Which of the following is true?
A)Financial intermediation inherently involves risk and although risk can be reduced, it can never be eliminated.
B)The layering of payments opens the possibility that a random default will set off a chain reaction of multiple defaults.
C)A recession can cause a financial crisis but a financial crisis can never cause a recession.
D)Both a and b are true.

Question

Quizplus · Accepted Answer

Both statements A and B are true. Financial intermediation involves risk as intermediaries borrow from some and lend to others, hence are exposed to various risk factors. Risk can be reduced by diversification and risk management practices, but it can never be completely eradicated. The layering of payments in the financial system can create a chain reaction of defaults if one institution fails to make payments, and the effects can ripple through the system causing multiple defaults. Therefore, both statements A and B are true.

Statement C, however, is false. A financial crisis can cause a recession, as it did in the Great Recession of 2008-09 when the collapse of housing and financial markets led to a broad economic downturn.

Which of the Following Is True