Deck 26: Issues in Financial Markets

Question 1

One implication of the efficient markets hypothesis is that stock prices do not follow a random walk.

Answer 1

False

Question 2

The efficient markets hypothesis suggests that since markets are efficient, it is easy to engage in fundamental analysis to purchase undervalued shares and then earn greater than average market returns.

Answer 2

False

Question 3

The value of a share is based on the present value of the future stream of dividend payments and the final sales price.

Answer 3

True

Question 4

The boom of the late 1980s gave way to recession in the early 1990s and then to a period of reduced volatility. In the UK, this was called the period of:

A) The Golden Generation.
B) The Orange Revolution.
C) The Great Stability.
D) The Great Adventure

Question 5

In the early 2000s, banks would bundle up individual mortgages to form a package containing billions in mortgage debt. In this case, the bank is known as the ____________.

A) credit-rating agency.
B) originator.
C) deal maker.
D) debtor.

Question 6

In the early 2000s, banks would package mortgage-backed securities into pools of debt and sell them on to investors. This practice is known as ________________.

A) classification.
B) mortgage-buying.
C) assets-making.
D) securitization.

Question 7

Positive equity allowed homeowners to be able to manage rising interest rates on their mortgages. However, when house prices began to fall and the option of remortgaging disappeared, many homeowners:

A) bought second homes.
B) were able to find renters.
C) discovered that their monthly repayments were rising beyond their ability to pay.
D) discovered that their monthly repayments were falling.

Question 8

In the early 2000s, the mortgage market rapidly developed by extending sub-prime mortgages to those who would not be considered to have a sound credit rating.

Question 9

For many construction workers, the problems in the housing market led to job gains. As mortgages became harder to access, demand for existing homes jumped.

Question 10

In 2005, few people were predicting the calamitous events which would take place over the next four years.

Question 11

Toxic debt refers to the stock of junk bonds held by banks and other financial institutions which are used to leverage further lending.

Question 12

In the early 2000s, mortgage banks would set up entities called Special Purpose Vehicles (SPVs), which enabled banks to issue bonds to investors to raise finance to buy collections of ________

A) houses.
B) mortgages.
C) assets.
D) debt.

Question 13

The period of reduced volatility from the late 1980s to the mid-2000s was characterized by:

A) low inflation, low unemployment and stable growth.
B) low inflation, high unemployment and low growth.
C) high inflation, high unemployment and unstable growth.
D) low inflation, low unemployment and poor growth.

Question 14

In the 1980s, deregulation was based on the belief that excessive regulation:

A) Encouraged the markets to take risks.
B) Helped banks gain new customers.
C) Limited the ability of the supply side of the economy to operate efficiently.
D) Built up momentum on the demand side.

Question 15

The challenges for central banks is to be able to tell when a bubble is occurring and if it is, whether to take action and when.

Question 16

A major cause of the global economic crisis was because businesses could not access funds from banks.

Question 17

For financial institutions in the above 20-year period, the expectations of continued economic growth partly explain how attention turned from what might be termed 'prudent' lending to:

A) risk free investments on the back of new financial instruments.
B) risk free investments on the back of existing financial instruments.
C) riskier investments on the back of existing financial vehicles.
D) riskier investments on the back of new financial instruments.

Question 18

In the early 2000s, banks would offer teaser rates in the sub-prime market designed to:

A) Test out how creditworthy potential house buyers were.
B) To provide an immediate good return for funders of the mortgage.
C) To entice new potential buyers within the sub-prime market.
D) All of the above.

Question 19

In the early 2000s, the demand for mortgages was _______ rather than effective because whilst there were plenty of people who might have been willing to enter the market they were not always able to do so because of an inability to access the mortgage market?

A) latent.
B) explicit.
C) implicit.
D) highlighted.

Question 20

As house prices go up the difference between the principal borrowed and the value of the house increases, which is referred to as negative equity.

Question 21

If unexpected news raised people's expectations of a corporation's future dividends and price, then before the price changes this corporation's stock would be

A) overvalued, so its price would rise.
B) overvalued, so its price would fall.
C) undervalued, so its price would rise.
D) undervalued, so its price would fall.

Question 22

In the early 2000s, an SPV would issue bonds in bundles to reflect different levels of risk. The process of splitting up the bundles of debt into these different levels of risk is called ________.

A) insuring.
B) priming.
C) protecting.
D) tranching.

Question 23

Speculative bubbles may occur in the shares market

A) during periods of extreme pessimism because so many stocks become undervalued.
B) only when people are irrational.
C) when stocks are fairly valued.
D) because rational people may buy an overvalued share if they think they can sell it to someone for even more at a later date.

Question 24

No particular stock is a better buy than any other stock if

A) stock prices are driven by the "animal spirits" of investors'
B) the random-walk theory of stock prices is incorrect.
C) the efficient markets hypothesis is correct.
D) actively managed mutual funds always outperform index funds.

Question 25

One problem with credit default swaps (CDS) was that:

A) House prices rose.
B) Interest rates fell.
C) There was no regulation required.
D) There was positive equity.

Question 26

Rather than looking at information, analyzing it rationally and then basing their decisions on the evidence available, some people just respond to the behavior of other people. This is called _____________.

A) behavioural economics
B) consumer behaviour
C) herd mentality
D) consulting

Question 27

According to the efficient market hypothesis

A) changes in the prices of stocks are predictable. Evidence shows that managed funds typically do better than indexed funds.
B) changes in the prices of stocks are predictable. Evidence shows that indexed funds typically do better than managed funds.
C) changes in the prices of stocks are not predictable. Evidence shows that managed funds typically do better than indexed funds.
D) changes in the prices of stocks are not predictable. Evidence shows that indexed funds typically do better than managed funds.

Question 28

According to the efficient markets hypothesis theory, asset prices reflect all ________ information about the value of an asset.

A) confidential
B) insider.
C) publically available
D) sensitive.

Question 29

Which of the following is correct concerning stock market irrationality?

A) Bubbles could arise, in part, because the price that people pay for stock depends on what they think someone else will pay for it in the future.
B) Economists almost all agree that the evidence for stock market irrationality is convincing and the departures from rational pricing are important.
C) Some evidence for the existence of market irrationality is that informed and presumably rational managers of mutual funds generally beat the market.
D) All of the above are correct.

Question 30

Which was not a key cause of the financial crisis?

A) The bonus culture in banks.
B) Quantitative easing.
C) Failures in corporate governance.
D) Poor risk management strategies and understanding.

Question 31

If share prices follow a random walk then investors can make large profits illegally by

A) using computer programs that perform technical analysis using past share price trends.
B) performing fundamental analysis of shares using data contained in annual reports.
C) quickly responding to rumours of mergers between companies.
D) using insider information.

Question 32

According to the efficient market hypothesis

A) You cannot beat the stock market.
B) You should be able to outperform the market.
C) You cannot beat the bond market
D) You can only beat the stock market if you engage in option trading.

Question 33

Share prices will follow a random walk if

A) shares are overvalued.
B) people behave irrationally when choosing shares.
C) markets reflect all available information in a rational way.
D) shares are undervalued.

Question 34

The targeting of the sub-prime market for loans caused:

A) the supply of housing to shift to the left in anticipation of a rise in house prices.
B) interest rates to fall.
C) those with high credit ratings to find it harder to access loans.
D) banks to be prepared to make riskier loans.
E) a slump in demand in the buy to rent sector.

Question 35

The tolerance of moral hazard means that:

A) Key banks are protected from failure because they are too big to fail.
B) Bankers have a duty to conduct their activities in an ethical way.
C) Risk seeking behaviour may be encouraged.
D) The risks of trading in the bond market are perceived as too high.

Question 36

If banks knew that they would be bailed out by the government, then they would have less of an incentive to pursue prudential lending practices. This is known as the problem of ___________.

A) moral hazard.
B) buying on the margin.
C) fiscal policy.
D) option trading.

Question 37

If share prices follow a random walk, it means

A) long periods of declining prices are followed by long periods of rising prices.
B) the greater the number of consecutive days of price declines, the greater the probability prices will increase the following day.
C) share prices are unrelated to random events that shock the economy.
D) share prices are just as likely to rise as to fall at any given time.

Question 38

Some critical observers of the stock market argue that the global economic crisis of 2007-09 is evidence that:

A) markets will always have winners and losers.
B) there is little rational behaviour in financial markets.
C) people will continue to buy houses.
D) no one knows when a bubble will next occur.

Question 39

When Lehman Brothers collapsed on 15 September 2008, it had a massive effect on other financial companies such as AIG because

A) Lehman's was an important player in the inter-bank market.
B) Many of them had sold CDS that provided insurance against default by Lehman's.
C) Governments and central banks panicked.
D) Redundant Lehman's employees made claims on their unemployment insurance policies, sold by these companies.

Question 40

If asset markets are driven by the "animal spirits" of investors, then

A) those markets reflect rational behaviour.
B) those markets reflect irrational behaviour.
C) the efficient markets hypothesis is correct.
D) the stock market exhibits informational efficiency.

Question 41

Give two conditions that are important to the efficient market theory. List one implication of the efficient market theory.

Question 42

The term Ponzi is named after Charles Ponzi, who developed a money-making scheme in the 1920s. A Ponzi scheme relies on:

A) attracting new investors to the scheme, whose money is used to pay existing investors and hence keep the scheme going.
B) asking existing investors in the scheme to pay back new investors and hence keep the scheme going.
C) finding new investors to keep the scheme going
D) Rewarding existing investors in the scheme with money from their investments.

Question 43

Explain how problems in the sub-prime market led to the global banking crisis in 2007-09?

Question 44

What is the sub-prime market?

Question 45

The South Sea Bubble is an example of how:

A) the shipping industry came out of a recession.
B) knowledge prevailed over ignorance.
C) the study of history does not matter much.
D) asset prices can rise way above their true market value.

Question 46

Why did mortgage defaults lead to home foreclosures?

Question 47

When buyers become too aggressive by borrowing funds for future investment in the expectation of a good return, this is called ______________.

A) arbitrage
B) leveraging
C) day trading
D) buying short

Question 48

Discuss the statistical evidence concerning the efficient markets hypothesis.

Question 49

Why do some observers think that the problem of moral hazard led to one of the most spectacular banking collapses in recent times, the collapse of the US investment bank?

Question 50

If returns on share prices are greater in certain months such as January, this would refute theories that suggest markets are ____________.

A) short
B) biased
C) long
D) efficient

Question 51

_____________ refers to a situation where regulatory agencies become unduly influenced and dominated by the industries they are supposed to be regulating.

A) financial accounting.
B) regulatory capture.
C) principal-agency conflict
D) regulatory discrimination.

Question 52

It could be argued that during the global economic crisis of 2007-09, the ratings agencies such as Moody's and Standard & Poors had a conflict of interest because banks paid hefty fees to the agencies rather than to investors. How did the conflict of interest arise? Because

A) the agencies had a little interest in keeping their clients (the banks) happy.
B) the agencies had plenty of business elsewhere.
C) the agencies had their reputations to think of.
D) the agencies had a vested interest in keeping their clients (the banks) happy because of their need for repeat business.

Question 53

Why did house prices fall so suddenly and what happened to homeowners trying to sell? Cite examples of entire urban areas that were affected by the downward spiral.

Question 54

Economist Hyman Minsky argued that financial markets create their own internal forces which generate periods of asset inflation and credit expansion. He said that these periods will be followed by:

A) economic prosperity.
B) depression and war.
C) contractions in credit and asset deflation.
D) mortgage borrowing.

Question 55

Following the global financial crisis of 2007-09, there was a revival of interest in Keynesian demand management and:

A) Adam Smith's theory of the invisible hand.
B) David Ricardo's theory of comparative advantage.
C) Karl Marx's theory of capital.
D) Hyman Minsky's Financial Instability Hypothesis.

Question 56

Why were CDSs based on residential mortgages developed and why did they fail?

Question 57

What happened when inflation began to rise in the mid-2000s?

Question 58

The global financial crisis of 2007-09 led to one of the most damaging economic episodes since _____________:

A) the Great Depression.
B) WW2.
C) the collapse of the Soviet empire.
D) the South Sea Bubble.

Question 59

Explain the process by which mortgage defaults occurred in the mid-2000s?