4) The dark side of financial liberalization is. A) market allocations B) credit booms C) currency appreciation D) financial innovation

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1 Chapter 9 Financial Crises 1) A major disruption in financial markets characterized by sharp declines in asset prices and firm failures is called a A) financial crisis B) fiscal imbalance C) free-rider problem D) "lemons" problem 2) Asymmetric information problems that act as a barrier to efficient allocation of capital are often described as A) financial treason B) financial markets C) financial frictions D) financial allocations 9.2 Dynamics of Financial Crises in Advanced Economies 1) The elimination of restrictions on financial markets and institutions is also known as A) financial engineering B) financial lending C) financial liberalization D) financial deleveraging 2) Financial crises A) are major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms B) occur when adverse selection and moral hazard problems in financial markets become less significant C) frequently lead to sharp expansions in economic activity D) are a free-rider problem 3) A financial crisis occurs when an increase in asymmetric information from a disruption in the financial system A) causes severe adverse selection and moral hazard problems that make financial markets incapable of channelling funds efficiently B) allows for a more efficient use of funds C) increases economic activity D) reduces uncertainty in the economy and increases market efficiency 4) The dark side of financial liberalization is A) market allocations B) credit booms C) currency appreciation D) financial innovation 5) When the value of loans begins to drop, the net worth of financial institutions falls causing them to cut back on lending in a process called A) deflation B) releveraging C) capitulation D) deleveraging 6) When financial institutions go on a lending spree and expand their lending at a rapid pace they are participating in a A) credit bust B) credit boom C) deleveraging D) market race 7) When financial intermediaries deleverage, firms cannot fund investment opportunities resulting in A) a contraction of economic activity B) an economic boom C) an increased opportunity for growth D) a call for government regulation

2 8) A decline in asset prices can lead to A) worsening adverse selection and moral hazard problems B) declining uncertainty C) increased economic activity D) anticipated increase in the price level 9) Factors that lead to worsening conditions in financial system include A) increases in net worth B) unanticipated increases in the price level C) unanticipated increases in the value of the domestic currency D) unanticipated declines in the value of the domestic currency 10) Factors that lead to worsening conditions in financial system include A) declining interest rates B) unanticipated increases in the price level C) the deterioration in banks' balance sheets D) increases in bond prices 11) When there is a deterioration in financial institutions' balance sheets A) economic activity contracts B) asset prices increase C) financial engineering takes place D) financial globalization increases its pace 12) Government safety nets A) weaken market discipline B) reduce moral hazard C) incent banks to take less risk D) require banks to loan less funds 13) A sharp decline in the stock market means that the of corporations has fallen. A) net worth B) interest rates C) liabilities D) payrolls 14) In a bank panic A) free-rider increase B) bond prices increase C) transactions costs increase D) multiple banks fail 15) In a bank panic, the source of contagion is the A) free-rider problem B) too-big-to-fail problem C) transactions cost problem D) asymmetric information problem 16) Factors that lead to worsening conditions in financial system include A) increases in net worth B) stock market increases C) decreases in interest rates D) stock market declines 17) Share prices are a valuation of a corporation's A) collateral B) net worth C) current capital D) net earnings 18) A sharp decline in the stock market means that the of corporations has fallen making lenders willing to lend. A) net worth; less B) net worth; more C) liability; less D) liability; more 19) A(n) is an increase in prices of assets above their fundamental economic values.

3 A) decrease in moral hazard B) asset-price bubble C) decline in lending D) liability war 20) Most financial crises have started during periods of either after the start of a recession or a stock market crash. A) high uncertainty B) low interest rates C) low asset prices D) high financial regulation 21) The start of a recession or a stock market crash can result in A) high financial regulation B) low interest rates C) low asset prices D) high uncertainty 22) Banking crises or bank panics have started when A) there is a reduction of the adverse selection and moral hazard problems B) there have been periods of low interest rates C) depositors withdraw their funds from banks D) when information is made available to investors 23) If uncertainty about banks' health causes depositors to begin to withdraw their funds from banks, the country experiences a(n) A) banking crisis B) financial recovery C) reduction of the adverse selection and moral hazard problems D) increase in information available to investors 24) A sharp stock market decline increases moral hazard incentives A) since borrowing firms have less to lose if their investments fail B) because it is immoral to profit from someone's loss C) since lenders are more willing to make loans D) reducing uncertainty in the economy and increasing market efficiency 25) If debt contracts are of fairly long maturity, then an unanticipated decline in the aggregate price level results in A) a decline in a firm's net worth B) an increase in a firm's net worth C) a decrease in adverse selection and moral hazard D) an increase in willingness to lend 26) Factors that lead to worsening conditions in financial system include A) increases in net worth B) unanticipated increases in the price level C) decreases in interest rates D) unanticipated declines in the price level 27) An unanticipated decline in the price level increases the burden of debt on borrowing firms but does not raise the real value of borrowing firms' assets. The result is A) that net worth in real terms declines B) that adverse selection and moral hazard problems are reduced C) an increase in the real net worth of the borrowing firm D) an increase in lending

4 28) A bank panic can lead to a severe contraction in economic activity due to A) a decline in international trade B) the losses of bank shareholders C) the losses of bank depositors D) a decline in lending for productive investment 29) If the anatomy of a financial crisis is thought of as a sequence of events, which of the following events would be least likely to be the initiating cause of the financial crisis? A) Increase in interest rates B) Bank panic C) Stock market decline D) Increase in uncertainty 30) If the anatomy of a financial crisis is thought of as a sequence of events, which of the following events would be least likely to be the initiating cause of the financial crisis? A) Increase in interest rates B) Stock market decline C) Unanticipated decline in price level D) Increase in uncertainty 31) An economic downturn which causes the price level to fall and a deterioration in firms' net worth because of the increased burden of indebtedness results in A) asset bubbles B) rising interest rates C) debt deflation D) financial recovery 32) 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) rising interest rates worsen adverse selection and moral hazard problems C) lenders reduce their lending due to declining stock prices (equity deflation) that lowers the value of collateral D) corporations pay back their loans before the scheduled maturity date 33) A substantial decrease in the aggregate price level that reduces firms' net worth may stall a recovery from a recession. This process is called A) debt deflation B) moral hazard C) insolvency D) illiquidity 34) A possible sequence for the three stages of a financial crisis in Canada might be leads to leads to A) asset price declines; banking crises; unanticipated decline in price level B) unanticipated decline in price level; banking crises; increase in interest rates C) banking crises; increase in interest rates; unanticipated decline in price level D) banking crises; increase in uncertainty; increase in interest rates 35) 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 severe economic contraction known as The Great Depression. A) debt deflation B) illiquidity C) an improvement in banks' balance sheets D) increases in bond prices 36) Financial innovations that emerged after 2000 in the mortgage markets included all of the following except A) adjustable-rate mortgages B) subprime mortgages C) Alt-A mortgages D) mortgage-backed securities

5 37) Before 2000, most borrowers in the mortgage markets were A) subprime B) credit-worthy (prime) C) risky D) less than stellar 38) Mortgages for borrowers with higher expected default rates are also known as A) Adjustable-rate mortgages B) Prime mortgages C) Alt-A mortgages D) Fixed-rate mortgages 39) is a process of bundling together smaller loans (like mortgages) into standard debt securities. A) Securitization B) Origination C) Debt deflation D) Distribution 40) is the development of new, sophisticated financial instruments. A) Discounting B) Origination C) Financial engineering D) Distribution 41) 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) Collateralized debt obligation (CDO) B) Adjustable-rate mortgage C) Negotiable CD D) Discount bond 42) A bank loan to a household or business was not a security because A) it could not be bought or sold in a financial market B) it was not a debt instrument C) there was no market for them D) they increased the asymmetric information problem 43) The originate-to-distribute business model has a serious problem since the mortgage broker has little incentive to make sure that the mortgagee is a good credit risk. A) principal-agent B) debt deflation C) democratization of credit D) collateralized debt 44) The originate-to-distribute business model is when A) mortgage originators made sure that the mortgage was a good credit risk B) mortgage originators distributed the mortgage to an investor as an underlying asset in a security C) homeowners could refinance their houses with larger loans when their homes appreciated in value D) mortgage originators were the credit rating agencies 45) Mortgage brokers often did not make a strong effort to evaluate whether the borrower could pay off the loan. This created a A) severe adverse selection problem B) decline in mortgage applications C) call to deregulate the industry D) decrease in the demand for houses 46) The agency problem in the mortgage markets was due to the business model. A) originate-to-distribute B) business-as-usual C) securitization D) "pass-through" 47) Credit default swaps

6 A) provide payments to holders of bonds if they default B) decrease asymmetric information in the mortgage markets C) had strong incentives to make sure CDO holders would be paid off D) were only a small part of insurance companies portfolios 48) The housing boom in the United States was aided by A) liquidity from China and India B) higher interest rates C) tariffs reducing global trade D) weak balance sheets in the banking industry 49) The "democratization of credit" was attributed to A) the subprime mortgage market B) the recession C) growth of prime mortgages D) asset-price gaps 50) Credit market problems of adverse selection and moral hazard increased as a result of all of the following except A) increase in housing market prices B) increased uncertainty from the failures of financial institutions C) deterioration in financial institutions' balance sheets D) decline in the stock market of over 40 percent from its peak 51) The housing price bubble A) was aided by low interest rates on residential mortgages B) only occurred in the emerging economies C) was not a contributing factor to the recession D) cannot be explained 52) The growth of the subprime mortgage market led to A) increased demand for houses and helped fuel the boom in housing prices B) a decline in the housing industry because of higher default risk C) a decrease in home ownership as investors chose other assets over housing D) decreased demand for houses as the less credit-worthy borrowers could not obtain residential mortgages 53) Agency problems in the subprime mortgage market included all of the following except A) homeowners could refinance their houses with larger loans when their homes appreciated in value B) mortgage originators had little incentives to make sure that the mortgage is a good credit risk C) underwriters of mortgage-backed securities had weak incentives to make sure that the holders of the securities would be paid back D) the evaluators of securities, the credit rating agencies, were subject to conflicts of interest 54) Credit rating agencies were subject to conflicts of interest in the subprime mortgage market because A) banks were earning large fees by underwriting the mortgage-backed securities B) they had little incentives to make sure that the mortgage was a good credit risk C) they had weak incentives to make sure that the holders of the securities would be paid back

7 D) they were earning fees from rating the mortgage-backed securities and from advising clients on how to structure the securities to get the highest ratings 55) Increased complexity of structured products can A) destroy information and improve adverse selection problems B) increase information and worsen adverse selection problems C) make asymmetric information better in the financial system D) make asymmetric information worse in the financial system 56) As housing prices rose, many subprime borrowers were able to A) default on their mortgage B) reduce their loan-to-value ratio C) get piggyback mortgages D) walk away from their houses 57) When housing prices began to decline after their peak in 2006, many subprime borrowers found that their mortgages were "underwater." This meant that A) the value of the house fell below the amount of the mortgage B) the basement flooded since they could not afford to fix the leaky plumbing C) the roof leaked during a rainstorm D) the amount that they owed on their mortgage was less than the value of their house 58) Between October 2007 and March 2009, asset prices fell by A) over 50 percent B) 10 percent C) around 16 percent D) less than 30 percent 59) Although the subprime mortgage market problem began in the United States, the first indication of the seriousness of the crisis began in A) Europe B) Australia C) China D) South America 60) Between 1995 and 2007, Ireland had an average annual GDP growth rate of A) 10.1 percent B) 6.3 percent C) 8.3 percent D) 5.7 percent 61) Fitch and Standard & Poor announced downgrades on of mortgage-backed securities and CDOs. A) more than $10 billion B) more than $100 billion C) $50 billion D) more than $10 million 62) During Ireland's financial crisis, housing prices A) fell by nearly 20 percent B) remained constant despite housing price declines across the globe C) fell by just less than 50 percent D) rose slightly and helped mitigate the country's recession 63) The Irish government helped mitigate the financial crisis by A) guaranteeing all deposits B) privatizing the banking system C) increasing short term borrowing D) refusing to inject more capital into the failing system 64) U.S. firms affected by the financial crisis included A) Bear Stearns and Merrill Lynch B) AIG and JP Morgan

8 C) Manulife and RBC D) Capital One and BNP Paribas 65) Which investment bank filed for bankruptcy on September 15, 2008 making it the largest bankruptcy filing in U.S. history? A) Lehman Brothers B) Merrill Lynch C) Bear Stearns D) Goldman Sachs 66) During the financial crisis in the U.S. the credit spreads peaked at in December A) nearly 6 percent B) nearly 5 percent C) nearly 4 percent D) 3 percent 67) In Canada, an early symptom of the U.S. subprime mortgage market problem was the A) financial engineering of the asset-backed commercial paper market B) freezing of the asset-backed commercial paper market C) increase of the asset-backed commercial paper market D) restructuring of the asset-backed commercial paper market 68) The government bailout of troubled financial institutions occurred in the U.S. and many other countries. Which country saw their banking system collapse requiring the government to take over its three largest banks? A) Iceland B) England C) Germany D) Belgium 69) Under the Montreal Accord investors A) froze losses to $200 million B) agreed to a standstill period C) were bailed out by the Bank of Canada D) were bailed out by the CDIC 70) Like a CDO, a structured investment vehicle pays off cash flows from pools of assets, however, rather than long-term debt the structured investment vehicle backs A) commercial paper B) Treasury notes C) corporate bonds D) municipal bonds 71) Asset-backed commercial paper is backed by all of the following except A) unsecured promissory notes B) mortgages C) car loans D) credit card receivables 72) The risk of asset-backed commercial paper depends on A) unsecured promissory notes B) the underlying securities C) commercial paper D) Treasury bills 73) "Plain vanilla" assets are A) unsecured promissory notes B) residential mortgages C) subprime mortgages D) CDOs 74) During the ABCP saga, The Bank of Canada A) shut down all non-bank sponsored conduits B) refused to accept ABCPs as collateral for loans to banks C) provided liquidity as a lender to the market D) was bailed out by the CDIC 9.3 Dynamics of Financial Crises in Emerging Market Economies

9 1) Financial crises in emerging-market economies generally develop along two basic paths: A) mismanagement of financial liberalization/globalization and severe fiscal imbalances B) stock market declines and severe fiscal imbalances C) mismanagement of financial liberalization/globalization and stock market declines D) stock market declines and unanticipated declines in the value of the domestic currency 2) In emerging market countries, the deterioration in bank's balance sheets has more effects on lending and economic activity than in advanced countries. A) negative B) positive C) affirming D) advancing 3) The mismanagement of financial liberalization in emerging market countries can be understood as a severe A) principal/agent problem B) asymmetric information problem C) lemons problem D) free-rider problem 4) Factors likely to cause a financial crisis in emerging market countries include A) fiscal imbalances B) decreases in foreign interest rates C) a foreign exchange crisis D) too strong oversight of the financial industry 5) The two key factors that trigger speculative attacks on emerging market currencies are A) deterioration in bank balance sheets and severe fiscal imbalances B) deterioration in bank balance sheets and low interest rates abroad C) low interest rates abroad and severe fiscal imbalances D) low interest rates abroad and rising asset prices 6) Severe fiscal imbalances can directly trigger a currency crisis since A) investors fear that the government may not be able to pay back the debt and so begin to sell domestic currency B) the government may stop printing money C) the government may have to cut back on spending D) the currency must surely increase in value 7) In emerging market countries, many firms have debt denominated in foreign currency like the dollar or yen. A depreciation of the domestic currency A) results in increases in the firm's indebtedness in domestic currency terms, even though the value of their assets remains unchanged B) results in an increase in the value of the firm's assets C) means that the firm does not owe as much on their foreign debt D) strengthens their balance sheet in terms of the domestic currency 8) A sharp depreciation of the domestic currency after a currency crisis leads to A) higher inflation B) lower import prices C) lower interest rates D) decrease in the value of foreign currency-denominated liabilities

10 9) The key factor leading to the financial crises in Mexico and the East Asian countries was A) a deterioration in banks' balance sheets because of increasing loan losses B) severe fiscal imbalances C) a sharp increase in the stock market D) a sharp decline in interest rates 10) In recent years, a number of developing and transition countries have experienced financial crises, the most dramatic of which was the A) Mexican crisis of B) Mexican crisis of C) Argentina crisis of D) Brazilian crisis of ) Factors that led to worsening conditions in Mexico's financial markets include A) failure of the Mexican oil monopoly B) the ratification of the North American Free Trade Agreement C) weak supervision by bank regulators D) decline in interest rates 12) An important factor leading up to the Mexican financial crisis of was A) the failure of the Mexican oil monopoly B) increasing loan losses at Mexican banks C) the ratification of the North American Free Trade Agreement D) the failure to ratify the North American Free Trade Agreement 13) Factors that led to worsening conditions in Mexico's financial markets included A) strong supervision by bank regulators B) bankers' lack of expertise in screening and monitoring borrowers C) improvement of banks' balance sheets because of decreasing loan losses D) decrease in interest rates 14) Factors that led to worsening conditions in Mexico's financial markets included A) fall in interest rates abroad B) a large increase in lending C) decreases in the price level D) strong supervision by bank regulators 15) Factors that led to worsening financial market conditions in East Asia in included A) weak supervision by bank regulators B) a rise in interest rates abroad C) unanticipated increases in the price level D) a decrease in interest rates 16) Factors that led to worsening financial market conditions in East Asia in included A) strong supervision by bank regulators B) bankers' lack of expertise in screening and monitoring borrowers C) improvement of banks' balance sheets because of decreasing loan losses D) unanticipated increases in the price level

11 17) Factors that led to worsening financial market conditions in East Asia in included A) rise in interest rates abroad B) bankers' lack of expertise in screening and monitoring borrowers C) unanticipated increases in the price level D) strong supervision by bank regulators 18) Factors that led to worsening financial market conditions in East Asia in included A) bankruptcy of large firms in South Korea and Thailand B) the ratification of the East Asia Free Trade Agreement C) bankers' expertise in screening and monitoring borrowers D) unanticipated increases in the price level 19) Factors that led to worsening conditions in Mexico's financial markets, but did not lead to worsening financial market conditions in East Asia in included A) rise in interest rates abroad B) bankers' lack of expertise in screening and monitoring borrowers C) deterioration of banks' balance sheets because of increasing loan losses D) unanticipated increases in the price level 20) Factors that led to worsening financial market conditions in East Asia in include A) weak supervision by bank regulators B) a rise in interest rates abroad C) unanticipated increases in the price level D) increased uncertainty from political shocks 21) Factors that led to worsening conditions in Mexico's financial markets, but did not lead to worsening financial market conditions in East Asia in include A) rise in interest rates abroad B) bankers' lack of expertise in screening and monitoring borrowers C) deterioration of banks' balance sheets because of increasing loan losses D) stock market decline 22) Argentina's financial crisis was due to A) poor supervision of the banking system B) a lending boom prior to the crisis C) fiscal imbalances D) lack of expertise in screening and monitoring borrowers at banking institutions 23) A feature of debt markets in emerging-market countries is that debt contracts are typically A) very short term B) long term C) intermediate term D) perpetual 24) The economic hardship resulting from a financial crises is severe, however, there are also social consequences such as A) increased crime B) difficulty getting a loan C) currency devaluations D) loss of output 25) Economic hardship resulting from a financial crisis includes A) increased crime B) ethnic violence C) currency appreciation D) high unemployment