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45 Cards in this Set

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Which of the following is associated with asymmetric information in financial crisis




A. Adverse selection can occur if lender must select from a pool of bad credit risks


B. There is a lack of information about one or more of the parties involved in transaction


C. Moral hazard could occur when only borrowers know if the funds will be used to finance high-risk activities


D. All of the above

All of the above

A financial crisis occurs when:




A. a particularly large disruption to information flows occurs in financial markets


B. There are predictable market disruptions


C. Financial frictions decrease sharply


D. Capital is allocated to its most productive uses



a particularly large disruption to information flows occurs in financial markets

A major disruption in financial markets characterized by sharp declines in asset prices and firm failures is called a




A. Free-rider problem


B. "Lemons" problem


C. Fiscal imbalance


D. Financial crisis

Financial Crisis



How can a bursting of an asset-price bubble in the stock market trigger a financial crisis




A. A reduction in asset prices causes borrowing firms to have less to lose so they are willing to take on additional risk


B. A reduction in asset prices causes lender to become more cautious and reduce the amount of loans they make


C. A reduction in asset prices causes a serious deterioration in borrowing firms' balance sheets


D. All of the above



All of the above



Defaults:




A. Are prevented by government insurance available to all banks


B. Arise when banks borrow money from the Federal Reserve


C. Occur when a borrower cannot make his loan payments


D. Are loans made to credit-worthy borrowers

Occur when a borrower cannot make his loan payments





Rising defaults from subprime mortgages led to a weakening of balance sheets of banks and other financial institutions. With less available, these financial institutions sold off assets and limited the availability of credit to households and businesses. This process is referred to as:




A. Financial engineering


B. A credit boom


C. Deleveraging


D. Securilization

Deleveraging


What is a credit spread




A. the difference between the interest rate on corporate bonds with different maturities


B. The difference between interest rates on loans to households and businesses and interest rates on completely safe assets such as U.S. Treasury Bonds


C. The difference between the net worth of a borrower and the amount of the loan the borrower would like to secure


D. The difference between a borrower's credit score and the score of the most credit-worthy borrower

The difference between interest rates on loans to households and businesses and interest rates on completely safe assets such as U.S. Treasury Bonds

Why do credit spreads rise during financial crises




A. Depositors with productive investment opportunities withdraw their funds from banks


B. Government is the only institution able to lend money


C. Asymmetric information problems increase


D. None of the above

Asymmetric information problems increase



Choose the components of the shadow banking system




A. Hedge Funds


B. Commercial Banks


C. Savings and loan associations


D. Investment banks


E. Money market funds

A,D, and E

Why is the shadow banking system an important part of the 2007-2009 financial crisis?




A. An increase of funding from the shadow banking system resulted in the issuance of CDO's, increasing the severity of adverse selection and moral hazard problems


B. The shadow banking system was able to take on significantly less risk than other financial firms, preventing the economy from losses


C. A decrease of funding from the shadow banking system caused a restriction of lending and a decline in economic activity

A decrease of funding from the shadow banking system caused a restriction of lending and a decline in economic activity

Why is a financial crisis likely to lead to a contraction in economic activity?




A. Those that borrow fund to finance productive investment opportunities will have a greater opportunity to obtain financing


B. A disruption in the financial system diminishes the flow of funds from savers to borrowers


C. Disruption in the financial system decreases asymmetric information, thereby decreasing the associated problems of adverse selection and moral hazard


D. None of the above

A disruption in the financial system diminishes the flow of funds from savers to borrowers

Which of the following is not a factor that commonly initiates financial crises?




A. Increases government regulation that make it hard to manage the risks of financial assets


B. The increase uncertainty that occurs when a major financial institution fails


C. Asset-price booms and busts

Increases government regulation that make it hard to manage the risks of financial assets

______ occurs when a substantial unanticipated decline in the price level sets in, leading to a further deterioration in a firm's net worth because of the increase burden of indebtedness




A. Deleveraging


B. Debt Inflation


C. Moral Hazard


D. Adverse Selection

Debt Inflation

A well-functioning financial system:




A. acts as a barrier to efficient allocation of capital


B. solves asymmetric information problem


C. Causes financial frictions to increase in an economy


D. creates unpredictable market disruptions

solves asymmetric information problem

How does an unanticipated decline in the price level cause a drop in lending?




A. A decline in the price level raises the real value of borrowing firms' liabilities while lowering the firms' real net worth


B. A decline in the price level reduces the moral hazard associated with borrowing firms


C. A decline in the price level lowers the nominal value of loan contracts that have already been made


D. A decline in the price level does not affect lending



A decline in the price level raises the real value of borrowing firms' liabilities while lowering the firms' real net worth

A deterioration in balance sheets of financial institutions reduces capital and causes a decline in economic activity




True or False

True

'A general increase in uncertainty as a result of a failure of a major financial institution makes it easier to separate good credit from bad credit, which can lead to a reduction in adverse selection and moral hazard problems.' Is this statement true of false?




True or False

False

Government fiscal imbalances can lead to financial crises by creating fears of default on government debt, thereby reducing purchases of a government's debt by investors




True or False

True

If financial liberalizations are not managed properly, it can lead to (reduced or excessive) risk taking and expansions of credit at a rapid pace. Losses from these lending activities will reduce balance sheet values for financial institutions. The reduction in capital will result in (fewer or more) loans, thus creating (increase, decrease, or no change) in investment and economic activity.

(excessive, fewer, and a decrease)



What role does weak financial regulation and supervision play in causing financial crises?




A. It allows financial institutions a better opportunity to engage in excessive risk-taking behavior


B. It reduces the risk that financial institutions will make bad loans


C. It creates higher interest rates, as government expenditures will tend to increase


D. It helps establish tighter rules and regulations for lending activities

It allows financial institutions a better opportunity to engage in excessive risk-taking behavior

Identify the similarities between the United States experiences during the Great Depression and the financial crisis of 2007-2009




A. Credit spreads widened and the availability of credit declined during both episodes


B. The source of the asset-price increase was the same for both episodes


C. Both episodes were preceded by sharp increases in asset prices


D. Both episodes resulted in significant declines in GDP and a significant increase in unemployment of 25%


E. A bank panic occurred during both episodes.

Credit spreads widened and the availability of credit declined during both episodes




Both episodes were preceded by sharp increases in asset prices

Which of the following did not help prevent the financial crisis of 2007-2009 from becoming a depression?




A. The creation of new programs, such as lending to investment banks and purchasing commercial paper, by the Federal Reserve


B. The Federal Reserve's use of monetary policy to lower the federal funds rate target


C. The purchase of stock and ownership takeovers of troubled banks by the Federal Reserve


D. The use of non-conventional policy by the Federal Reserve to create term auction facilities

The purchase of stock and ownership takeovers of troubled banks by the Federal Reserve

Advances in computer technology and new statistical techniques led to the development of subprime mortgages




True or False

True

Which of the following effects listed above may have helped trigger the subprime financial crisis starting in 2007?




1. Subprime borrowers found the value of the house fell below the amount of the mortgage


2. Defaults on houses declined during this period


3. Banks began to restrict the availability of credit to households





1 and 3

What are the components of the shadow banking system




A. Savings and loan associations


B. Money market funds


C. Hedge funds


D. Commercial banks


E. Investment banks

Hedge funds


Money market funds


Investment banks

Why would haircuts on collateral increase sharply during a financial crisis?




A. There is a decrease in the number of non-depository financial firms


B. There is an increase in demand for loans


C. There is a lack of credit standards and rules


D. There is an increase in the uncertainty over the value assets



There is an increase in the uncertainty over the value assets

What would be the result of an increase in haircuts on collateral




A. The shadow banking system would play an even more prominent role in financial markets


B. With increased collateral requirements, balance sheets of firms and households would greatly improve


C. Increasing haircuts would allow a financial institution to borrow a higher level of funds


D. Financial institutions would engage in the firs sales on assets



Financial institutions would engage in the firs sales on assets



What similarities exist between experiences in the United States and Ireland during the 2007-2009 crisis?




A. Debt inflation occurred in both countries


B. Both countries experienced painful recessions with significant declines in GDP


C. Both countries experienced painful recessions with increases in the unemployment rate


D. High real estate prices were fueled by sharp increases in mortgages lending in both countries

Both countries experienced painful recessions with significant declines in GDP




Both countries experienced painful recessions with increases in the unemployment rate




High real estate prices were fueled by sharp increases in mortgages lending in both countries

Why do debt deflations occur in advanced countries, but not in emerging market countries?




A. Adverse selection and moral hazard problems do not exist in emerging market countries


B. Asset markets are not as large or prominent in emerging market countries


C. Emerging market countries have well-established financial markets


D. None of the above are correct



Asset markets are not as large or prominent in emerging market countries

______ occurs when a substantial unanticipated decline in the price level sets in, leading to a further deterioration in a firm's net worth because of the increase burden of indebtedness




A. Debt Deflation


B. Adverse selection


C. Deleveraging


D. Moral Hazard



Deleveraging

A well-functioning financial system:




A. acts as a barrier to efficient allocation of capital


B. Causes financial frictions to increase in an economy


C. Solves asymmetric information problems


D. Creates unpredictable market disruptions

Solves asymmetric information problems

Which of the following statements correctly describes financial crises in emerging market countries




A. Prudential regulation and supervision to eliminate excessive risk taking are strong in emerging market countries


B. Regulation and supervision are typically weak because of the financial liberalization problem


C. Taxpayers almost always bear the cost of bailing out the banking sector if losses occur


D. Lending booms and busts are inevitable outcomes of financial liberalization and globalization in emerging market countries


Taxpayers almost always bear the cost of bailing out the banking sector if losses occur

At what stage of a financial crisis do adverse selection and moral hazard problems start to develop in emerging economies




A. Stage One: Initiation of Financial Crisis


B. Stage Two: Currency Crisis


C. Stage Three: Full-Fledged Financial Crisis


D. Adverse selection and moral hazard problems develop in all three stages



Adverse selection and moral hazard problems develop in all three stages

Which of the following is not a principal-agent problem resulting from the originate-to-distribute business model?




A. When investors purchase motgage-backed securities, it is in their best interest to purchase low-risk securities, which may be contrary to the mortgage brokers' best interest


B. Since mortgage brokers do not intend to hold the mortgage loans they make, they take extra care to gather as much information as possible about the borrower


C. When investors are willing to purchase bundled mortgage-backed securities, it is in the best interest of mortgage brokers to make lost of loans.


D. When mortgage brokers do not intend to hold the mortgage loans they make, they have little reason to be concerned whether the borrower can pay off the loan

Since mortgage brokers do not intend to hold the mortgage loans they make, they take extra care to gather as much information as possible about the borrower

Advances in computer technology and new statistical techniques led to the development of subprime mortgages




True or False

True

In emerging market countries, the deterioration in bank's balance sheets has more _____ effects on lending and economic activity than in advanced countries




A. Affirming


B. Negative


C. Advancing


D. Positive

Negative

A ______ pays out cash flows from subprime mortgage-backed securities in different tranches, with the highest-rated tranch paying out first, while lower ones paid out less if there were losses on the mortgage-backed securities




A. Adjustable-rate mortgage


B. Negotiable CD


C. Collateralized debt obligation (CDO)


D. Discount bond

Collateralized debt obligation (CDO)

Mortgage brokers often did not make a strong effort to evaluate whether the borrower could pay off the loan. This created a




A. Call to deregulate the industry


B. Decrease in the demand for houses


C. Severe adverse selection problem


D. Decline in mortgage applications

Severe adverse selection problem

Factors likely to cause a financial crisis in emerging market countries include




A. Decreases in foreign interest rates


B. A foreign exchange crisis


C. Severe fiscal imbalances


D. Too strong oversight of the financial industry

Severe fiscal imbalances

The economy recovers quickly from most recessions, but the increase in adverse selection and moral hazard problems in the credit markets caused by ______ led to the sever economic contraction known as the Great Depression




A. An improvement in banks' balance sheets


B. Illiquidity


C. Increases in bond prices


D. Debt Deflation

Debt Deflation

Which of the following not a reason why bank failures worsen financial crises?




A. The closing of many banks worsen adverse selection and moral hazard problems.


B. As bank panics occur, banks begin to sell so many assets that it can lower asset prices so much that even good banks become insolvent


C. Bank panics reduce the amount of asymmetric information, which makes it more difficult to lend funs

Bank panics reduce the amount of asymmetric information, which makes it more difficult to lend funs

A sharp depreciation of the domestic currency after a currency crisis leads to




A. Higher inflation


B. Lower import prices


C. Lower interest rates

Higher inflation

Which of the following is not a factor that commonly initiates financial crises




A. Increases in government regulations that make it harder to manage the risks of financial assets


B. Asset-price booms and busts


C. The mismanagement of financial liberalization and innovation

Increases in government regulations that make it harder to manage the risks of financial assets

If financial liberalizations are not managed properly, it can lead to _______ risk taking and expansions of credit at a rapid pace. Losses from these lending activities will reduce balance sheet values for financial institutions. The reduction in capital will result in _____ loans, thus creating ______ in investment and economic activity.

Excessive, Fewer, and a Decrease

Debt Deflation occurs when




A. An economic downturn causes the price level to fall and a deterioration in firms' net worth because of the increased burden of indebtedness


B. Corporations pay back their loans before the scheduled maturity date


C. Rising interest rates worsen adverse selection and moral hazard problems

An economic downturn causes the price level to fall and a deterioration in firms' net worth because of the increased burden of indebtedness