Deck 33: Financial Crisis

Question 1

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.

Answer 1

the recency effect.

Question 2

When the U.S.housing market crashed,it caused:

A)lenders to stop lending.
B)banks to go bust.
C)the U.S.economy to tip into the Great Recession.
D)All of these statements are true.

Answer 2

All of these statements are true.

Question 3

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.

Answer 3

All of these statements are true.

Question 4

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)None of these statements is true.

Question 5

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)None of these statements is true.

Question 6

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 7

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 8

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.

Question 9

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)None of these statements is true.

Question 10

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 11

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 a rise in demand that is unexplained,increasing its price.
D)inflation begins to accelerate,and monetary and fiscal policy are ineffective at slowing its growth.

Question 12

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 13

Markets are a powerful tool for the efficient allocation of:

A)money.
B)scarce resources.
C)bartered goods.
D)All of these statements are true.

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)None of these statements is true.

Question 15

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

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

Question 16

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

A)to start to inflate.
B)to be on the verge of bursting.
C)to burst.
D)None of these statements is likely.

Question 17

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

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

Question 18

The "housing bubble" discussed in Chapter 33 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 19

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)are a global marketplace in which sophisticated investors make billion-dollar decisions nearly every second of the day.
D)All of these statements are true.

Question 20

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.

Question 21

Stock markets in England were started in:

A)the late seventeenth century.
B)the late sixteenth century.
C)the late eighteenth century.
D)the late nineteenth century.

Question 22

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

A)the Leverage Act.
B)the Bubble Act.
C)the Company Act.
D)None of these statements is true.

Question 23

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

A)booming;multiplies the gains;crash;magnifies the losses
B)booming;magnifies the losses;crash;multiplies the gains
C)crash;multiplies the gains;booming;magnifies the losses
D)None of these statements is true.

Question 24

Leveraging investments based on irrational expectations:

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

Question 25

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 26

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 27

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 28

Before it went bankrupt in 2008,Lehman Brothers investment bank was:

A)highly hedged.
B)in debt more than it was worth.
C)highly leveraged.
D)None of these statements is true.

Question 29

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 30

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 31

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 32

A rapidly falling stock price can trigger:

A)a flood of margin calls.
B)massive sales of the stock.
C)the price to be pushed down even more.
D)All of these statements are true.

Question 33

Leverage:

A)is a dangerous tool,especially for big companies who do not understand its risk.
B)has been outlawed since 2010.
C)is often cited as the single reason for the Great Recession of 2008.
D)All of these statements are true.

Question 34

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 35

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 36

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

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

Question 37

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 38

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 39

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 40

Margin calls are more likely to happen when markets are:

A)crashing.
B)booming.
C)stable.
D)None of these statements is true.

Question 41

After World War II,the value of homes:

A)did not fall for 60 years.
B)were unaffected by recessions until the 2000s.
C)seemed immune to the business cycle.
D)All of these statements are true.

Question 42

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 43

Subprime mortgages are:

A)mortgage loans made to borrowers with low credit scores.
B)mortgage loans that have less than prime interest rates.
C)mortgage loans made to borrowers with higher than average credit scores.
D)All of these statements are true.

Question 44

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

A)decreased by nearly 50 percent.
B)more than tripled.
C)more than quadrupled.
D)decreased by nearly 90 percent.

Question 45

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)None of these statements is true.

Question 46

The Great Depression was characterized by:

A)unemployment of 25 percent.
B)the Roaring Twenties.
C)accelerated economic growth.
D)All of these statements are true.

Question 47

Subprime lending gained popularity because:

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)All of these statements are true.

Question 48

What event led to the end of the Great Moderation?

A)The Great Depression
B)The Great Crash
C)Black Thursday
D)None of these statements is true.

Question 49

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 CBO
D)All of these statements are true.

Question 50

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

A)3 years
B)13 years
C)25 years
D)54 years

Question 51

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

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

Question 52

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)more than quadrupled.

Question 53

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)Formation of the SEC
C)Formation of the FDIC
D)All of these statements are true.

Question 54

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 55

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 56

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 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

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)Black Thursday.

Question 60

Banks became more willing to make subprime loans because of:

A)securitization.
B)leveraging.
C)hedging.
D)All of these statements are true.

Question 61

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 62

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 63

The practice of securitization:

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)None of these statements is true.

Question 64

Historically,household debt in the U.S.:

A)had been rising steadily since the Great Depression until the early 2000s,when it accelerated.
B)had been rising steadily since the Great Depression until the early 2000s,when it declined.
C)had been fairly constant since the Great Depression until the early 2000s,when it accelerated.
D)had been fairly constant since the Great Depression until the early 2000s,when it declined.

Question 65

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 66

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 back by the government.
D)individual mortgage loans,and an overwhelming 80 percent had become securitized loans.

Question 67

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

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

Question 68

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)None of these statements is true.

Question 69

Tranching allows 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 70

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)All of these statements are true.

Question 71

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 72

One reason the housing bubble occurred is because:

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)All of these statements are true.

Question 73

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 74

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

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

Question 75

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)All of these statements are true.

Question 76

One reason the housing bubble occurred is because:

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

Question 77

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 78

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

A)were very removed from the original mortgage.
B)were all very comfortable assuming high-risk assets.
C)were confident in the rising home value underlying each mortgage.
D)knew exactly what they were buying.

Question 79

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.

Question 80

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 as 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.