FIN3244 EXAM 2
Financial innovation in mortgage markets
- financial engineers created financial products that allowed for "subprime mortgages" to become more available -they would "bundle" these mortgages into a single security (MBS) or mortgage backed securties -this allowed these portages to be traded like stocks by investors
federal reserve system
-board of governors -federal open market committee -chairman -3000 member banks
Asymmetric information in the credit ratings
-they get paid by creating ratings for securities and also helped create the MBS in the first place through advising -If they did not give these junk bonds MBS good ratings, the people making the MBS will just go to another credit rating agency
recent example of financial crisis
2007-2008 finial crisis is the largest financial crisis in recent history
Americans' fear of centralized power and their distrust of moneyed interests explain why the U.S. did not have a central bank until the 19th century. 18th century. 20th century. 17th century.
20th century.
how much did house prices fall by from 2007-2009
30%
board of governers
7 members main governing body in the fed
financial innovation
CDO's are an example from 2008 -a new product was introduced on financial markets and then was abused, causing a bible in asset prices that later popped
CDO
Collateralized Debt obligations
what country is insider trading legal(F)
Germany
who is the current chairman
Jerome Powell as of 2018
Factors that can lead to worsening conditions in financial markets include increasing interest rates and asset price booms.
True
Agency problems in mortgage markets
- mortgage brokers did not care if people could repay their mortgages because they would not be stuck with the loan because they would sell it as a securities to investors -these mortgage brothers get their fee for creating the mortgages and then not have to worry about the mortgages being paid back
Factors that provide the Federal Reserve with a high degree of independence include -14-year terms for members of the Board of Governors. -a four-year term for the chairman of the Board of Governors that is not coincident with the president's term of office. -constitutional independence from Congress and the president. -all of the above.
-14-year terms for members of the Board of Governors. -a four-year term for the chairman of the Board of Governors that is not coincident with the president's term of office.
what areas suffered the most from this crisis
-US residential market -financial institutions -the "shadow" banking system -global financial markets -major financial firms
Most financial crises in the United States have begun with -an increase in uncertainty resulting from the failure of a major firm. -a steep stock market decline. -a steep decline in interest rates.
-an increase in uncertainty resulting from the failure of a major firm. -a steep stock market decline.
what happens when investors rush to buy securities when low
-buy until the price rises to the point that returns are normal is an unexploited profit opportunity -Think demand goes up if something is underpriced until the price rises and reaches an equilibrium point, where it is appropriately price.
Federal reserve
-central bank of the US -responsible for managing monetary policy
what happened in the residential housing market during the crisis
-housing prices went way up as the subprime mortgage grew -when the bubble burst, housing prices fell sharply
Debt deflation
-if the economy does poorly enough, prices will go down -companies will not be able to make as much doing the same thing they were doing before, however they will still owe the same amount of money in debt -therefore, the real value of their debt goes up
According to the efficient market hypothesis -information in newspapers and in the published reports of financial analysts is already reflected in market prices. -one cannot expect to earn an abnormally high return by purchasing a security. -unexploited profit opportunities abound, thereby explaining why so many people get rich by trading securities. -all of the above are true. -only A and B of the above are true.
-information in newspapers and in the published reports of financial analysts is already reflected in market prices. -one cannot expect to earn an abnormally high return by purchasing a security.
who is to blame for the crisis
-low interest rates on housing cause bubble -relaxed lending standards and subprime mortgages -creation of MBS and CDO -money coming from other countries to invest caused a large money supply in the housing market -prob combination of lots of things
An increase in uncertainty
-when major shock occurs in financial markets, it causes uncertainty among investors (ex: bank failure) -this can create moral hazards and adverse selection, causing economic activity to decline
what are the three stages of a financial crisis
1-initial phase 2-banking crisis 3-debt deflation
three major factors in the financial crisis
1. financial innovation in mortgage markets 2. agency problems in mortgage markets, and asymmetric information in credit ratings
when does a credit boom or bust happen
1. financial innovation is mismanaged 2. financial liberalization is mismanaged
how many federal reserve banks
12
when was the first US bank terminated and why
1811 due to mistrust of centralized authority and moneyed interests
when was the second US bank terminated
1836 because there was no lender for distressed banks
what was the credit spread of banks after the great depression
2% to 8%
Currently about 38% of the commercial banks in the United States are members of the Federal Reserve System, having declined from a peak figure of ________ in 1947. 49% 63% 42% 55%
49%
how much did the stock market fall by from 2007 to 2009
50%
how many meetings a year does the fed have
8 a year normally in secret and can be held more often
From its peak in 1929 to the trough in December 1932, the Dow Jones Industrial Average fell how much? 90% 80% 70% 60%
90%
January effect(UF)
=high returns in january investors could be trying to lower tax liability by selling off capital losses in December
The ________ of the Board of Governors is the spokesperson for the Fed. president chairman either of the above can be the spokesperson neither of the above
chairman
what happens when banks start deleveraging
depositors see the risk and pul funds from banks
what did such a high credit spread lead to
lead to debt deflation as price levels fell by 25% and company value began to fall
what do the 3000 member banks do
maintain the reserve deposits in the FED bank within their respective districts
what was the affect of the FED increasing interest rates to decrease the bubble
the stock market crashes by 40% from October through December of 1929
fundamental value
the value that an asset should have
Stock prices publicly reflect available info (F)
true
economic contraction was severe
true
what was the stock market worth in 1932
worth 10% of what it had been worth at the peak in 1929
Which of the following is NOT considered one of the four groups in the Federal Reserve System? Federal Reserve banks Federal Deposit Insurance Corporation Board of Governors Federal Open Market Committee
Federal Deposit Insurance Corporation
where else were there debt crisis besides the US in 2008
Greece, Ireland, Portugal and Spain hit hard
The national economic forecast for the next two years prepared by the staff of the Board of Governors is published in the Green Book Beige Book Blue Book Fed Book
Green Book
Which of the following does not weaken the efficient markets hypothesis? Success of buy-and-hold strategy Mean reversion January effect Excessive volatility
Success of buy-and-hold strategy
When was the worst and longest economic recession in modern history
THE GREAT DEPRESSION began in 1929 with stock crash ended in 1946 at the end of WW2
Housing prices boomed from 2002 to 2006, fueling the market for subprime mortgages and forming an asset-price bubble. Housing prices began declining in 2006, falling by more than 30%, which led to defaults by subprime mortgage holders.
True
Technical analysis is a popular technique used to predict stock prices by studying past stock price data and searching for patterns such as trends and regular cycles.
True
This worldwide depression led to the rise of fascism in Europe and some would argue WW2
True
Should you be skeptical of hot tips?
YES! EMH indicates fi the market is efficient it is already prices in the stock and as soon as information is available to everyone, someone will have already exploited the profit opportunity (could also be insider trading)
did the bank panics in the US affect other countries
YES- the worldwide depression led to the rise of fascisim in Europe and some argue started WW2
was a bailout package created for 2008 crisis?
Yes- created to purchase this worthless assets from banks to keep them from failing
what is the small-firm effect for EMH(UF)
abnormally high returns
example of a government safety net company
FDIC bank insurance -banks know they are protected form losses and take on more risk
Federal Open Market Committee
FOMC -makes monetary policy decisions -consists of 7 BOG members and 5 federal reserve bank presidents
An unusual feature of the "Great Recession" in the U.S. from 2007-2009 was that the crisis did not spread to European nations.
False
Evidence that a mutual fund has performed extraordinarily well in the past contradicts the efficient market hypothesis.
False
Evidence that stock prices sometimes fall when a firm announces good news contradicts the efficient market hypothesis.
False
Initial phase
can be caused by a credit boom or bust, asset price boom or bust or an increase in uncertainty
chairman
chairs of BOG and FOMC
Sometimes one observes that the price of a company's stock falls after the announcement of favorable earnings. This phenomenon is -consistent with the efficient market hypothesis if the earnings were not as low as anticipated. -clearly inconsistent with the efficient market hypothesis. -consistent with the efficient market hypothesis if the earnings were not as high as anticipated. -the result of none of the above.
consistent with the efficient market hypothesis if the earnings were not as high as anticipated.
CDO def
created to further break up MBS. it created default priorities for the owners of MBS- in other words, the highest CDO would be paid first
What happens when some banks become insolvent?
depositors run to their banks that may or may not be in financial trouble and pull their deposits out to be safe, this causes more banks to be insolvents and worsen the issue
higher tranches of CDO vs lower tranches
higher tranches get a lower interest rate so their investment is safer lower tranches get higher interest rates but bear more risk of default
What is the only way to beat the market?(F)
insider information which is illegal in the U.S.
The efficient market hypothesis suggests that allocating your funds in the financial markets on the advice of a financial analyst -will always mean lower returns than if you had made selections by throwing darts at the financial page. -will certainly mean higher returns than if you had made selections -by throwing darts at the financial page. -is not likely to prove superior to a strategy of making selections by throwing darts at the financial page. -is good for the economy.
is not likely to prove superior to a strategy of making selections by throwing darts at the financial page.
financial crisis
is when a disruption occurs in the flow of information in financial markets causing to slow or even stop -this causes market inefficiencies-money goes to the wrong use or does not flow at all
what is the important of October 24th, 1929
known as Black Thursday because it was a huge single day los in stock value
technical analysis(F)
looks at past trees and irregular cycles to predict stock prices which it can not accurately do because stock prices are unpredictable
how to fix banks insolvency
must sell assets quickly to further deteriorating their balance sheets
The advantage of a "buy and hold strategy" is that -net profits will tend to be higher because there will be fewer brokerage commissions. -losses will eventually be eliminated. -the longer a stock is held, the higher its price will be. -only B and C of the above are true.
net profits will tend to be higher because there will be fewer brokerage commissions.
do anticipated announcements reflect stocks?(F)
no, on average earnings announcements do not raise the stock prices
new information in EMH (UF)
not always immediately incorporated into stock prices
Bubble
occurs when the price of an asset gratuity exceeds the fundamental value of that asset
how often did bank insolvency happen
semi regular occurrence before WW2 and occurred about every 20 years and takes years to recover as an economy
Purpose of EMH
should eliminate all unexploited profit opportunities because some investors will find them and exploit these opportunities
Random walk behavior(F)
stock prices are not predictable because if they are predicated to fall/rise, investors would sell/buy to equilibrium
Market Overreaction(UF)
stock prices overreact to news announcements -Investors may purchase a stock after bad earnings report then sell it a couple of weeks later after it gone back to normal level
mean reversion(UF)
stocks with low return tend to have high returns in the future
what was the view on stocks before the great depression
the American public began investing in stocks carelessly and raising the price of stocks -also borrowed money on "margin" to invest in other people money as well and created a bubble
Evidence in favor of market efficiency does not include -technical analysis. -walk behavior. -performance of investment analysts and mutual funds. -the January effect.
the January effect
Bank panic
the banks balance sheets value go low enough
when did the stock market recover half of its value
the middle of 1930
how is the 2008 crisis similar to the great depression
the raised credit spreads and made loans harder to come by, in turn causing the economy to contract
The Federal Open Market Committee consists of the seven members of the Board of Governors and seven presidents of the regional Fed banks. the seven members of the Board of Governors and five presidents of the regional Fed banks. the twelve regional Fed bank presidents and the chairman of the Board of Governors. the five senior members of the seven-member Board of Governors.
the seven members of the Board of Governors and five presidents of the regional Fed banks.
what happened in 1920-1921
there was a short depression in which the stock market fell by 50% and corporate profits fell by 90%
Frannie mae and Freddie mac
they were protected by the government from failing but would have failed in much of the same way if they had not been bailed out
"Investment dartboard" often beats investment managers
true
1/3 of American banks had failed by the end of it all
true
Any time you find a pattern, its against EMH since EMH says you can't predict stock prices (UF)
true
In an efficient profit market, all the unexploited profit opportunities will be eliminated
true
adverse selection and moral hazard were created as loans were hard to come by
true
droughts entered the midwest, causing farmers to default on loans, and causing bank panics as banks went out of business
true
investment markets and mutual funds dont beat the market(F)
true
the unemployment rate rose to 25% during the great depression
true
banks charged higher interest rates due to uncertainty creating high credit spread
true -the difference between the rates on loans and the rates on US treasury securities = credit spread
Deleverage
when baks have stocks in the overpriced assets, they will see the value of their assets fall causing credit to be less available and adverse selection
what leads to a credit bust
when banks start deleveraging and depositors pull their funds from the bank
economic contraction
when firms that should be getting loans are not because the banks have less money to loan and are loaning less in general. this lack of available funds for firms cause them to not be able to invest in new projects which creates the economic contraction
when will the bubble burst
when investors being to sell off these overprices assets
what creates moral hazard problem
when investors sell these overprices assets, companies make more risky investment to try and save their companies
financial liberalization
when laws are lifted and the market is allowed to operate more freely- this can cause rapid growth that later pops when the price becomes too inflated
deleveraging
when risky loans they give out start defaulting, they loan out less
Government safety nets
when the govenment introduces laws that protect companies, those companies feel that they can take more risks and this weakens incentives for risk management
Buy-and-hold strategy
where they buy stocks, construct a portfolio and hold them for a long time (should be embraces by investors)
panic of 1907
widespread bank failures resulted in substantial losses
can EMH be used to predict foreign exchange rates/currency(F)
yes, evidence shows these are unpredictable
Which of the following statements regarding member banks is TRUE? -A majority of banks are part of the Federal Reserve System, and they hold a majority of all bank deposits. -A minority of banks are part of the Federal Reserve System, but they hold a majority of all bank deposits. -A majority of banks are part of the Federal Reserve System, but they hold a minority of all bank deposits. -A minority of banks are part of the Federal Reserve System, and they hold a minority of all bank deposits.
A minority of banks are part of the Federal Reserve System, but they hold a majority of all bank deposits.
Efficient Market Hypothesis (EMH) def
A security's price fully reflects all available information in an efficient market
examples of bank failures
Bear Stern and Lehman brothers in 2008 crisis
what was the first bank to fail
Bear and Stearns and sold to JP Morgan for 5% of their value -american banks with the high levels of investment in MBS failed
How valuable are published reports by investment advisors?
EMH says it can't help you to beat the market. empirical evidence backs this up
do stock prices always rise when there is good news?
NO, it depends not the news. if expected the price shouldn't change, but if unexpected there will be a response
Do stock prices always rise when there is good news?
NO- in the EMH, they will only rise when the information being announced is new or unexpected
Does every investor need to be aware of every security?
NO- only a few do, they will eliminate the profit opportunities that appear because in so doing, they make a profit
Do mutual funds consistently outperform the market?
NO- they can't constantly outperform the market, therefore investors shouldn't buy into ones that have high fees or sales commissions to brokers but buying mutual funds are a sensible strategy for small investors
does the EMH support technical analysis
NO- they think it is a waste of time because it does not successfully predict forecast of stock because stock prices are unpredictable
Which of the following banks are required to be members of the Federal Reserve System? State-chartered banks Banks having over $500 million in assets Insured banks None of the above
None of the above
Which of the following types of information will most likely enable the exploitation of a profit opportunity? Financial analysts' published recommendations Hot tips from a stockbroker Technical analysis None of the above
None of the above
Investors should try to outguess the market with constant buying and selling of securities, which only puts money in the brokers pockets
false
federal reserve act of 1913
fed established to facilitate economic stability
what happened to Lehman brothers
filed for bankruptcy and Meriil Lynch sold to Bank of America in "fire" sale
How much did real GDP and unemployment increase in 2009
over 10%
Instrument independence means the central bank is free from -political pressure regarding how it uses the tools of monetary policy. -political pressure regarding the goals it pursues. -both A and B of the above. -neither A nor B of the above.
political pressure regarding how it uses the tools of monetary policy.
what did the FED do in attempt to decrease the bubble before the great depression
raised interest rates, therefore people saw the higher interest rates and began investing in bonds by pulling their money out of the stock market to lend at higher interest rates
