ECON 2010 Ch.29

Which statement is TRUE about securitization?

Once assets are securitized, the revenue streams from them can be divided up and sold in a variety of ways.

Which statement is TRUE of leverage?

Owner's equity is the value of the asset minus the debt associated with it.

What is one problem with the use of government guarantees covering the shadow banking system?

These guarantees could exacerbate the problem of managers having an incentive to take big risks.

Which statement is TRUE of bonds?

When interest rates rise, bond prices fall.

When does a stock exchange turn savings into investment?

When new shares of stock are issued

Which event would cause the equilibrium quantity of savings to decrease?

a leftward shift in the demand for loanable funds

If you own stock in a corporation, you are:

a part owner of that corporation, and you are entitled to a share of the firm's profits.

Unlike stocks, corporate bonds do not provide:

a share of ownership in the corporation.

A certificate of ownership in a corporation is called:

a share of stock.

bond

a sophisticated IOU that documents who owes how much and when payment must be made

A borrower would likely pay a high interest rate on a loan taken out to pay for a vacation because:

a vacation cannot be repossessed if the borrower defaults on the loan.

Select the definition of consumption smoothing.

borrowing in periods of low income and saving in periods of high income to make consumption less variable than income

The economy was fragile leading up to the Great Recession in part because:

both homeowners and banks were using more leverage.

Modern economies rely on financial intermediaries to:

bridge the gap between savers and borrowers.

The impact of government borrowing on private consumption and private investment is known as:

crowding out.

The government may offer an investment tax credit during a recession in order to counteract the:

decrease in investment demand.

The source of the _______ for loanable funds is investment.

demand

The FDIC ensures that:

depositors can get their money back, even if their bank fails.

A bank run occurs when:

depositors lose trust in a bank and rush to the bank to pull out their deposits.

The profits of a public corporation can be paid directly to shareholders in the form of:

dividends.

An investment tax credit offered during a recession is most likely to be temporary so that:

firms have an incentive to invest quickly.

Bank managers have to make sure that the bank has enough of their depositors' cash on hand to:

fund depositors that come to make withdrawals.

A financial intermediary is an institution that:

helps bridge the gap between savers and borrowers.

Which timeline puts the events leading to the financial crisis of 2007-2008 in proper chronological order?

high leverage in the shadow banking system, falling asset prices, reduction in the amount of lending in the economy

The shadow banking system is:

more prone to panic than commercial banks because deposits are not guaranteed.

market for loanable funds

the market where suppliers of loanable funds (savers) trade with demanders of loanable funds (borrowers), thereby determining the equilibrium interest rate

arbitrage

the practice of taking advantage of price differences for the same good in different markets by buying low in one market and selling high in another market

leverage ratio

the ratio of debt to equity, D/E

All else equal, a bond that is rated AAA:

will pay a lower interest rate than a bond that is rated A−.

Which statement is TRUE of leverage?

An insolvent firm has liabilities that exceed its assets.

Which statement is TRUE of the bond market?

Arbitrage ensures that equally risky assets earn equal returns.

Which of the following is one of the services that banks provide?

Banks link savers and borrowers.

Which of the following correctly summarizes the three main stages of the lifecycle theory of savings?

Borrowing then saving then dissaving

Zombie banks are:

insolvent banks that are propped up by the government, like some banks in Japan.

Howard Schultz is used in the video as an example of which of the following?

An entrepreneur who used different types of financial intermediaries to raise capital

Which statement is TRUE about stock?

Shareholders benefit directly if the firm pays out its profits in dividends or indirectly if profits are used to increase the value of the stock.

What's the price of saving and borrowing?

The interest rate

Which of the following does the video suggest is true for countries where the share of government ownership of banks is especially high?

They will have lower GDP per capita growth and lower productivity growth.

A bond is essentially:

an IOU.

The _____ the interest rate, the smaller the quantity of funds demanded for _____.

higher; investment

Financial intermediaries are necessary because:

in many cases, people who want to save don't interact directly with people who want to borrow.

In a world without saving or borrowing:

income and consumption would have to be equal.

All else equal, _____ interest rates usually result in less _____.

lower; savings

Stocks are traded in:

organized markets called stock exchanges.

People whose incomes fluctuate (like salespeople, writers, and homebuilders) smooth consumption by:

saving.

Stocks are:

shares of ownership in a corporation.

One of the benefits to a bank of securitizing its loans is that:

sloppy or under-researched loans can be sold to unsuspecting buyers.

People borrow, save, and dissave according to the lifecycle theory of savings in order to:

smooth their consumption.

Collateral

something of value that helps to secure a loan; if the borrower defaults, ownership of the collateral transfers to the lender

If a homebuyer puts 20% down on the purchase of a home, then immediately after closing the buyer has a leverage ratio of:

4

If the projected rate of return for a project is less than the interest rate for a loan that is necessary to complete the project, how will the borrowing business act?

The business will not take out the loan.

In which case below would the owner's equity on a house definitely rise?

The buyer pays down the mortgage and the house's value goes up

Which of the following describes a typical pattern of income over a person's lifetime?

Income is low when a person is young, rises throughout their working life, and then falls dramatically at retirement.

IPO stands for:

initial public offering.

An employer automatically enrolling employees in a retirement plan is an example of a nudge that:

leads to higher rates of savings.

When an investor buys a bond from a corporation, the investor is:

lending to the corporation directly.

Bonds, in general, are:

less risky than stocks, but they are still subject to default risk.

Both households and businesses:

rely on credit to thrive.

The source of the _______ for loanable funds is saving.

supply

Securitization refers to:

the bundling together of mortgages which are then sold as liquid financial assets.

The key difference between saving in a bank and saving in the stock market is that:

the stock market carries more risk since you are buying a share of a company that might fail.

Like stocks, bonds are:

traded on markets.

insolvent

a bank or institution whose liabilities are greater in value than its assets

The higher the _____ rate, the _____ the quantity of funds demanded for investment.

interest; smaller

By taking in deposits from many savers and lending money to many borrowers, banks:

spread the risk, so no one lender is in danger of going bankrupt if a borrower fails to pay back a loan.

The _______ represents the price of a loan.

interest rate

All else equal, if consumers decide to save less, the:

supply curve in the market for loanable funds will shift to the left.

Stocks

is a certificate of ownership in a corporation

How much you save and borrow depends on how patient you are or, using the language of economics, it depends on your:

time preference.

The desire to have goods and services sooner rather than later is called:

time preference.

Buying and selling existing shares of stock in a stock exchange:

transfers ownership of the stock but does not give the corporation more money to invest.

How do banks earn a profit?

By charging a higher interest rate on the money they lend than they pay on deposits.

How do banks ensure that the loans they make are productive?

By evaluating the quality of the borrowers.

Stock markets:

encourage entrepreneurship by providing a big payoff for company founders and venture capitalists.

The money that banks keep on hand is called:

reserves.

As interest rate decreases, what happens to the quantity of loanable funds demanded?

Quantity demanded will increase.

All else equal, lower _____ rates usually result in _____ savings.

interest; less

crowded out

the decrease in private consumption and investment that occurs when government borrows more; also, the decrease in private spending that occurs when government increases spending

time preference

the desire to have goods and services sooner rather than later (all else being equal)

initial public offering

the first instance of a corporation selling stock to the public in order to raise capital

Managers at Lehman Brothers might have had an incentive to take on a lot of risk because:

they received huge bonuses if the company was profitable but faced little downside risk if the company was not.

What effect will an increase in interest rates have on the quantity of loanable funds supplied?

Quantity supplied will increase.

How do shareholders receive the profit to which they are entitled if a firm decides to reinvest its profits?

Through a rising stock price

The lower the _____ rate, the _____ the quantity of funds demanded for investment.

interest; greater

Usury laws that limit interest rates that someone can be charged for a loan are an example of:

price ceilings, which typically don't work well.

There were many causes that contributed to the financial crisis of 2007-2008. Which of the choices most accurately describes the role of securitization in contributing to the crisis?

Banks bundled mortgages together and then sold them on the market as a financial asset. However, the risk level of these securitized assets was often much higher than the purchaser thought.

Which of the situations is an example of the crowding-out effect on investment as it pertains to macroeconomics?

Jack wants to borrow money to create a cowboy-themed inflatable bounce house for kids called "Wild Wild West." However, the government is running a deficit which has increased interest rates so much that Jack can no longer afford to borrow the money.

The shadow banking system refers to

Non-bank financial firms that acted as banks by borrowing and lending in an effort to make a profit.

At lower interest rates, the cost of investing _____ and the quantity of funds demanded for investment _____.

decreases; increases

All else equal, higher _____ rates usually result in _____ savings.

interest; more

Financial intermediaries:

reduce the costs of moving savings from savers to borrowers and investors.

The process in which bank loans are bundled together and sold on the market as financial assets is called:

securitization

In the context of budget deficits, what is crowding out?

when government borrowing leads to higher interest rates and corresponding decreases in private investment

If individuals become more impatient, what will happen in the market for loanable funds?

The supply of loanable funds will decrease, interest rates will rise, and the quantity of saving and borrowing will decrease.

Insecure property rights in bank account deposits typically lead to:

a decrease in the supply of savings.

Which of the following best defines a financial intermediary?

a financial institution that transforms investor funds into financial assets

Which of the following is an example of crowding out?

a firm that chooses not to borrow money to invest in new machinery because government borrowing has contributed to high interest rates

The main reason people save during their working years is:

a preference toward a smooth consumption path over time.

What is crowding out?

a reduction in consumption and investment spending that results from government borrowing

Which of the following is TRUE about the life-cycle theory of savings?

People tend to borrow during the early years of their lifetimes, save during their prime working years, and dissave during their retirement years.

Which of the following chains of logic explain the functions of banks in the process of economic growth?

Savers deposit their savings in banks. Banks direct these funds to firms that invest and engage in capital accumulation that furthers economic growth.

If the interest rate increases, then:

both the quantity saved and the quantity supplied of loanable funds will increase.

If the government raises taxes on investment returns, then the:

demand for loanable funds will decrease and the equilibrium interest rate will decrease.

Time preference is the desire to:

have goods and services sooner rather than later.

Bond prices and bond interest rates move:

in opposite directions.

Savings is

income that is not spent on consumption goods.

Which of the following represents ownership in a corporation?

stocks

Identify an example of consumption smoothing.

taking student loans, depositing a portion of one's salary into a retirement account, and acquiring a mortgage to purchase a house

Which of the terms acts as the "price" in the market for loanable funds?

interest rate

When General Motors decides to purchase a new assembly line in order to produce a new line of cars, this activity can be BEST categorized as:

investment.

When the U.S. government borrows money in the bond market:

it affects the entire market for saving and borrowing, because it is such a big part of the market.

When Professor Tabarrok says that banks provide "valuable middleman services," he is most likely referring to their role in:

linking savers and borrowers.

The difference between the value of a house and the unpaid amount of the mortgage is known as:

owner's equity.

Why don't entrepreneurs borrow directly from large groups of savers rather than borrowing from a bank?

It would be time consuming and costly to coordinate such an effort.

financial intermediaries

institutions such as banks, bond markets, and stock markets that reduce the costs of moving funds from savers to borrowers and investors

Argentina and Brazil are mentioned in the video as examples of countries in which:

property rights over bank deposits are insecure.

As the financial crisis unfolded, banks could not access capital and started selling assets simply to cover operating costs. This:

reduced the price of these assets, pushing more banks closer to insolvency and causing more assets to be put up for sale.

________ are a mechanism by which crowding out occurs.

Increases in interest rates

Banks attract savings from many depositors by:

paying interest on deposits.

A strong financial system relies on:

good institutions.

The market for loanable funds is comprised of:

the supply of savings and the demand for borrowing.

owner's equity

the value of the asset minus the debt E = V-D