Chapter 1-6 Quiz
What is the purpose of the Basel Committee on Banking Supervision of the BIS?
educate policymakers on the key issues associated with the supervision of banks to improve the quality of bank supervision throughout the world.
what is operational risk
risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events.
In March 1996, the Committee on Payment and Settlement Systems of the BIS published a report titled "Settlement Risk in Foreign Exchange Transactions" that offers a practical approach that banks can employ when dealing with settlement risk. What is meant by "settlement risk"?
settlement risk: the transfer fails to take place as expected; consists of counter-party risk (form of credit risk) and a form of liquidity risk.
Explain why some subsidiaries of a non-financial business can be classified as financial businesses.
some non-financial corporations have subsidiaries that are involved in the same activities as financial corporations and are referred to as captive finance companies. These subsidiaries often provide a wide range of financial products and services.
Why do you think a debt instrument whose interest rate is changed periodically based on some market interest rate would be a more suitable investment vehicle for a depository institution than a long-term debt instrument with a fixed interest rate?
a variable, market-based interest rate can adapt to changing market condition that may impact the indebted party's ability to repay the amount owed. because future outside economic forces are unpredictable, having the market periodically set the rate could properly adjust the rate to account for changes in the risk of default that a fixed interest rate simply could not.
On August 25, 2017, the market capitalization of ExxonMobil was $324.73 billion. In terms of market cap, how would this company's stock be classified?
Mega-cap stock: companies with market values well above the rest of the market, with valuations over $200 billion.
What is meant by "regulation of financial activities?"
Regulation of financial activities consists of rules about traders of securities and trading on financial markets, for instance, laws that prevent insider trading.
Why is the distinction between investment grade and non-investment important for investors?
Regulations may prohibit institutional investors from purchasing non-investment grade debt
Explain why liquidity may depend not only on the type of financial asset but also on the quantity one wishes to sell or buy.
available liquidity is depended on the number of market participants and relative demand for a financial asset.
Why are the characteristics of an issuer important in determining the price of a financial asset?
characteristics of an issuers can collectively determine a risk level of a financial asset. The level of risk can have a large impact on the expected cash flow
What is meant by a systemically important financial institution (SIFI)?
in the view of regulators is a large firm whose failure would cause a financial crisis.
A bank issues an obligation to depositors in which it agrees to pay 3% guaranteed for one year. With the funds it obtains, the bank can invest in a wide range of financial assets. What is the risk if the bank uses the funds to invest in common stock?
it faces market risk and will be subject to the level and volatility of market prices
What is the source of income for an asset management firm?
receive their compensation primarily from management fees charged based on the market value of the assets managed for clients
What is meant by the "rating shopping hypothesis"?
asserts that an issuer will search among the CRAs of the one that provides the best credit rating or shop for as many ratings as possible.
What role does a CRA play in the financial market?
credit rating agencies (CRA): (not gov affiliated) commercial companies that perform credit analysis and produce assessments of default risk in the form of credit ratings. emphasis on bonds Provide a critical function in the financial system by reducing information asymmetry in the market for debt obligations and private contracts
What is the difference between an emerging stock market and a frontier stock market?
emerging markets are currently developing while frontier markets have not begun developing yet
a. Why do credit rating agencies evaluate municipal debt obligations of U.S. entities that are tax-backed and revenue-backed in a different way? b. Which type of municipal debt is analyzed in a manner similar to corporate debt?
tax-backed debt requires an analysis of future tax revenue revenue-backed debt requires an analysis of cash flow generated by a specific project. revenue-backed debt obligations is comparable to the factors considered when rating corporate debt
Explain the ways in which a bank can accommodate withdrawal of deposits.
through their required reserves. if banks are temporarily short of their required reserves they can borrow reserves in the federal funds market or borrow temporally from the Fed at its discount window. required reserves: the amount of funds that a bank holds in reserve to ensure that it is able to meet liabilities in case of sudden withdrawals.
On August 25, 2017, Facebook's common stock closed at a price of $166.32 and the market cap of the company was $489.97 billion. What was the approximate number of shares outstanding?
489.97 / 166.32 = 29,459,476 shares.
What is the purpose of the Markets Committee of the BIS?
provide policy guidelines for enhancing market transparency, discussion of developments in finance markets, and an exchange of views on future developments that will have an impact of financial markets
An example typically given to illustrate systemic financial risk is a run on the bank (i.e., many bank depositors simultaneously withdrawing their funds from a bank). Explain why.
A bank run could theoretically occur at any bank and spread across the financial system as more people demand their money from their banks. the interconnectedness of banks could possibly cause a failure of the entire financial system. banks must have risk-based capital requirements.
What are the views held by economists on the degree of regulation needed for financial markets?
1. there should be large-scale government interventions to solve problems that involve massive market failures 2. government intervention is the problem, not the solution. it may lead to market failures by implementing policies that are not beneficial to financial markets
Explain whether you agree or disagree with the following statement: "A nationally recognized statistical rating organization is permitted to provide a credit rating for any type of debt obligation."
A NRSRO may only issue ratings for different types of debt obligations based on which of the five rating categories it is registered in.
How did the U.S. congress deal with the financial problems faced by Fannie Mae and Freddie Mac in 2008?
Bailing them out and placing them under the conservatorship of the US government.
A U.S. investor who purchases the bonds issued by the Japanese government makes the following comment: "Assuming that the Japanese government does not default, I know what the cash flow of the bond will be." Explain why you agree or disagree with this statement.
If the government does not default, the investor will receive money but the purchasing power of the cash flow is not known with certainty and the currency risk could change the amount of cash flow received.
Explain why you agree or disagree with the following statement: "Not only does the Fed have the power to examine banks, it now oversees the country's systemic risk."
Modern legislation has significantly expanded the Fed's role to include examining banks and overseeing the country's systemic risk. The Financial Services Modernization Act of 1999 made the Fed the umbrella regulator for financial holding companies. Additionally, the Dodd-Frank Act made the Fed the primary regulator of all financial firms that the Financial Stability Oversight Council (FSOC) designates as systemically significant, as well as the safety and soundness authority over the payment, clearing, and settlement systems that the FSOC identifies as systemically important and that are not regulated by the Commodities Futures Trading Commission or the SEC.
What are the stated objectives of SWFs?
Sovereign wealth funds (SWF): country-or-state owned investment funds that counties establish to maximize returns from investments outside their country. Operating in the motivations of their citizens, maximizing their returns They are generally used for commercial purposes but may be used for noncommercial purposes
Consider this headline from the New York Times of March 26, 1933: "Bankers Will Fight Deposit Guarantees.... Bad Banking Would Be Encouraged." a. What do you think this headline is saying? b. Discuss the pros and cons of whether deposits should be insured by the U.S. government.
a) The headline is likely saying that removing deposit guarantees would lead to banks making riskier investments as they would not be constrained by deposit guarantees. b) Insuring all deposits provides stability across the banking system and gives depositors peace of mind concerning the safety of their money. However, requiring deposit insurance has historically incentivized some banks to take on more risk under the assumption that federal guarantees would protect their depositors, should the investments fail to generate a return.
a. How is an asset class defined? b. What are the traditional asset classes?
a. an asset class is defined in terms of the investment attributes that the members of the asset class have in common b. common stocks, bonds, cash equivalents
Explain each of the following types of deposit accounts: a. Demand deposits b. Certificates of deposit c. Money market demand accounts d. Share deposits e. Negotiable order of withdrawal accounts
a. demand deposits do not pay interest but can always be withdrawn on demand b. time deposits (or CD): a deposit account having a fixed maturity date and paying either a fixed or floating interest rate c. money market demand accounts: a deposit account paying interest based on short-term interest rates; (checking account with interest) d. share deposits: accounts at a credit union which are similar to checking accounts but pay interest e. negotiable order or withdrawal accounts: similar to demand deposits but pay interests
a. What are the arguments in favor of government bailouts? b. What are the arguments against government bailouts?
a. financial institutions may be "too big to fail" because of interconnectedness with other financial institutions. By allowing them to fail would cause market turmoil that would adversely affect the real economy b. bailing out the largest institutions incentivized bad or irresponsible behavior at those institutions because they know that, should they fail, the government will bail them out. (moral hazard)
Indicate whether each of the following instruments trades in the money market or the capital market: a. General Motors Acceptance Corporation issues a financial instrument with four months to maturity. b. The U.S. Treasury issues security with 10 years to maturity. c. Microsoft Corporation issues common stock. d. The State of Mississippi issues a financial instrument with eight months to maturity.
a. money market b. capital market c. capital market d. money market
Explain the difference between each of the following: a. money market and capital market b. primary market and secondary market c. domestic market and foreign market d. national market and Euromarket
a. money market is used to exchange short-term debt instruments while capital market is used to exchange longer-maturity financial assets b. primary market is used to exchange newly issued financial claims (IPO) while the secondary market is used to exchange previously issued financial claims c. (both under national market) domestic market is where issuers domiciled in a country issue securities and where those securities are subsequently traded. foreign market is where the securities of issuers not domiciled in the country are sold and traded. d. national market is internal euro market is external dealing with a number of different countries
a. In setting forth monetary policy, certain objectives, such as price stability, can be quantified. Explain why. b. In contrast to such objectives as price stability, monetary policy objectives dealing with financial stability cannot be quantified. Explain why.
a. price stability objectives target a specific rate like inflation, which is easily quantified b. other factors dealing with financial stability are often complex non-monetary factors which change over time and cannot be necessarily counted or quantified
Explain why you agree or disagree with the following statement: "In recent years, the differences in regulatory treatment and activities of banks compared to thrifts have increased."
although there are differences between banks and thrifts in terms of the activities in which they specialize and certain regulatory oversight, all depository institutions have become more alike as a result of the Dodd-Frank Act and the adoption of the international; capital standards required by the Basel Accords.
What are the different forms of support that government bailouts can take?
can take the form of federal loans: better terms of interest lines of credit: flexible loan that consists of a defined amount , gain access to short-term funding. stock warrants: represents a stock at a certain company's stock at a certain time and date; the company gets the funds directly. allows taxpayers to benefit from a recovery.
Defined benefits plan vs defined contribution plan
defined benefit plan: a plan in which the plan sponsor agrees to pay qualified employees covered by the plan benefits on retirement. the plan sponsor guarantees the retirement benefits, makes the investment choices, and bears the investment risk Defined contribution plan: the employer does not guarantee any retirement benefits but does agree to make specific contributions to the employee's account, the employee selects the investment options, and the employee's retirement payments come from the return on the investment portfolio and employee and employer contributions
What are the two basic types of derivative instruments?
future/forwards contracts: agreement whereby two parties agree to transact with respect to some financial asset at a predetermined price at a specified future date options contracts: gives the owner of the contract the right, but not the obligation, to buy (or sell) a financial asset at a specified price from (or to) another party
What does the Financial Stability Oversight Council (FSOC) have the authority to do?
has the authority to constrain nonbank financial entities from what the FSOC views as excessive risk taking that threatens the stability of the financial system.
Why do CRAs assign both a local currency debt rating and a foreign currency debt rating?
historically the default frequency differs by the currency denomination of the debt. defaults have been greater on foreign denominated debt. the reason for the difference is that if the government is willing to raise taxes and control its domestic financial system, it can generate sufficient local currency to meet its local currency debt obligation. This is not the case with foreign currency - dominated debt
Why is there concern that investors over-rely on credit ratings when making investment decisions?
investors, particularly institutional investors, may rely on ratings without performing their own credit analysis and that herd behavior may result from relying solely on ratings.
what is liquidity risk
it is the risk that the counter party can eventually meet its obligation, but not at the due date. The party failing to receive timely payment must be prepared to finance any shortfall in the contractual payment.
Explain why you agree or disagree with the following statement: "When a household purchases life insurance, there is no risk, insofar as the issuer of the policy guarantees a death benefit payment."
life insurance companies provide protection in the form of financial guarantees to policyholders. Life insurance companies are therefore the risk bearers, not households.
What is meant by the "institutionalization" of capital markets?
markets have grown in size, institutional investors have begun to trade more than individual investors. More trading is being conducted by highly experienced and large institutional investors
What is meant by a performance-based management fee, and what is the basis for determining performance in such an arrangement?
performance-based management fees: sometimes combined with a fixed fee based on assets managed, are variable fees to investors that depend upon the return generated by the asset management company. generally a percentage of the return generated by the asset management firm
What is the purpose of the bank for international settlements (BIS)?
provides research, education, and guidance for central bankers to help improve various aspects of banking supervision, infrastructure market issues, and financial stability policies. Main objective is to oversee the adoption of best practices by central banks as they address the various issues they face.
Explain why you agree or disagree with the following statement: "Risk-based capital requirements for banks consider only credit risk."
risk-based capital requirements for banks consider credit risk and capital requirement. banks have to counteract the increased risk of an asset with an increased capital requirement
In an April 8, 2008, article in Bloomberg Business Week, the following appeared: "China Investment Corp.'s chief risk officer denies allegations that the fund has hidden objectives in its investment strategy." a. What is the "China Investment Corp."? b. What types of allegations do you think the quotation is referring to?
sovereign wealth fund the allegations likely refer to the Corp's non-commerical purposes, possibly investments in specific industries to gain military technology or trade secrets
In 2016, McDonald's issued in the Swiss bond market an eight-year bond denominated in Swiss francs (CHF). The par value was CHF 400 million. From the perspective of the Swiss financial market, indicate whether this issue is classified as being issued in the domestic market, the foreign market, or the offshore market.
the bond would be issued on Switzerland's foreign market
What is the basic principle followed in determining the value of a financial asset?
the price of a financial asset is equal to the present value of its expected cash flow, even if the cash flow is not known with certainty.
What are the primary assets held by S&Ls?
they primarily hold qualified thrift investments
Describe the current system for charging premiums for federal deposit insurance and how it differs from the way premiums were charged up until 1980.
today, banks no longer pay premiums for federal government insurance. They effectively pay a premium in the form of a fine only if they violate risk-based capital requirements or acts that violate the supervisory process.
What are the two principal roles of financial assets?
1. Transfer funds from those who have surplus funds to invest to those who need funds to invest in tangible assets. 2. transfer funds in such a way as to redistribute the unavoidable risk
In September 1990, a study by the U.S. Congress, Office of Technology Assessment, titled "Electronic Bulls & Bears: U.S. Securities Markets and Information Technology," included the following statement: "Securities markets have five basic functions in a capitalistic economy: 1. they make it possible for corporations and governmental units to raise capital. 2. they help to allocate capital toward productive uses. 3. they provide an opportunity for people to increase their savings by investing in them. 4. they reveal investors' judgments about the potential earning capacity of corporations, thus giving guidance to corporate managers. 5. they generate employment and income." For each of the functions cited above, explain how financial markets (or securities markets, in the parlance of this Congressional study) perform each function.
1. corps and gov sell financial assets in exchange for capital 2. investors receive return while the companies are able to expand, employ more people, fund innovation, serve consumers better. 3. investment options for different levels of potential return. low return is connected with low risk government bonds. high risk is connected to potentially high return equities or derivative contracts. 4. the price of a financial asset is determined through the price discovery process of a financial market. This provides signals responsive to actions that managers make. 5. capital is put into companies, allowing more employees to be hired and higher incomes.
Give three reasons for the trend toward greater integration of financial markets throughout the world.
1. deregulation or liberalization of markets and the activities of market participants in key financial centers of the world 2. technological advances for monitoring world markets, executing orders, and analyzing financial opportunities 3. increased institutionalization of financial markets (as opposed to individual investors)
Each year, millions of American investors pour billions of dollars into investment companies, which use those dollars to buy the common stock of other companies. What do the investment companies offer investors who prefer to invest in the investment companies rather than buying the common stock of these other companies directly?
1. maturity intermediation: convert a longer term asset into a shorter term asset by pooling many people's funds at once. 2. reducing risk via diversification: create a portfolio 3: reducing the costs of contracting and information processing 4. providing a payment mechanisms: payment options different from cash
What two solutions to the "too big to fail" issue have been suggested?
1. no longer permit a bailout 2. implement the Dodd-Frank Act which requires higher capital requirements on such firms.
What is the difference between the claim of a debt holder of Chevron Corporation and a common stockholder of Chevron Corporation?
A debt holder will be paid first. common stockholders will receive the remaining amount
What is a rating transition matrix, and how can it be used by an investor?
A rating transition matrix is a table of information published periodically by a CRA that shows the hypothetical probability of how multiple issue grades may change over a set time period. Investors can use this information to make informed credit decisions.
What is the difference between a financial asset and a tangible asset?
A tangible asset: value depends on particular physical properties. A financial asset: value is a claim to future cash.
Why are households viewed as the ultimate risk bearers?
Although there are financial institutions and government programs that provide different forms of guarantees for financial products that they issue, if the guarantors fail to fulfill their obligation, the risk is borne by households.
When assigning a credit rating, the CRAs analyze a company's business risk. What is meant by business risk?
Business risk associated with generating operating cash flows, which are uncertain
a. In what ways does a government act like a financial intermediary? b. What are the concerns when a government plays the role of a financial intermediary?
By providing loans and guarantees by providing low interest loans, a gov may fuel bubbles and cause market failure by encouraging activity that would otherwise not take place. Additionally, a gov may underestimate risk when pricing loans due to the lack of a profit motive.
Why is it difficult to determine the cash flow of a financial asset?
Cash flow is influenced by a large number of factors which could change in the future. Some factors are controlled by issuer while others are out of their control.
What is a central bank, and how does it participate in the financial market of another country as a foreign investor?
Central bank: participates by buying or selling financial market either to stabilize that country's currency relative to its domestic currency or as an investment vehicle. It acts to influence financial markets at the macroeconomic level.
What is meant by corporate governance risk, and why do credit rating agencies employ it?
Corporate governance risk is the eagerness of corporate management to present favorable results to shareholders and the market for the purpose of acting in their own self-interest. CRAs employ this to ensure that management avoids scandals and losses by acting in the interest of the company, rather than themselves
Explain how the household sector participates as both a borrower and a lender of funds in the financial market.
Households issue debt obligations in the financial market when they borrow funds to finance consumer purchases on credit, purchase a home by borrowing funds, or obtain student loans to pay for higher education. When households save, they use those funds to invest in financial assets. Most households both save and borrow funds, making them important participants in the financial market.
Why does a defined benefit plan create a future liability for a plan sponsor?
Defined benefit plan: a plan in which the plan sponsor agrees to pay qualified employees covered by the plan benefits on retirement in the future. The financial risk associated with the future payments of a defined benefit plan are those of the sponsor because the sponsor is obligated to make the payments to pay qualified employees regardless of future corporate earnings.
What is the basic function of depository institutions?
Depository institutions: raise funds through deposits and other sources and then use those funds to make direct loans to individuals, non-financial and financial businesses, and state and local governments. They generate a profit by earning a spread between the return realized on their investment and the cost of obtaining funds. commercial banks, thrifts, and credit unions
"Derivatives markets are nothing more than legalized gambling casinos and serve no economic function." Comment on this statement.
Derivative contracts provide issuers and investors an inexpensive way of controlling some major risks. Controlling risk can take the form of greatly reducing price volatility (price fluctuations) for corporations and costumers. The increasing complexity of derivatives shows just how useful they can be in managing specific types of risk.
Does ERISA require that a corporation establish a pension fund?
Employee Retirement Income Security Act (ERISA) governs how employers provide benefit plans to employees. it does not require that a corporation establish a pension plan, it only requires that those who establish plans must meet certain minimum standards
Explain how a financial intermediary reduces the cost of contracting and information processing.
Financial intermediaries have highly trained employees focused on contracting and information processing. This lowers the cost of contracting and information processing through efficiency via economies of scale. economies of scale: a proportionate saving in costs gained by an increased level of production.
"All financial intermediaries provide the same economic functions. Therefore, the same investment strategy should be used in the management of all financial intermediaries." Indicate whether you agree or disagree with this statement. Explain your answer.
Financial intermediaries vary greatly in their organizational structure and purpose, therefore should have different investment strategies that suit the needs of their clients and themselves. Types of financial intermediaries: commercial banks: banks that accept deposits and use the proceeds to lend funds to consumers and businesses S&L associations: savings and loan associations; similar to a bank that specializes in helping people get residential mortgages. investment companies: pools the funds of market participants and uses those funds to buy a portfolio of securities, such as stocks and bonds insurance companies: life, property, and casualty companies. pools clients' risks to make payments more affordable for insured; used to hedge against the risk of financial losses. pension funds: investment pools that pay for workers' retirements
The Insightful Management Company sells financial advice to investors. This is the only service provided by the company. Is this company a financial intermediary? Explain your answer.
Financial intermediary: obtains funds by issuing financial claims against themselves to market participants, and then invests those funds. A company that only sells financial advice does not fit this description and is therefore not a financial intermediary.
a. What is meant by "financial stability"? b. Why is a macroprudential perspective important when dealing with financial stability?
Financial stability: financial system where systemic risk is low regulation of the broader financial system and not only select financial institutions may be necessary to create financial stability.
What is the difference between FDI and foreign portfolio investment?
Foreign direct investment (FDI): cross-border investment by a resident entity in one economy with the objective of obtaining a lasting interest in an enterprise resident in another economy Foreign portfolio investment (FPI): cross-boarder trading by a resident entity in one economy in investment instruments, such as stocks and bonds, of another economy Foreign portfolio investment is of a more temporary nature than foreign direct investment.
Explain what is meant by each of the following: a. Individual banking b. Institutional banking c. Global banking
Individual banking encompasses consumer lending, residential mortgage lending, consumer installment loans, credit card financing, automobile and boat financing, brokerage services, student loans, and individual-oriented financial investment services. Institutional banking encompasses loans to nonfinancial corporations, financial corporations, and government entities. Global banking covers a broad range of activities involving corporate financing and capital market and foreign exchange products and services. Global banks compete directly with investment banking firms.
What is the basic function of insurance companies?
Insurance companies: provide insurance protection against the occurrence of future events that will adversely affect the insured. For providing this protection they receive an insurance premium
What is the concern with the issuer-pay model used by credit rating agencies?
Issuer-pay model can result in conflicts of interest, which calls into question the objectivity of ratings. it is argued that issuers will select a CRA from which it can obtain the highest possible rating, and that, in an attempt to attract issuers, a CRA will compromise its rating criteria to the benefit of the issuer
Compare macroprudential and microprudential perspectives
Macroprudential policy: seeks to reduce systemic risk. focuses on the welfare of the entire financial system by ultimately acting to limit costs to real GDP. Because this policy involves interconnected institutions, correlations and common exposure are important aspects to pay attention to. Top-down approach that focuses on the large scale. Microprudential policy: seeks to control the risks associated with financial intermediaries. focuses on the welfare of the individual financial institutions by ultimately acting to limit consequences for consumers in a particular institution. involves independent institutions. Bottom up approach that focuses on the small scale.
What is the relationship between a CRA and a nationally recognized statistical rating organization?
Nationally recognized statistical rating organizations (NRSRO) are entities that have been recognized by the Securities and Exchange Commission (SEC) to assign credit ratings
A U.S. investor who purchases the bonds issued by the U.S. government makes the following statement: "By buying this debt instrument, I am not exposed to default risk or purchasing power risk." Explain why you agree or disagree with this statement.
No investment is without risk. But the US government is recognized as low default risk, as they are the safest bond investment in terms of default risk. Purchasing power risk (inflation risk) still remains as the stability of the US government provides no guarantee of future purchasing power.
How do non-financial corporations participate in the financial markets?
Non-financial corporations: issue both common stock and debt obligations, which are then traded in financial markets. additionally, non-financial corporations sometimes invest excess cash in the financial markets on a short-term bases.
a. What is the function of the PBGC? b. Explain whether you agree or disagree with the following statement: "Workers whose pension plan is insured by the PBGC are guaranteed the full amount of their pension income."
Pension Benefit Guaranty Corporation (PBGC): insures qualified private defined benefit plans in the event of bankruptcy. The PBGC's guarantee is not a guarantee by the US government. the likelihood is that without a bailout, the PBGC will not have sufficient funds to pay off the obligations that it has insured.
What factors affect the interest rate used to discount the cash flow expected from a financial asset?
Purchasing Power Risk: inflation risk Credit Risk: risk that the issuer or borrower ill default Currency Risk: risk that exchange rate will change adversely
What is meant by a rating "notch"?
Rating notches are subcategories within a grade of bond ratings. can involve pluses or minuses
Explain what is meant by each of the following: a. Reserve ratio b. Required reserves c. Excess reserves
Reserve ratios: specified percentage of their deposits in a non-interest-bearing account at one of the 12 federal reserve banks Required reserves are the dollar amounts based on a bank's reserve ratios that are required to keep Excess reserves: the positive difference between actual reserves and required reserves
What is a supranational institute, and what is its general objective?
Supranational institution: an organization formed by two or more central governments through international treaties. Their general objective is to promote economic development for their member countries
What is meant by "systemic financial risk?"
Systemic financial risk: risk to the entire financial system, market risk, the probability that an entire system will collapse or fail. unavoidable risk.
What was the purpose of the Targeted Asset Relief Program (TARP)?
The purpose of TARP was to deal with the adverse economic consequences resulting from the subprime mortgage crisis that began in the summer of 2007.
Why do some economists believe that disclosure regulation is unnecessary?
They argue that the securities market would, without governmental assistance, get all the information necessary for a fair pricing of new as well as existing securities.
In 2004, then chair of the President's Council of Economic Advisers, Gregory Mankiw, stated: "Expecting a government bailout if things go wrong creates an incentive for a company to take on risk and enjoy the associated increase in return." Explain whether you agree or disagree with this statement.
This statement makes sense because unregulated action in systemically important financial institutions combined with the near guarantee of a government bailout creates moral hazard.
What is the economic rationale for the widespread use of disclosure regulation?
To prevent asymmetric information. The managers of the issuing firm have more information about the financial health and future of the firm than investors who own or are considering the purchase of the firm's securities, therefore disclosure regulation is necessary to prevent asymmetric information.
Look at table 3.1 again. Match the types of liabilities to these four assets that an individual might have: a. car insurance policy b. variable-rate certificate of deposit c. fixed-rate certificate of deposit d. a life insurance policy that allows the holder's beneficiary to receive $100,000 when the holder dies; however, if the death is accidental, the beneficiary will receive $150,000
Type 1: amount of cash outlay: known; timing: known Type 2: amount of cash outlay: known, timing: unknown Type 3: amount of cash outlay: unknown, timing: known Type 4: amount of cash outlay: unknown, timing: unknown a. Type 4 b. Type 3 c. Type 1 d. Type 2
Why is the holding of a claim on a financial intermediary by an investor considered an indirect investment in another entity?
When an investor holds a claim on a financial intermediary, he or she also effectively has made an indirect investment in the borrowing entity because the financial intermediary's direct investment is in that borrowing entity.
explain why banks are seen as dangerous institutions, borrow short and lend long
When banks receive their depositor's money, they are liable to pay some or all of it back to the depositors at any time. Banks then take this money and loan it out to individuals who often cannot afford to pay back even the initial amount of the loan before the addition of interest until a time further in the future. Because banks are large institutions and most depositors leave a significant portion of their deposits in banks for a long period of time, banks have the ability to borrow short and lend long. This service makes illiquid investment projects feasible and puts capital to use in search of returns.
