Question 1

Which of the following describes the relationship between interest rates and interest-sensitive goods, such as housing?
A) As interest rates decline, the demand for interest-sensitive goods increases.
B) As interest rates decline, the demand for interest-sensitive goods decreases.
C) As interest rates increase, the demand for interest-sensitive goods increases, driving prices upward.
D) As interest rates increase, the demand for interest-sensitive goods decreases, driving prices upward.

Accepted Answer

As interest rates decline, the cost of borrowing money decreases, making it easier for consumers to access credit and finance purchases such as homes. This increase in affordability and access leads to an increase in demand for interest-sensitive goods, such as housing. Therefore, choice A accurately describes the relationship between interest rates and interest-sensitive goods.

Question 2

Fannie Mae and Freddie Mac's rapid increase in the percentage of all mortgages held encouraged mortgage lenders to
A) tighten credit standards and decrease the number of sub-prime loans extended to borrowers.
B) offer lower rates than what Fannie Mae and Freddie Mac could offer.
C) lower credit standards and offer terms acceptable to Fannie Mae and Freddie Mac.
D) scrutinize the credit-worthiness of borrowers and require higher down payments on mortgages.

Accepted Answer

The answer of Fannie Mae and Freddie Mac's rapid increase...

Question 3

Regulatory policies requiring lenders to extend more low down-payment loans to higher-risk borrowers along with the Fed's low short-term interest rate policy during 2002-2004 caused
A) an increase in demand for housing and higher housing prices.
B) an increase in demand for housing and lower housing prices.
C) a reduction in demand for housing and higher housing prices.
D) a reduction in demand for housing and lower housing prices.

Accepted Answer

The regulatory policies requiring lenders to extend more low down-payment loans to higher-risk borrowers led to an increase in demand for housing from these borrowers. Additionally, the Fed's low short-term interest rate policy made the cost of borrowing lower, encouraging more people to take out mortgages and buy homes. With more demand for housing but limited supply, housing prices increased.

Question 4

Interest payments on home mortgages and home equity loans are tax deductible. This tax deductibility encourages households to
A) shift other forms of debt to their home mortgage.
B) increase the equity in their house.
C) make larger payments and pay down their mortgage loan more rapidly.
D) decrease the overall amount of household debt in relation to household income.

Accepted Answer

The answer of Interest payments on home mortgages and home...

Question 5

Adjustable rate mortgages became increasingly attractive and grew as a percentage of total outstanding mortgages during 2002 to 2004 because
A) interest rates were kept artificially low during this period.
B) interest rates rose sharply during this period.
C) lending standards were tightened during this period.
D) housing prices declined during this period.

Accepted Answer

Adjustable rate mortgages often have a lower initial interest rate than fixed rate mortgages. During 2002 to 2004, the Federal Reserve kept interest rates low to stimulate the economy after the 2001 recession, making adjustable rate mortgages more attractive to borrowers.

Question 6

Between 2001 and 2005, sub-prime (including Atl-A) mortgages ____________ as a share of the total.
A) fell from 30 percent to less than 10 percent
B) rose from 5 percent to 10 percent
C) rose from 10 percent to more than 30 percent
D) fell from more than 20 percent to less than 10 percent

Accepted Answer

According to the passage, sub-prime mortgages (including Atl-A) rose from 10 percent to more than 30 percent between 2001 and 2005.

Question 7

Which of the following contributed to the soaring housing prices during 2002-2004?
A) the Fed's high-interest rate policy
B) the tightening of loan standards by commercial lenders
C) the increasing popularity of fixed-rate, long-term loans to lock in low interest rates
D) the Fed's low-interest rate policy

Accepted Answer

The Fed's low-interest rate policy contributed to the soaring housing prices during 2002-2004 as it made it easier for people to obtain loans, resulting in increased demand for housing and driving up prices.

Question 8

Which of the following was the result of Fannie Mae and Freddie Mac being both privately-owned and government-sponsored enterprises?
A) Their government sponsorship increased their cost of acquiring loanable funds.
B) They were unable to earn profits and pay dividends to their shareholders.
C) Congressional regulations exerted little or no impact on their business operations.
D) Their activities were more susceptible to political influence and favoritism.

Accepted Answer

Fannie Mae and Freddie Mac being both privately-owned and government-sponsored enterprises made their activities more susceptible to political influence and favoritism. This was because they were able to receive support and bailouts from the government, but they were also driven by profit motives, which created a conflict of interest. This led to risky behavior, such as offering loans to individuals with poor credit histories or insufficient income to cover the mortgage. These actions contributed to the 2008 financial crisis.

Question 9

Between 2001-2005,
A) both sub-prime and adjustable rate mortgages decreased as a share of the total.
B) both sub-prime and adjustable rate mortgages increased as a share of the total.
C) sub-prime loans increased, but adjustable rate loans decreased as a share of the total.
D) sub-prime loans decreased, but adjustable rate loans increased as a share of the total.

Accepted Answer

The answer of Between 2001-2005,
A) both sub-prime and adjustable rate...

Question 10

The increase of sub-prime (including Alt-A) loans as a share of the total from 2001-2005 was an important contributing factor to the economic crisis of 2008 because
A) these loans initially reduced the demand for housing.
B) these loans initially reduced housing prices.
C) the default and foreclosure rates on these loans are several times higher than conventional loans to prime borrowers.
D) the default and foreclosure rates on these loans are considerably lower than conventional loans to prime borrowers.

Accepted Answer

The default and foreclosure rates on sub-prime loans (including Alt-A) were several times higher than conventional loans to prime borrowers. This led to a significant amount of defaults and foreclosures, resulting in a housing market collapse and ultimately contributing to the 2008 economic crisis.

Question 11

Residential mortgages historically carried a capital requirement of 4 percent. Why did these mortgages, bundled as part of the mortgage-backed securities issued by investment banks, turn out to be far more risky than historically indicated?
A) Rating agencies miscalculated the historical risk of traditional fixed-rate residential mortgages.
B) Investment banks leveraged these mortgage-backed securities more than was allowable under SEC rules.
C) Lower mortgage lending standards increased the likelihood that defaults would occur.
D) Investment banks held too much capital relative to these mortgage-backed securities.

Accepted Answer

Lower mortgage lending standards increased the likelihood that defaults would occur, leading to higher risk than historically indicated.

Question 12

Based on the rising housing prices of 2000-2005, many buyers opted for interest-only loans and variable rate mortgages with little or no down payment because
A) they expected short-term interest rates to fall substantially in the future and this would reduce their monthly mortgage payment in the years ahead.
B) variable rate mortgages are a good way to reduce the risk accompanying your investment when you plan to stay in the house for a long time.
C) they thought housing prices would continue to rise and therefore they would be able to sell the house for a profit within a couple of years.
D) they could easily recoup their investment, even if there was a downturn in housing prices in the future.

Accepted Answer

The answer of Based on the rising housing prices of...

Question 13

Which of the following is most likely to result from a rising household debt/income ratio?
A) Household income will rise rapidly.
B) Household consumption will fall as a share of income.
C) Households will be in a better position to deal with unexpected events that force major adjustments.
D) A larger share of household income will be required to meet interest payments on debt.

Accepted Answer

As the household debt/income ratio rises, a larger share of household income will be required to meet interest payments on debt, reducing the amount of money available for household consumption.

Question 14

Which of the following was a contributing factor to the rising default and foreclosure rates beginning in the latter half of 2006?
A) the increasing share of 30-year, fixed rate loans as a share of outstanding mortgages
B) the rigid standards of rating agencies, such as Moody's and Standard and Poors, which limited the development of mortgage-backed securities
C) the price-stability policies of the Federal Reserve during 1998-2008
D) the erosion of lending standards during the preceding decade

Accepted Answer

The erosion of lending standards during the preceding decade contributed significantly to the rising default and foreclosure rates beginning in the latter half of 2006. Lending standards were relaxed, and loans were given to people who did not have the capacity to pay them back, resulting in a high level of default and foreclosure.

Question 15

Fannie Mae and Freddie Mac's dominance of the secondary mortgage market during 1995-2008 encouraged mortgage originators to
A) extend only 30-year, fixed-rate mortgages.
B) require higher down payments in order to obtain a home mortgage.
C) loosen lending standards as long as the mortgages were acceptable to Fannie Mae and Freddie Mac.
D) scrutinize the credit-worthiness of borrowers more carefully.

Accepted Answer

Fannie Mae and Freddie Mac's dominant position in the secondary mortgage market during 1995-2008 gave originators confidence that they could sell the mortgages they originated to these GSEs. This encouraged lenders to loosen their lending standards as long as the mortgages met the criteria set by Fannie Mae and Freddie Mac. As a result, risky loans were made and sold to these institutions, contributing to the subprime mortgage crisis.

Question 16

The leverage ratio of an investment firm refers to
A) the ratio of its investment holdings relative to its vault cash.
B) the ratio of its investment holdings relative to its capital.
C) the percentage of deposits held by the firm relative to its deposits with Federal Reserve banks.
D) the percentage of down payments made to the investment firm relative to the size of mortgages issued by the firm.

Accepted Answer

The leverage ratio of an investment firm refers to the ratio of its investment holdings relative to its capital. This measures the amount of debt the firm is using to finance its investments, and a higher leverage ratio indicates a greater level of risk.

Question 17

A sub-prime loan is a loan extended to borrowers
A) at a subsidized interest rate below the prime rate normally offered to the most creditworthy borrowers.
B) with blemished credit or limited documentation of their income, employment history, and other indicators of credit worthiness.
C) seeking a 30-year, fixed rate mortgage.
D) who have a FICO score above 660.

Accepted Answer

Sub-prime loans are typically extended to borrowers with blemished credit or limited documentation of their creditworthiness. They generally have higher interest rates to compensate for the increased risk of default.

Question 18

Regulatory policies requiring lenders to extend more low down-payment loans to higher-risk borrowers along with the Fed's low short-term interest rate policy during 2002-2004 caused
A) housing prices to fall during that period.
B) a reduction in the use of adjustable rate mortgages to finance the purchase of housing.
C) a reduction in housing construction during 2002-2005.
D) mal-investment, that is, excessive investment in housing construction during 2002-2005.

Accepted Answer

Regulatory policies requiring lenders to extend more low down-payment loans to higher-risk borrowers, along with the Fed's low short-term interest rate policy during 2002-2004, led to mal-investment in housing construction during 2002-2005, as many builders and investors became overly optimistic about the potential profits in the housing market. This led to an excessive supply of housing units, which ultimately contributed to the bursting of the housing bubble and the subsequent financial crisis. Housing prices did not fall during that period and the use of adjustable rate mortgages actually increased.

Question 19

What was the original stated purpose of Fannie Mae and Freddie Mac?
A) to allow the government to extend loans directly to low-income and minority households
B) to help provide liquidity in the secondary mortgage markets
C) to operate as non-profit entities that would provide competition for for-profit mortgage companies
D) to take on mortgages going into default in order to prevent them from going into foreclosure

Accepted Answer

The original stated purpose of Fannie Mae and Freddie Mac was to help provide liquidity in the secondary mortgage markets. This means that they were created to encourage lenders to make more loans by purchasing mortgages from them and then selling them as securities to investors. This would allow lenders to free up capital to make new loans, increasing homeownership rates and boosting the economy. It was not their original purpose to extend loans directly to low-income and minority households or to operate as non-profit entities. While they may have taken on mortgages going into default to prevent foreclosures, this was not their primary purpose.

Question 20

During the 1980s and 1990s, the Federal Reserve's monetary policy focused primarily on
A) keeping short-term interest rates low in order to stimulate real output and economic growth.
B) a variety of factors, such as unemployment and real GDP, resulting in variable inflation rates throughout this period.
C) keeping inflation low and the general price level relatively stable.
D) monetary expansion in order to reduce unemployment.

Accepted Answer

During the 1980s and 1990s, the Federal Reserve's monetary policy was primarily focused on keeping inflation low and stable. This was reflected in the Fed's adoption of a target for the federal funds rate, which was intended to influence borrowing costs and ultimately control inflation. This policy approach was seen as successful in bringing down inflation rates from double digits in the 1970s to more manageable levels in the 1980s and 1990s.

Quiz 16: Applying the Basics: Special Topics in Economics

Which of the following describes the relationship between interest rates and interest-sensitive goods, such as housing?

Fannie Mae and Freddie Mac's rapid increase in the percentage of all mortgages held encouraged mortgage lenders to

Regulatory policies requiring lenders to extend more low down-payment loans to higher-risk borrowers along with the Fed's low short-term interest rate policy during 2002-2004 caused

Interest payments on home mortgages and home equity loans are tax deductible. This tax deductibility encourages households to

Adjustable rate mortgages became increasingly attractive and grew as a percentage of total outstanding mortgages during 2002 to 2004 because

Between 2001 and 2005, sub-prime (including Atl-A) mortgages ____________ as a share of the total.

Which of the following contributed to the soaring housing prices during 2002-2004?

Which of the following was the result of Fannie Mae and Freddie Mac being both privately-owned and government-sponsored enterprises?

Between 2001-2005,

The increase of sub-prime (including Alt-A) loans as a share of the total from 2001-2005 was an important contributing factor to the economic crisis of 2008 because

Residential mortgages historically carried a capital requirement of 4 percent. Why did these mortgages, bundled as part of the mortgage-backed securities issued by investment banks, turn out to be far more risky than historically indicated?

Based on the rising housing prices of 2000-2005, many buyers opted for interest-only loans and variable rate mortgages with little or no down payment because

Which of the following is most likely to result from a rising household debt/income ratio?

Which of the following was a contributing factor to the rising default and foreclosure rates beginning in the latter half of 2006?

Fannie Mae and Freddie Mac's dominance of the secondary mortgage market during 1995-2008 encouraged mortgage originators to

The leverage ratio of an investment firm refers to

A sub-prime loan is a loan extended to borrowers

Regulatory policies requiring lenders to extend more low down-payment loans to higher-risk borrowers along with the Fed's low short-term interest rate policy during 2002-2004 caused

What was the original stated purpose of Fannie Mae and Freddie Mac?

During the 1980s and 1990s, the Federal Reserve's monetary policy focused primarily on