Deck 17: Financial Crisis

Question 1

When investors invest in something simply because everyone else is doing it, they are:

A) suspect to "tulip mania."
B) following a "herd instinct."
C) acting objectively on full information available in the market.
D) leveraging market performance for their own gain.

Answer 1

following a "herd instinct."

Question 2

In finance, leverage is using:

A) borrowed money to pay for investments.
B) the equity one owns to pay for investments planned in the future.
C) predicted earnings to pay for current investments.
D) forecasted future earnings to pay for current loans.

Answer 2

borrowed money to pay for investments.

Question 3

When investors become irrationally optimistic that an asset's price will continue to rise, it causes a financial bubble to:

A) start to inflate.
B) be on the verge of bursting.
C) burst.
D) become doubted by most serious investors.

Answer 3

start to inflate.

Question 4

A bubble is defined to be when:

A) an asset is not being traded very heavily.
B) financial advisors purposely trying to deceive the public and sell a worthless asset.
C) when the financial markets are trading an asset at much higher than historically justifiable prices.
D) there are a limited number of buyers of an asset which causes the market to crash.

Question 5

A financial bubble starts to inflate when:

A) investors become irrationally optimistic that an asset's price will continue to rise.
B) investors become irrationally pessimistic that an asset needs to be sold immediately.
C) a good experiences an unexplained rise in demand increasing its price.
D) inflation begins to accelerate, and monetary and fiscal policy are ineffective at slowing its growth.

Question 6

An investor who sees through irrational optimism of a market could:

A) earn a profit by betting against what everyone else is doing.
B) follow the lead of what most are doing, and earn consistent profits.
C) earn a profit by being a "leader" among the "herd."
D) be overwhelmed by market optimism and simply do what everyone else is doing.

Question 7

Financial markets are:

A) in many ways the purest expression of the market mechanism.
B) a powerful tool for the efficient allocation of scarce resources.
C) a global marketplace where sophisticated investors make billion-dollar decisions.
D) All of these statements are true.

Question 8

If the efficient-market hypothesis is true, then the idea of:

A) herd instinct holds.
B) herd instinct doesn't always hold.
C) tulip mania holds.
D) tulip mania doesn't always hold.

Question 9

The two interconnected concepts that lie at the heart of many financial crises are:

A) rational expectations and leverage.
B) irrational expectations and forecasting.
C) forecasting and leverage.
D) irrational expectations and leverage.

Question 10

In finance, leverage:

A) multiplies the effect of gains and losses in financial markets.
B) is using borrowed money to pay for investments.
C) helps explain why a crash is so damaging after a bubble bursts.
D) All of these statements are true.

Question 11

The recency effect is:

A) a basic human tendency to overvalue recent experience when trying to predict the future.
B) a hotly debated concept among psychologists and economists.
C) earning a profit by betting against what everyone else is doing.
D) accounting for most recent profits or losses first on financial statements.

Question 12

When investors follow a "herd instinct," they make decisions:

A) based on hearsay, not objective information.
B) based on emotion, not objective information.
C) as a group, inflating the prices of goods somewhat arbitrarily.
D) based on the sound logic of a group, rather than the individual.

Question 13

When investors use borrowed funds to pay for investments, it's called:

A) leveraging.
B) tulip mania.
C) hedging.
D) herding.

Question 14

When investors follow a "herd instinct," they:

A) invest in something as a group, making it appear more valuable than it is.
B) make decisions as a group, inflating the prices of goods somewhat arbitrarily.
C) invest in something simply because everyone else is doing it.
D) only makes decisions as a group, making it hard to determine individual behavior.

Question 15

When the U.S. housing market crashed, it caused all of the following except:

A) lenders to stop lending.
B) banks to go bust due people not paying their mortgages.
C) the U.S. economy to tip into the Great Recession.
D) all sellers of real estate to profit when selling their house.

Question 16

The basic human tendency to overvalue recent experience when trying to predict the future is called:

A) tulip mania.
B) the leverage effect.
C) herd instinct.
D) the recency effect.

Question 17

When the housing market bubble burst, many people found that:

A) they owed more than their house was now worth.
B) it was much easier to sell their home.
C) the value of their homes exceeded their mortgage loans.
D) there was a limited number of houses for sale.

Question 18

If the idea of herd instinct is true, it suggests that the:

A) efficient-market hypothesis doesn't always hold.
B) efficient-market hypothesis does, in fact, hold.
C) inefficient-market hypothesis doesn't always hold.
D) inefficient-market hypothesis does, in fact, hold.

Question 19

The first recorded example of a financial bubble was:

A) called the Enclosure Movement.
B) the "dot com" bubble of the 1990s.
C) a "tulip mania" in the 1600s.
D) the "stock market" bubble of the 1920s.

Question 20

The "housing bubble" discussed in the text book refers to:

A) housing prices rising much more quickly than the rest of prices in the economy.
B) housing prices within a certain area of the U.S. rising disproportionately with the rest of houses in the economy.
C) an unexplained increase in the demand for houses which caused the prices of houses to rise.
D) a supply shock to the housing market, which caused housing prices to increase.

Question 21

Leverage is thought to be:

A) a dangerous tool, especially for big companies who do not understand its risk.
B) the most widely used of hedging risk in markets.
C) the single reason for the Great depression.
D) a relatively riskless strategy used by companies to grow quickly.

Question 22

When financial markets are __________, leverage ______________; when they are _______, leverage ____________.

A) booming; multiplies the gains; crashing; magnifies the losses
B) booming; magnifies the losses; crashing; multiplies the gains
C) crashing; mitigates the losses; booming; mitigates the gains
D) crashing; magnifies the losses; booming; mitigates the gains

Question 23

If you lost 50 percent on $100 worth of stock in a 3x margin account, then you would lose:

A) $50.
B) $150.
C) $300.
D) $600.

Question 24

If you have $1,000 in an account that offers "3x" margin, you can effectively buy:

A) $1,000 worth of stocks.
B) $2,000 worth of guaranteed government bonds.
C) $3,000 worth of stocks.
D) $3,000 worth of guaranteed government bonds.

Question 25

Stock markets in England were started in the late:

A) Seventeenth century.
B) Sixteenth century.
C) Eighteenth century.
D) Nineteenth century.

Question 26

Margin calls are more likely to happen when markets are:

A) crashing.
B) booming.
C) stable.
D) irrational.

Question 27

If you lost 20 percent on $100 worth of stock in a 2x margin account, then you would:

A) lose $20.
B) gain $20.
C) lose $40.
D) gain $40.

Question 28

One of the first issuances of stock was offered by the:

A) East India Company.
B) South Seas Company.
C) Apple Company.
D) North Seas Company.

Question 29

Leveraging investments based on irrational expectations:

A) can lead to gradually deflating financial bubbles.
B) is cited as a root cause of financial crises.
C) explains the success of companies like Apple.
D) All of these statements are true.

Question 30

If you have $100 in an account that offers "2x" margin, you can effectively buy:

A) $200 worth of stocks.
B) $1,000 worth of stocks.
C) $100 worth of stocks.
D) $2,000 worth of stocks.

Question 31

If you lost 10 percent on $200 worth of stock in a 3x margin account, then you would lose:

A) $60.
B) $20.
C) $30.
D) $40.

Question 32

In the late 1600s, the stock being traded in London's Exchange Alley that created a financial bubble belonged to the:

A) South Seas Company.
B) East India Company.
C) Bubble Company.
D) Mediterranean Company.

Question 33

The English Parliament regulates companies that trade stock publicly through a law known as the:

A) Leverage Act.
B) Bubble Act.
C) Company Act.
D) Anti-Corruption Act.

Question 34

When your broker sees that you are in danger of running through your money and forces you to sell your stock and use the money to pay back your loan, he is making a:

A) margin call.
B) leverage call.
C) stock sales call.
D) futures call.

Question 35

The worst financial crisis in history was the:

A) Great Crash of 1929.
B) South Seas bubble.
C) Great Recession.
D) housing bubble of 2007.

Question 36

If you lost 10 percent on $200 worth of stock in a 2x margin account, then you would:

A) lose $20.
B) gain $20.
C) lose $40.
D) gain $40.

Question 37

Before it went bankrupt in 2008, Lehman Brothers investment bank had a leverage ratio of 30 which meant it was:

A) highly hedged.
B) in debt more than it was worth.
C) highly leveraged.
D) not very leveraged.

Question 38

A rapidly falling stock price would most likely trigger all of the following except:

A) a flood of margin calls.
B) massive sales of the stock.
C) the price to be pushed down even more.
D) a massive amount of purchases.

Question 39

In finance, the leverage ratio refers to:

A) how a firm decides to borrow funds that it doesn't have.
B) using borrowed money to pay for investments.
C) ratio of assets it has relative to its equity.
D) ratio of assets it has relative to debt.

Question 40

A margin call is when:

A) it looks like you are in danger of running through your money, and your broker forces you to sell your stock and use the money to pay back your loan.
B) the market reaches a tipping point, and the financial bubble bursts.
C) prices on future values of a stock are forecasted to be lower than current prices.
D) prices on future values of a stock are forecasted to be higher than current prices.

Question 41

Securitization is the practice of:

A) packaging individual debts into a single uniform asset that can be easily bought and sold.
B) the government guaranteeing repayment of risky home loans made to individuals with lower credit.
C) borrowing based on expected future earnings.
D) backing a security with a riskless asset.

Question 42

Which of the following actions did Congress NOT take in the 1930s, in an effort to prevent future financial crises like the stock market crash of 1929?

A) Glass-Steagall Banking Act
B) Formation of the SEC
C) Formation of the FDIC
D) Federal Reserve Act

Question 43

The financial crisis that began in late 2007 ended which era?

A) The Great Recovery
B) The Golden era
C) The Great Moderation
D) The Great Recession

Question 44

From 1922 to 1929, the total value of the stock market:

A) more than tripled.
B) decreased by nearly 50 percent.
C) decreased by nearly 90 percent.
D) stayed the same.

Question 45

How many years did it take the stock market to recover to the value it had been in September 1929?

A) 3 years
B) 10 years
C) 25 years
D) 54 years

Question 46

A mortgage loan made to a borrower with a low credit score is called a:

A) prime mortgage.
B) hi-risk mortgage loan.
C) bundled financial loan.
D) subprime mortgage.

Question 47

The stock market crash of 1929 led to:

A) the South Seas bubble burst.
B) the Great Depression.
C) the Great Recession.
D) Black Thursday.

Question 48

Subprime lending gained popularity because of all of the following, except:

A) investing in a home was seen as the safest investment one could make.
B) it was meant to encourage those with risky credit to make a safe investment.
C) the value of homes had not fallen for over 60 years.
D) helping poor to own a home.

Question 49

The overall drop in stock prices that began in 1929 and continued through 1932 was due to:

A) dropping stock prices causing a rational sale of certain stocks.
B) a panicked massive sale of stocks which caused the stock prices to plummet.
C) the exuberant confidence in the rising value of the stock market in general.
D) the decline in profitability of companies.

Question 50

The reforms introduced by Congress in the 1930s led to the era now referred to as the Great:

A) Moderation.
B) Crash.
C) Depression.
D) Recession.

Question 51

Which of the following actions did Congress take in the 1930s, in an effort to prevent future financial crises like the stock market crash of 1929?

A) Glass-Steagall Banking Act
B) Bubble Act
C) Hastings Banking Act
D) Formation of the CBO (Congressional Budget Office)

Question 52

The Great Depression was characterized by:

A) unemployment exceeding 25 percent.
B) the Roaring Twenties.
C) accelerated economic growth.
D) firms rapidly expanding their borrowing rates.

Question 53

After World War II, which of the following about the value of homes is not true?

A) On average they did not fall for 60 years.
B) They were unaffected by recessions until the 2000s.
C) They seemed immune to the business cycle.
D) It remained relatively unaffected by inflation.

Question 54

Subprime mortgages are mortgage loans:

A) made to borrowers with low credit scores.
B) that have less than prime interest rates.
C) made to borrowers with higher than average credit scores.
D) made at lower than general market interest rates.

Question 55

From 1929 to 1932, the total value of the stock market:

A) stayed the same.
B) more than tripled.
C) more than quadrupled.
D) decreased by nearly 90 percent.

Question 56

Banks became more willing to make subprime loans because of:

A) securitization.
B) leveraging.
C) hedging.
D) herd behavior.

Question 57

The reforms introduced by Congress in the 1930s led to:

A) the Great Crash.
B) relative financial stability for over 70 years.
C) a further decline that lasted for 25 years.
D) the Great Depression to be worse than it needed to be.

Question 58

The stock market crash of 1929 may have been avoided if:

A) investors had acted rationally.
B) investors had acted irrationally.
C) large companies had been more objective in their decision making.
D) large companies had been more emotional in their decision making.

Question 59

What event led to the end of the Great Moderation?

A) The Great Depression
B) The Great Crash
C) Stagflation
D) The Great Recession

Question 60

Which of the following actions did Congress take in the 1930s, in an effort to prevent future financial crises like the stock market crash of 1929?

A) Formation of the FDIC
B) Bubble Act
C) Formation of the Federal Reserve Bank
D) American Anti-Corruption Act

Question 61

In events leading to the collapse of the housing bubble, inflated home values caused consumers to:

A) save less and spend more.
B) spend less and save more.
C) spend more on homes and less on all other goods.
D) hold their savings to equity in their homes and stop saving more liquid forms of assets.

Question 62

Mortgage-backed securities are:

A) tradable assets made up of packages of individual mortgages.
B) investments that people bought based on the equity of their homes.
C) assets that were purchased based on the leveraged value of people's homes.
D) securities that are often purchased by homeowners.

Question 63

In events leading to the collapse of the housing bubble, inflated home values created a:

A) wealthier economy, which caused economic growth.
B) false sense of wealth, which increased aggregate demand.
C) false sense of wealth, which spurred economic growth to decrease.
D) wealthier economy, which caused inflation.

Question 64

The sudden explosion of cheap and readily available mortgages encouraged people to:

A) buy bigger and better homes.
B) become less risk-averse.
C) become more risk-averse.
D) securitize their investments.

Question 65

In events leading to the housing bubble, investment banks on Wall Street made money through the housing market by:

A) buying as many loans as possible to create mortgage-backed securities.
B) relying on banks to sell as few high-risk mortgages as possible.
C) ensuring local banks were making good loans.
D) offering low interest loans to those with very good credit.

Question 66

The same tools that were intended to allocate funds and spread risk more efficiently in the housing market made it:

A) easier to keep everyone fully informed.
B) more difficult to keep everyone fully informed.
C) easier to understand the true risk involved with these assets.
D) more difficult to justify buying mortgage-backed securities over other low-risk assets.

Question 67

One reason the housing bubble occurred is because the:

A) securitization of mortgages meant more mortgages were low-risk, attracting investors.
B) herd instinct caused everyone to stop buying homes.
C) recency effect affected people's perceptions of home values.
D) All of these statements are true.

Question 68

In events leading to the housing bubble, the credit-rating agencies rated the assets associated with the housing market proper:

A) mid-level ratings indicating moderate risk, but were ignored.
B) AAA ratings indicating low risk, but turned out to be a right judgment.
C) AAA ratings indicating low risk, and turned out to be too optimistic.
D) mid-level ratings indicating moderate risk, and turned out to be too pessimistic.

Question 69

The investors who bought mortgage-backed securities just before the housing bubble burst:

A) were not concerned about the original mortgage.
B) were all very comfortable assuming high-risk assets.
C) were not confident in the rising home value underlying each mortgage.
D) knew exactly what they were buying.

Question 70

As the housing market took off in the early 2000s:

A) household debt became positive for the first time since the Great Depression.
B) the growth in household debt slowed.
C) the growth in household debt accelerated.
D) household debt became negative for the first time since the Great Depression.

Question 71

The practice of securitization of mortgages:

A) pooled high-risk mortgages together, which raised the prices of them to investors.
B) allowed investors to profit from the mortgage payments without being exposed to any risk.
C) pooled the risk of mortgages, allowing higher risk mortgages to be more safely sold to investors.
D) was undertaken by government to guarantee the values of real estate.

Question 72

When the housing bubble occurred it can be attributed to all of the following except:

A) people expected housing prices to continue to rise.
B) it became easier to leverage more of a home's value, putting buyers more into debt.
C) the seller of the mortgage had lost incentive to properly assess the risk.
D) homeowners lack of confidence in the institutions who made the loan to them.

Question 73

Tranching makes it so that packages of reliable, low-risk mortgages could be sold to ______________, while higher-risk subprime mortgages could be sold to ___________.

A) more risk-averse investors; risk-loving investors
B) more risk-loving investors; risk-averse investors
C) national banks; local banks
D) local banks; the government

Question 74

By 2006, 20 percent of the mortgage market consisted of:

A) subprime loans, while 80 percent were still regular prime mortgages.
B) prime loans, and an overwhelming 80 percent had become subprime mortgages.
C) securitized loans, and the rest were backed by the government.
D) individual mortgage loans, and an overwhelming 80 percent had become securitized loans.

Question 75

Local banks could pass the risk involved in holding mortgage debts on to an investor with a higher risk tolerance using:

A) mortgage-backed securities.
B) leveraged securities.
C) leveraged investments.
D) government-backed securities.

Question 76

The practice of packaging individual debts into a single uniform asset that can be easily bought and sold is called:

A) leveraging.
B) securitization.
C) federally-backed financing.
D) bundled risk.

Question 77

The practice of dividing packages of debts into slices, each with different risk and return characteristics, is called:

A) leveraging.
B) bundling.
C) pooling.
D) tranching.

Question 78

The introduction of the practice of securitization allowed:

A) banks to more safely assume subprime mortgage loans.
B) the government to promote a sense of security in the banking industry.
C) banks to more safely leverage their investments.
D) borrowers to feel better about taking out subprime loans.

Question 79

Because local banks earn fees for each loan, their role to:

A) properly assess the risk of each borrower is misaligned with their incentive.
B) create not many mortgages perfectly aligns with their incentives.
C) provide mortgage loans only to those with low credit scores is misaligned with their incentive.
D) properly assess the risk of each borrower is perfectly aligned with their incentive.

Question 80

One reason the housing bubble occurred is because:

A) the recency effect caused homes to typically be undervalued.
B) the herd instinct caused everyone to believe home prices would continue to fall.
C) securitization removed much of the risk from the sellers of subprime mortgages.
D) All of these statements are true.