Question 1

Most U.S.financial crises have started during periods of ________ either after the start of a recession,a stock market crash,or the failure of a major financial institution.

Accepted Answer

Most U.S. financial crises have started during periods of high uncertainty, as evidenced by the start of the Great Depression in 1929, the Savings and Loan Crisis in the late 1980s, and the Global Financial Crisis of 2008. High uncertainty can result from a variety of factors, such as economic recessions, stock market crashes, or the failure of major financial institutions. These events can lead to a loss of confidence in the financial system, causing investors and consumers to pull back spending and exacerbating the crisis.

Question 2

A serious consequence of a financial crisis is

Accepted Answer

A financial crisis often leads to a contraction in economic activity, as credit becomes tight and consumer and business confidence drops. This can result in job losses, reduced investment, and a negative impact on GDP. Options B, C, and D are not necessarily serious consequences of a financial crisis but rather concepts or reactions that can occur during or after a crisis.

Question 3

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

Accepted Answer

A financial crisis is a major disruption in financial markets characterized by sharp declines in asset prices and firm failures. This can have significant impacts on the economy as a whole and can lead to recession or even depression. Examples include the 2008 global financial crisis and the 1929 stock market crash.

Question 4

When asset prices rise above their fundamental economic values,a(n)________ occurs.

Accepted Answer

When asset prices rise above their fundamental economic values, it creates a situation known as an asset-price bubble. This occurs when investors and traders bid up the prices for an asset to unsustainable levels driven by speculation, hype, and expectations without regard for the underlying economic fundamentals. When the bubble eventually bursts, it can lead to a significant decline in asset values and even cause economic recessions.

Question 5

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

Accepted Answer

The answer of Typically,the economy recovers fairly quickly from a...

Question 6

________ are asymmetric information problems that act as a barrier to efficient allocation of capital.

Accepted Answer

Financial frictions such as adverse selection and moral hazard can create asymmetry of information between borrowers and lenders, causing credit rationing and hindering the efficient allocation of capital. Asset prices, credit imbalances, and financial derivatives may also be affected by asymmetric information, but they are not the root cause of the problem.

Question 7

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

Accepted Answer

Securitization is the process of combining smaller loans into a single pool and then issuing securities backed by that pool. This allows lenders to free up capital for new loans while investors can purchase securities with a reduced risk profile.

Question 8

Debt deflation occurs when

Accepted Answer

Debt deflation refers to an economic situation where falling prices lead to a decline in the value of assets that serve as collateral, such as real estate or stocks, which make it difficult for borrowers to repay their existing debts, leading to a further drop in prices, a decrease in net worth, and an increase in indebtedness. This, in turn, can trigger a downward spiral in economic activity as consumers, firms, and financial institutions struggle to service their debt obligations, reducing spending, investment, and lending. Option A captures this scenario most accurately. Option B refers to the adverse selection and moral hazard problems that arise when the cost of borrowing becomes expensive, but this is not directly related to debt deflation. Option C refers to equity deflation or falling stock prices that lower the value of pledged collateral; this can exacerbate debt deflation but is not the cause of it. Option D is irrelevant to debt deflation.

Question 9

In a bank panic,the source of contagion is the

Accepted Answer

In a bank panic, the source of contagion is the asymmetric information problem. This occurs when some investors or depositors have information that others do not, leading to a loss of confidence and a rush to withdraw funds, which can ultimately cause the bank to fail.

Question 10

A ________ pays out cash flows from a collection of assets in different tranches,with the highest-rated tranch paying out first,while lower ones paid out less if there are losses on the underlying assets.

Accepted Answer

This describes a collateralized debt obligation (CDO), which is a type of structured asset-backed security. Essentially, it is a pool of different assets (usually loans or bonds) that are divided into tranches based on the level of risk. The highest-rated tranches receive the best credit ratings and have the lowest risk of default, so they receive the first payments from the underlying assets. The lower-rated tranches have higher risk and therefore receive lower payments or even no payments if there are losses on the underlying assets.

Question 11

Financial crises in advanced economies might start from a

Accepted Answer

The answer of Financial crises in advanced economies might start...

Question 12

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

Accepted Answer

The withdrawal of funds from banks due to uncertainty about their health can lead to a banking crisis, as banks may not have enough reserves to cover all the withdrawal requests, leading to a cascade of bank failures and the potential for a wider economic recession.

Question 13

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.

Accepted Answer

Debt deflation refers to a situation where falling prices lead to a chain reaction of defaults, asset sales, and further price declines, which ultimately causes a reduction in the money supply and a contraction in economic activity. This was a major factor that contributed to the severity and length of the Great Depression. Choices B, C, and D are not relevant to the causes of the Great Depression.

Question 14

The ________,the difference between the interest rate on Baa corporate bonds and U.S.Treasury bonds.rose sharply during the Great Depression.

Accepted Answer

The credit spread is the difference between the interest rate on corporate bonds and U.S. Treasury bonds. During the Great Depression, this spread rose sharply, indicating increased risk and uncertainty in the corporate bond market.

Question 15

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

Accepted Answer

When financial institutions expand their lending at a rapid pace, they are participating in a credit boom. This can lead to an increase in debt levels and asset prices, which can ultimately result in a credit bubble and subsequent bust.

Question 16

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

Accepted Answer

Deleveraging by financial intermediaries leads to a decrease in their lending activities, resulting in reduced availability of funds for investment by firms. This can lead to a contraction of economic activity due to a decline in investment, leading to reduced production, income, and employment.

Question 17

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

Accepted Answer

The three stages of a financial crisis are typically triggered by asset price declines, which lead to banking crises as financial institutions suffer losses from the declining asset values. This can then lead to an unanticipated decline in the price level as a result of the banking crises and overall economic uncertainty.

Question 18

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

Accepted Answer

Debt deflation refers to a situation in which falling prices lead to an increase in the real value of debt, thus causing a decrease in net worth for firms and individuals. This can lead to decreased investment, consumption, and economic growth, which can stall a recovery from a recession. Moral hazard refers to situations in which individuals or firms take on riskier behavior because they are protected from the full consequences of their actions. Insolvency refers to a situation in which a firm or individual is unable to meet their financial obligations, while illiquidity refers to a situation in which assets cannot be sold quickly enough to meet financial obligations. While these concepts may be related to a decrease in the aggregate price level, they do not directly address the issue of stalled recovery from a recession.

Question 19

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

Accepted Answer

A financial crisis occurs when there is a disruption in the financial system, leading to an increase in asymmetric information. This increase results in adverse selection and moral hazard problems, reducing the efficiency of financial markets in allocating funds. This, in turn, leads to a reduction in economic activity and can have severe consequences for the overall economy.

Question 20

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

Accepted Answer

When the value of loans begins to drop, the net worth of financial institutions falls, which leads them to cut back on lending in a process called deleveraging. This is because financial institutions rely on their net worth to maintain their loan-to-value ratios and meet regulatory requirements, and if their net worth falls, they may be forced to reduce their lending to maintain their ratios and stay in compliance. Therefore, deleveraging is the correct answer.

Quiz 12: Financial Crises