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Economics of Money, Banking, and Financial Markets 6e (Mishkin)

Chapter 9 Financial Crises

9.1 What is a Financial Crisis?

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
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.1 Define the term "financial crises"

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
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 9.1 Define the term "financial crises"

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9.2 Dynamics of Financial Crises

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
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: A
Diff: 3 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

4) The dark side of financial liberalization is ________.


A) market allocations
B) credit booms
C) currency appreciation
D) financial innovation
Answer: B
Diff: 1 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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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
Answer: D
Diff: 2 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: B
Diff: 1 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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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
Answer: D
Diff: 2 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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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
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

14) In a bank panic ________.


A) free-rider increase
B) bond prices increase
C) transactions costs increase
D) multiple banks fail
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: D
Diff: 1 Type: MC
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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17) Share prices are a valuation of a corporation's ________.
A) collateral
B) net worth
C) current capital
D) net earnings
Answer: B
Diff: 1 Type: MC
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

19) A(n) ________ is an increase in prices of assets above their fundamental economic values.
A) decrease in moral hazard
B) asset-price bubble
C) decline in lending
D) liability war
Answer: B
Diff: 2 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: A
Diff: 1 Type: MC
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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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
Answer: D
Diff: 1 Type: MC
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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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
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: D
Diff: 2 Type: MC
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: A
Diff: 3 Type: MC
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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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
Answer: B
Diff: 2 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: C
Diff: 2 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: C
Diff: 2 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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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
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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
Answer: A
Diff: 3 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

36) 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
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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37) 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
Answer: A
Diff: 1 Type: MC
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis

38) 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
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

39) How do increases in interest rates play a role in promoting financial crises?
Answer: Students should discuss the increase in adverse selection, the decline in lending, the
decline in investment and aggregate economic activity, and the effects on cash flow.
Diff: 2 Type: ES
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

40) Describe an asset-price bubble.


Answer: An asset-price bubble is a term which describes asset prices (in the stock market or
real estate) that have been driven above their fundamental economic values by investor
psychology.
Diff: 2 Type: ES
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

41) What is debt deflation?


Answer: Debt deflation occurs when a decline in price levels leads to deterioration in firms' net
worth because of the increased burden of indebtedness.
Diff: 2 Type: ES
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis

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42) Typically, the economy recovers fairly quickly from a recession. Why did this not happen
in the United States during the Great Depression?
Answer: The 25 percent decline in the price level from 1930-1933 triggered a debt deflation.
The loss of net worth increased adverse selection and moral hazard problems in the credit
markets and increased and prolonged the economic contraction.
Diff: 2 Type: ES
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis

9.3 The Global Financial Crisis of 2007-2009

1) ________ is a process of bundling together smaller loans (like mortgages) into standard debt
securities.
A) Securitization
B) Origination
C) Debt deflation
D) Distribution
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

2) 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
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

3) ________ is the development of new, sophisticated financial instruments.


A) Discounting
B) Origination
C) Financial engineering
D) Distribution
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

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4) 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
Answer: A
Diff: 3 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

5) 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
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

6) 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
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

7) 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
Answer: B
Diff: 2 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

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8) 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
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

9) 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"
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

10) Credit default swaps ________.


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
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

11) 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
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

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12) The "democratization of credit" was attributed to ________.
A) the subprime mortgage market
B) the 2000-2001 recession
C) growth of prime mortgages
D) asset-price gaps
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

13) 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
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

14) 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 2007-2008 recession
D) cannot be explained
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

15) 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
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

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16) 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
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

17) 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
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
Answer: D
Diff: 3 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

18) 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
Answer: D
Diff: 2 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

19) 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
Answer: C
Diff: 2 Type: MC
Skill: Applied
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

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20) 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
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

21) Between October 2007 and March 2009, asset prices in the stock market fell by ________.
A) over 50 percent
B) 10 percent
C) around 16 percent
D) less than 30 percent
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

22) 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
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

23) 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
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

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24) U.S. firms affected by the financial crisis included ________.
A) Bear Stearns and Merrill Lynch
B) AIG and JP Morgan
C) Manulife and RBC
D) Capital One and BNP Paribas
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

25) 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
Answer: A
Diff: 1 Type: MC
Skill: Applied
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

26) During the 2007-2009 financial crisis in the U.S. the credit spreads peaked at ________ in
December 2008.
A) nearly 6 percent
B) nearly 5 percent
C) nearly 4 percent
D) 3 percent
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

27) By 2012, the debt to GDP ratio for Greece had climbed to ________.
A) 60%
B) 100%
C) 160%
D) 200%
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

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28) What triggered the 2007-2008 financial crises ?
Answer: The crises was triggered by mismanagement of financial innovation in the sub prime
residential mortgage market and the bursting of a bubble in housing prices.
Diff: 1 Type: ES
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009

29) How can asymmetric information lead to a bank panic?


Answer: Depositors cannot judge the quality of their banks' loan portfolios. So, when they hear
about a failed financial institution, they may worry about the safety of their deposits and begin
to withdraw their funds from their bank. Even healthy institutions can go under if enough
deposits are withdrawn quickly.
Diff: 3 Type: ES
Skill: Recall
Objective: 9.1 Define the term "financial crises"

9.4 Canada and the 2007-2009 Financial Crisis

1) 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
Answer: B
Diff: 1 Type: MC
Skill: Recall
Objective: 9.4 Describe the impact of the 2007-2009 financial crisis on Canada

2) 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
Answer: B
Diff: 3 Type: MC
Skill: Recall
Objective: 9.4 Describe the impact of the 2007-2009 financial crisis on Canada

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3) 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
Answer: B
Diff: 2 Type: MC
Skill: Recall
Objective: 9.4 Describe the impact of the 2007-2009 financial crisis on Canada

4) "Plain vanilla" assets are ________.


A) unsecured promissory notes
B) residential mortgages
C) subprime mortgages
D) CDOs
Answer: B
Diff: 1 Type: MC
Skill: Recall
Objective: 9.4 Describe the impact of the 2007-2009 financial crisis on Canada

5) 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
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.4 Describe the impact of the 2007-2009 financial crisis on Canada

6) The risk of asset-backed commercial paper depends on ________.


A) unsecured promissory notes
B) the underlying securities
C) commercial paper
D) Treasury bills
Answer: B
Diff: 1 Type: MC
Skill: Applied
Objective: 9.4 Describe the impact of the 2007-2009 financial crisis on Canada

7) What triggered the ABCP saga in Canada?


Answer: The ABCP saga was triggered when investors in the Canadian ABCP market declined
to roll over maturing notes because of concerns about exposure to the U.S. subprime mortgage
sector in the underlying assets.
Diff: 2 Type: ES
Skill: Applied
Objective: 9.3 Describe the causes and consequences of the global financial crisis of 2007-2009
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8) What were some of the changes to the regulations for real estate lending that were
implemented in 2012?
Answer: A reduction in the maximum amortization period to 25 years, a restriction on a home
to 80% of its value and a requirement that housing costs are not more than 39% of gross
household income.
Diff: 2 Type: ES
Skill: Recall
Objective: 9.4 Describe the impact of the 2007-2009 financial crisis on Canada

9.5 Response of Financial Regulation

1) A major shift in the US system of financial regulation in the aftermath to the financial crisis
is ________.
A) an easing of monetary policy
B) a tightening of monetary policy
C) a shift from microprudential supervision to macroprudential supervision
D) a shift from macroprudential supervision to microprudential supervision
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009

2) When regulators examine a financial institution's risk incurring activities it is engaging in


________ supervision.
A) microprudential
B) macroprudential
C) both microprudential and macroprudential
D) neither microprudential nor macroprudential
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009

3) When regulators examine the financial system's risk incurring activities it is engaging in
________ supervision.
A) microprudential
B) macroprudential
C) both microprudential and macroprudential
D) neither microprudential nor macroprudential
Answer: B
Diff: 2 Type: MC
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009
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Copyright 2017 Pearson Canada, Inc.
4) The recognition that increased availability of credit leading to higher asset prices and
financial buffers at lending institutions and therefore further expansion of credit availability is
referred to as ________.
A) microprudential supervision
B) macroprudential supervision
C) the leverage cycle
D) a liquidity crisis
Answer: C
Diff: 2 Type: MC
Skill: Applied
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009

5) When regulators examine the adequacy of the financial system's liquidity it is engaging in
________ supervision.
A) microprudential
B) macroprudential
C) both microprudential and macroprudential
D) neither microprudential nor macroprudential
Answer: B
Diff: 1 Type: MC
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009

6) When regulators examine a financial institution's capital ratios it is engaging in ________


supervision.
A) microprudential
B) macroprudential
C) both microprudential and macroprudential
D) neither microprudential nor macroprudential
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009

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Copyright 2017 Pearson Canada, Inc.
7) The net stable funding ratio is the ratio of ________ and ideally should be relatively
________.
A) the percentage of long-term to total funding; low
B) the percentage of long-term to total funding; high
C) the percentage of short-term to total funding; low
D) the percentage of short-term to total funding; high
Answer: C
Diff: 2 Type: MC
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009

8) The Dodd-Frank Act of 2010 requires financial institutions to ________.


A) lend to all individuals who need loans
B) require verification of a borrowers job status but not credit history and income
C) require verification of a borrowers income and job status but not their credit history
D) require verification of a borrowers income, credit history and job status
Answer: D
Diff: 2 Type: MC
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009

9) The Dodd-Frank Act of 2010 ________.


A) prevents the US government from taking over small financial institutions and rescue them
from a potential bankruptcy
B) allows the US government from taking over small financial institutions and rescue them
from a potential bankruptcy
C) prevents the US government from taking over large financial institutions and rescue them
from a potential bankruptcy
D) allows the US government from taking over large financial institutions and rescue them
from a potential bankruptcy
Answer: D
Diff: 2 Type: MC
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009

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10) The Volcker rule ________.
A) raises the limit on proprietary trading but decreases the allowable holdings of hedge funds
B) raises the limit on proprietary trading and increases the allowable holdings of hedge funds
C) lowers the limit on proprietary trading and decreases the allowable holdings of hedge funds
D) lowers the limit on proprietary trading but increases the allowable holdings of hedge funds
Answer: C
Diff: 3 Type: MC
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009

11) Describe the rising phase of the leverage cycle.


Answer: A boom in lending, increased asset prices and increasing financial buffers at financial
institutions which lead to further rounds of credit expansion.
Diff: 1 Type: ES
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009

12) Describe the declining phase of the leverage cycle.


Answer: A reduction in lending, decreased asset prices and decreasing financial buffers at
financial institutions which lead to further rounds of credit contraction.
Diff: 1 Type: ES
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009

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9.6 Too-Big-To-Fail and Future Regulation

1) The too-big-to-fail problem is a ________ problem.


A) economic
B) regulatory
C) moral hazard
D) adverse selection
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 9.6 Identify the gaps in current financial regulation and how those gaps may be
addressed with future regulatory changes

2) Other than breaking systematically important financial institutions, the too-big-to-fail


problem could be mitigated by requiring ________.
A) lower capital requirements
B) making capital requirements procyclical
C) making it easier for the Fed to bail out failing banks
D) revoking the Volker rule
Answer: B
Diff: 2 Type: MC
Skill: Recall
Objective: 9.6 Identify the gaps in current financial regulation and how those gaps may be
addressed with future regulatory changes

3) To reduce the incentives of financial institution managers to engage in excessive risk taking
regulators might require that bonuses be ________.
A) paid immediately
B) paid after several years
C) paid after several years only if the firm remains in good financial health
D) paid in the form of stock options
Answer: C
Diff: 2 Type: MC
Skill: Recall
Objective: 9.6 Identify the gaps in current financial regulation and how those gaps may be
addressed with future regulatory changes

4) Explain why the too-big-to-fail problem is a moral hazard problem.


Answer: The student should point out that when financial firms become very large their
managers will come to believe that should they run into financial and liquidity problems, the
government or the central bank will have no choice but to bail them out. This will lead them to
take higher risks to seek higher profits.
Diff: 2 Type: ES
Skill: Applied
Objective: 9.6 Identify the gaps in current financial regulation and how those gaps may be
addressed with future regulatory changes

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5) Explain the reasoning behind the recommendation that capital requirements be pro-cyclical.
Answer: When the economy is improving the requirement that financial institutions increase
their capital requirements will curtail their risk taking behaviour and when the economy is
slowing, lower capital requirements will encourage them to take more risk and lend to
businesses and individuals.
Diff: 1 Type: ES
Skill: Applied
Objective: 9.6 Identify the gaps in current financial regulation and how those gaps may be
addressed with future regulatory changes

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