Money and Banking Exam 2 Parish
which of the following statements is true of financial frictions
financial frictions are a set of conditions that prevents financial markets from effectively assigning funds to the best investment opportunities
the seeds of a financial crisis are often sown when an economy eliminates restrictions on financial markets and institutions, an event known as ________
financial liberalization
was the process of securitization solely responsible for the Great Recession of 2007-2009?
No
What would be the result of an increase in haircuts on collateral?
Financial institutions would engage in fire sales on assets.
What might lead to poor management when control and ownership are separate, like in many American corporations? ; what is the reason for this problem?
Principal-agent problem.; A manager does not have sufficient incentive to maximize the company's profits.
Bonds account for a larger fraction of external funds relative to equities raised by American businesses because:
costly state verification makes the equity contract less desirable than the debt contract.
The _______ problem helps to explain why the private production and sale of information cannot eliminate asymmetric information.
free rider
When your required return on an equity investment decreases, then according to the Gordon Growth Model you will be willing to pay _______ for the investment.
more
The largest source of external finance for U.S. businesses is_______
bank and nonbank loans
If the dividend of a stock decreases, then according to the Gordon Growth Model, holding everything else constant, the price of the stock will _______.
decrease
With higher losses on loans, financial institutions undergo_______, the process of cutting back their lending to borrower-spenders.
deleveraging
Financial crises occur when:
information flows in financial markets experience a particularly large disruption.
An increase in adverse selection and moral hazard in credit markets _______ bank lending.
tends to decrease
Which of the following is not an example of a restrictive covenant in a debt contract?
requiring borrowers to pay a high interest rate
According to the Gordon Growth Model, the price of stocks depend on the following except
return on Treasure bills
Why is the shadow banking system an important part of the 2007-2009 financial crisis?
A decrease of funding from the shadow banking system caused a restriction of lending and a decline in economic activity.
How did innovations in mortgage markets contribute to the 2007-2009 financial crisis?
Advantages in information technology and new statistical techniques lowered the cost of evaluating the risk of mortgages to subprime borrowers who did not meet the standards for traditional mortgage loans; Information technology lowered the cost of packaging numerous subprime mortgages into mortgage-backed securities that could be sold in financial markets, attracting more funds into mortgage finance; Borrowers could get mortgage loans with little or no money down and could borrow more money relative to the value of the house they were buying and relative to their incomes than allowed with traditional mortgages.
Which of the following is associated with asymmetric information in a financial crisis?
Adverse selection can occur if lenders must select from a pool of bad credit risks; There is a lack of information about one or more of the parties involved in a transaction; Moral hazard could occur when only borrowers know if the funds will be used to financial high-risk activities.
Which of the following problems that arise in any financial system are aggravated by financial repression?
Adverse selection, Moral hazard, and Principal-agent problem
which of the following factors apart from securitization was responsible for the Great Recession of 2007-2009
An increase in funds lent to subprime borrowers
Which of the following is not a reason why bank failures worsen financial crises?
Bank panics reduce the amount of asymmetric information, which makes it more difficult to lend funds.
Which of the following describes the 'lemons problem' as an example of asymmetric information?
Buyers have less information than sellers and few transactions occur
_______ is property that is pledged to a lender to guarantee payment in the event that the borrower is unable to make debt payments.
Collateral
Why were consumer protection provisions included in the Dodd-Frank bill, a bill designed to strengthen the financial system?
Consumer protection will avert future financial problems in the housing market.
What are the five areas included in the Dodd-Frank Act of 2010?
Consumer protection, resolution authority, systemic risk regulation, Volcker rule, and derivatives.
_________ 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 increased burden of indebtedness.
Debt inflation
_______ is an issue that occurs when people who do not pay for information take advantage of the information that other people have paid for.
Free rider problem
In which country among the United States, Germany, Japan, and Canada do firms use bonds to the least degree when compared to the firms of the other countries?
Germany
which of the following is true of securitization?
It is a process that converts a series of financial instruments into marketable securities
Choose the components of the shadow banking system
Money market funds; Hedge funds; Investment banks
Suppose you are applying for a mortgage loan. The loan officer tells you that if you get the loan, the bank will keep the house title until you pay back the loan. Which problem of asymmetric information is the bank trying to solve?
Moral hazard in debt contracts
Housing prices boomed from 2002 to 2006, and then prices started to decline in 2006, falling by more than 30%, which led to defaults by subprime mortgage holders.
Subprime borrowers found the value of the house fell below the amount of the mortgage; Banks began to restrict the availability of credit to households
Again, consider the effect of tight money policy on stock prices. Which of the following accurately describes the effects of tight money policy on stock prices, according to this model?
The economy would slow down, causing an increase in the denominator of the simplified Gordon Growth model and a decrease in the price of stock (Po).
Suppose that in a given bond market, there is currently no information that can help potential bond buyers to distinguish between bonds. Which bond issuers have an incentive to disclose information about their companies? Explain why.
The issuer of a good quality (low risk) bond would have an incentive to disclose information. When information about good quality bonds is made available, potential buyers will pay a higher price for these bonds than they would otherwise.
Consider tight money policy and its effects on stock prices via the simplified Gordon Growth Model equation. Which of the following accurately describes the effects of tight money policy on stock prices, according to this model?
The return on bonds and the required return on an equity investment (Ke) would rise, while the price of stock (Po) would fall.
Why would haircuts on collateral increase sharply during a financial crisis?
There is an increase in the uncertainty over the value of assets.
An incentive to withdraw their deposits before the bank runs out of funds. If this becomes a widespread occurrence, it is know as:
a bank panic
Debt contracts are
long legal documents with substantial provisions
Restrictive covenants
make debt contracts more incentive compatible
Banks reduce the free-rider problem in information by
making private, nontraded loans so other lenders cannot benefit from the information they have collected about the borrower.
Because stockholder-owners, called the _______, have greater incentive to maximize profits than the managers, called the _______, do, stockholders find it costly to monitor managers; thus, they are reluctant to purchase equities.
principals; agents
