Question 1

To reassure investors who were unwilling to buy mortgages in the secondary market,the U.S.Congress used two government sponsored enterprises,________,to sell bonds to investors and use the funds to purchase mortgages from banks.

Accepted Answer

Fannie Mae and Freddie Mac were created by Congress to provide stability to the secondary mortgage market by buying mortgages from banks and selling bonds to investors. This helped to reassure investors and increase the availability of funds for banks to lend for mortgages.

Question 2

While many analysts defended the actions taken by the Fed and the Treasury to respond to the financial crisis in 2008,others were critical of these actions.The critics were concerned that by not allowing large firms to fail

Accepted Answer

Critics argued that rescuing large firms sets a precedent, encouraging other firms to take on excessive risk with the expectation of government bailouts, a concept known as "moral hazard."

Question 3

A financial asset is considered ________ if it can be sold in a secondary market.

Accepted Answer

A financial asset is considered a security if it can be sold in a secondary market. Securities include stocks, bonds, and mutual funds. Commodity refers to physical goods like gold or oil. Liability refers to a company's debts or obligations. Durable refers to a physical product's ability to remain in good condition over time.

Question 4

The Federal Reserve responded to the 2008 financial crisis in several ways.Which of the following is one of the ways the Fed responded?

Accepted Answer

The Fed engaged in a process called quantitative easing, where it lent investment banks Treasury securities in exchange for mortgage-backed securities. This was done to increase the liquidity of the banks and stimulate lending. Option A is incorrect as investment banks were allowed to obtain discount loans. Option C is partially correct, as the Fed did lower the required reserve ratio, but it was on all types of deposits, not just demand deposits. Option D is incorrect as the Fed did not help Citibank acquire General Motors or Chrysler.

Question 5

Although the Federal Reserve had traditionally made discount loans only to ________,in response to the financial crisis in 2008 the Fed made primary dealers eligible for discount loans as well.

Accepted Answer

The Federal Reserve traditionally made discount loans primarily to commercial banks. In response to the financial crisis in 2008, it expanded eligibility to include primary dealers, which are not limited to commercial banks but can include other financial institutions.

Question 6

The larger the fraction of an investment financed by borrowing

Accepted Answer

Financing a larger portion of an investment with borrowing (leverage) amplifies both potential returns and potential losses because the investor is using borrowed funds to increase the size of the investment, which magnifies outcomes in both directions.

Question 7

Which of the following explains why mortgages weren't considered securities prior to 1970?

Accepted Answer

Prior to 1970, mortgages were rarely resold in the secondary market, which means they were not considered securities as they didn't fit the definition of a security at the time.

Question 8

In October 2008,Congress passed the ________,under which the Treasury provided funds to banks in exchange for stock.

Accepted Answer

The Troubled Asset Relief Program (TARP) was passed by Congress in October 2008, which provided funds to banks in exchange for stock.

Question 9

In 2008,the Treasury and Federal Reserve took action to save large financial firms such as Bear Stearns and AIG from failing.Which of the following is one reason why these measures were taken?

Accepted Answer

If a large financial firm were to declare bankruptcy, it would have to sell off its holdings of securities. This would flood the market with securities, which would lead to a decrease in their value. As a result, other firms that hold these securities would also face losses, which could lead to their failure. This domino effect could put the entire financial system at risk, leading to a severe economic downturn. Therefore, the government took action to prevent the failure of these firms to avoid such a scenario.

Question 10

When housing prices ________,as they did beginning in 2006 following the housing market bubble,consumption spending on furniture,appliances,and home improvements decline as many households find it ________ to borrow against the value of their homes.

Accepted Answer

When housing prices fall, it becomes harder for households to borrow against the value of their homes. This is because their equity in their homes decreases, making it harder for them to tap into that equity to spend on furniture, appliances, and home improvements.

Question 11

By the 2000s,an important change in the mortgage market had occurred when ________ became significant participants in the secondary market for mortgages.

Accepted Answer

Investment banks became significant participants in the secondary market for mortgages in the 2000s. This was due to the growth of mortgage-backed securities, which investment banks packaged and sold to investors.

Question 12

If the amount you owe on your house is greater than the price of the house,you have

Accepted Answer

If you owe more on your house than its current value, you have negative equity in your house. This means that if you were to sell the house, you would not make enough money to pay off the mortgage. It is important to address negative equity and work to increase the value of the house or pay down the mortgage to avoid financial issues in the future.

Question 13

Although the Federal Reserve had traditionally made discount loans only to commercial banks,in response to the financial crisis in 2008 the Fed made ________ eligible for discount loans as well.

Accepted Answer

In response to the financial crisis in 2008, the Federal Reserve made primary dealers eligible for discount loans in addition to commercial banks. Primary dealers are brokers or dealers who trade securities directly with the Federal Reserve Bank of New York.

Question 14

By the 2000s,an important market change occurred when investment banks became significant participants in the secondary market for

Accepted Answer

By the 2000s, investment banks had become significant participants in the secondary market for mortgages, particularly through the securitization of mortgage-backed securities. This played a key role in the financial dynamics leading up to the 2008 financial crisis.

Question 15

The Federal Reserve responded to the 2008 financial crisis in several ways.Which of the following is not one of the ways the Fed responded?

Accepted Answer

The Fed actually raised the required reserve ratio during the financial crisis in order to prevent banks from overextending themselves with risky loans. The other options listed are accurate responses by the Fed to the crisis.

Question 16

By the height of the housing bubble in 2005 and early 2006,lenders had greatly loosened the standards for obtaining a mortgage loan,with many mortgages being granted to sub-prime borrowers ________ and "Alt-A" borrowers ________.

Accepted Answer

By the height of the housing bubble in 2005 and early 2006, lenders had greatly loosened the standards for obtaining a mortgage loan. Many mortgages were granted to sub-prime borrowers with flawed credit histories who did not document their incomes. Alt-A borrowers were also granted loans without verifying their incomes or employment, but they typically had better credit scores than sub-prime borrowers.

Question 17

When housing prices ________ as they did beginning in 2006 following the housing market bubble,most banks and other lenders tightened the requirement for borrowers,making it ________ for potential home buyers to obtain mortgages.

Accepted Answer

When housing prices fell, banks and other lenders tightened the requirements for borrowers, making it harder for potential home buyers to obtain mortgages.

Question 18

By the height of the housing bubble in 2005 and early 2006,lenders had greatly loosened the standards for obtaining a mortgage loan,with many mortgages being granted to ________ borrowers with flawed credit histories and ________ borrowers who did not document their incomes.

Accepted Answer

The term "sub-prime" refers to borrowers with flawed credit histories, while "Alt-A" refers to borrowers who did not document their incomes. These were the types of borrowers who were being granted mortgages during the height of the housing bubble. The other options listed are not relevant or accurate to the situation.

Question 19

To reassure investors who were unwilling to buy mortgages in the secondary market,the U.S.Congress used two government sponsored enterprises,Fannie Mae and Freddie Mac,to stand between investors and banks that grant mortgages.Fannie Mae and Freddie Mac

Accepted Answer

Fannie Mae and Freddie Mac sell bonds to investors and use the funds to purchase mortgages from banks. This ensures that investors can easily buy and sell mortgage-backed securities without having to take on the risk of lending directly to homeowners. Fannie Mae and Freddie Mac also provide guarantees on these mortgages, further reducing the risk for investors.

Question 20

Firms that participate in regular open market transactions with the Federal Reserve are called

Accepted Answer

Firms that participate in regular open market transactions with the Federal Reserve are known as primary dealers. These primary dealers are firms that are authorized to trade securities directly with the Federal Reserve Bank of New York, which is the Federal Reserve's main operational arm. The primary dealers play a critical role in the functioning of the monetary policy, as they are the principal counterparties for the Federal Reserve's open market operations.

Quiz 15: Monetary Policy