Question 1

All of the following are government bailouts except:

Accepted Answer

D

Question 2

Moral Hazard and compensation contracts that reward large profits with bonuses both give executives similar incentives to increase risk.

Accepted Answer

Both moral hazard and bonus compensation contracts reward executives for taking on more risk in pursuit of higher profits. In the case of moral hazard, executives may feel emboldened to take greater risks knowing that the potential downside will be borne by shareholders or the government. In the case of bonus contracts, executives may be incentivized to pursue short-term gains at the expense of long-term stability, since their rewards are tied to quarterly or annual profits. Both scenarios create a misalignment between executive interests and those of the company and its stakeholders.

Question 3

Investment banks made similar decisions with respect to betting the firms existence on a single sector of the economy when they were partnerships as when they were publicly traded corporations.

Accepted Answer

When investment banks were partnerships, the partners were more cautious with their investments because they had personal assets at risk. After transitioning to publicly traded corporations, the risk was spread among shareholders, leading to potentially riskier decisions that could focus on a single sector without the same level of personal financial consequence for the decision-makers.

Question 4

Government bailouts are motivated by the concern that the economy will be severely affected if critically important firms are permitted to fail.

Accepted Answer

Government bailouts are typically done to prevent the failure of important firms in order to prevent a negative impact on the economy.

Question 5

Bailouts are common features of government because they avoid any adverse incentive effects.

Accepted Answer

Bailouts can create adverse incentive effects where companies become dependent on government assistance and may take on more risk in the future knowing that they would be bailed out if things go wrong. Additionally, bailouts can raise moral hazard issues where companies are less likely to take steps to protect themselves from risk knowing that the government will be there to rescue them.

Question 6

Systemic risk describes risk that an audit system will not pick up fraud within a firm.

Accepted Answer

Systemic risk refers to the risk of a widespread disruption or collapse of a financial system or market, not specifically related to fraud within a firm.

Question 7

The collapse of Iceland's financial market and economy in 2008 show that the concern over the "domino effect" in financial markets is a concern that should be taken seriously.

Accepted Answer

The collapse of Iceland's financial market and economy in 2008 had far-reaching effects on the global financial system, highlighting the potential for a "domino effect" in financial markets when one country's financial crisis spreads to others. This is a concern that should be taken seriously.

Question 8

Managers of U.S.auto companies could not have known in 2008 that gas prices could increase suddenly leaving them unable to sell their lineup of gas guzzling vehicles.

Accepted Answer

In 2008, the volatility of gas prices and the potential for sudden increases were well-known factors that could impact the automotive industry, making it possible for managers to foresee the risk of focusing heavily on gas-guzzling vehicles.

Question 9

What does TARP stand for in the $700 billion program enacted in the fall of 2008?

Accepted Answer

TARP stands for Troubled Asset Relief Program.

Question 10

What was the primary motivation for the Federal Reserve and U.S.Treasury in spending more than a trillion dollars to bailout firms in the fall of 2008?

Accepted Answer

The primary motivation for the bailout was to avoid a financial collapse that could have led to another Great Depression. The other choices are not accurate as there is no evidence to suggest that campaign contributions or reducing moral hazard played a significant role in the decision to bailout firms in 2008.

Quiz 10: Systemic Risk, Moral Hazard Bailouts