Services Oversight Council was established to coordinate the activities of various U.S. regulatory agencies to identify and respond to risks to the financial stability of the United States.

Question 20

The potential problem faced by the rest of Europe in the event of a Greek debt default is:

Accepted Answer

If Greece were to default on its debt, the banks that hold its debt would become insolvent, causing a ripple effect throughout the European banking system. This could potentially lead to a wider financial crisis across Europe.

Quiz 18: The Financial System: Opportunities and Dangers

Prior to the U.S. financial crisis of 2008-2009, financial regulation in the United States consisted of a _ system of regulators, which the Dodd-Frank Act sought to improve upon by _ the number of regulatory bodies.