Deck 17: Financialcrisis

Question 1

The recency effect is:

A) the basic human tendency to overvalue recent experience when trying to predict the future.
B) shorting financial investments that are subject to a bubble.
C) earning a profit by betting against what everyone else is doing.
D) accounting for the most recent profits or losses first on financial statements.

Answer 1

the basic human tendency to overvalue recent experience when trying to predict the future.

Question 2

When investors follow a "herd instinct," they make decisions:

A) based on the results of performance analysis.
B) based on emotion, not objective information.
C) as a group, inflating the prices of goods somewhat arbitrarily.
D) based on the sound logic of a group, rather than the individual.

Answer 2

based on emotion, not objective information.

Question 3

If you gained 20 percent on $200 worth of stock in a 4x margin account, then you would gain:

A) $20.
B) $40.
C) $100.
D) $160.

Answer 3

$160.

Question 4

If you have $1,000 in an account that offers "3x" margin, you can effectively buy _______ worth of stocks.

A) $1,000
B) $333
C) $3,000
D) $300 worth

Question 5

If you lost 50 percent on $100 worth of stock in a 3x margin account, then you would lose:

A) $50.
B) $150.
C) $300.
D) $600.

Question 6

On the whole, when financial markets are _______, leverage _______; when markets are _______, leverage _______.

A) expanding; multiplies the gains; crashing; magnifies the losses
B) expanding; magnifies the losses; crashing; multiplies the gains
C) crashing; diminishes the losses; expanding; diminishes the gains
D) crashing; magnifies the losses; expanding; diminishes the gains

Question 7

If you lost 10 percent on $200 worth of stock in a 3x margin account, then you would lose:

A) $60.
B) $20.
C) $30.
D) $40.

Question 8

If you have $100 in an account that offers "2x" margin, you can effectively buy _______ worth of stocks.

A) $200
B) $25000
C) $50
D) $2,000

Question 9

In finance, the leverage ratio is the ratio of a company's assets relative to its:

A) total investments.
B) profits.
C) equity.
D) debt.

Question 10

A bubble occurs when:

A) an asset is not being traded very heavily.
B) financial advisors purposely deceive the public and sell a worthless asset.
C) financial markets are trading an asset at a much higher than historically justifiable price.
D) a limited number of people are buying an asset, causing the market to crash.

Question 11

A financial bubble inflates when:

A) investors become irrationally optimistic that an asset's price will continue to rise.
B) investors become irrationally pessimistic and desire to sell off an asset immediately.
C) investors apply the efficient market hypothesis to a financial product for the first time.
D) inflation begins to accelerate, and monetary and fiscal policy are ineffective at slowing its growth.

Question 12

In finance, leverage:

A) multiplies the effects of gains and losses in financial markets.
B) can require investors to dig deep into their own resources.
C) helps explain why a crash is so damaging after a bubble bursts.
D) All of these are true.

Question 13

If you lost 20 percent on $100 worth of stock in a 2x margin account, then you would:

A) lose $20.
B) gain $20.
C) lose $40.
D) gain $40.

Question 14

If you lost 10 percent on $200 worth of stock in a 2x margin account, then you would:

A) lose $20.
B) gain $20.
C) lose $40.
D) gain $40.

Question 15

Which interconnected concepts lie at the heart of many financial crises? I. Rational expectations
II) Irrational expectations
III) Forecasting
IV) Leverage

A) I and IV
B) II and III
C) III and IV
D) II and IV

Question 16

When investors follow a "herd instinct," they:

A) invest in something as a group, making it appear more valuable than it is.
B) quickly move from one investment to another as a group.
C) invest in something simply because everyone else is doing it.
D) only makes decisions as a group, making it hard to determine individual behavior.

Question 17

In finance, leverage is using:

A) borrowed money to pay for investments.
B) the equity one owns to pay for future investments.
C) predicted earnings to pay for current investments.
D) forecasted future earnings to pay for current loans.

Question 18

The basic human tendency to overvalue recent experience when trying to predict the future is called the _______ effect.

A) anchoring
B) leverage
C) optimism
D) recency

Question 19

When investors invest in something simply because everyone else is doing it, they are:

A) following their "rational intuition."
B) following a "herd instinct."
C) supporting the efficient market hypothesis.
D) conducting performance analysis.

Question 20

The practice of using borrowed funds to pay for investments is:

A) leverage.
B) recency.
C) hedging.
D) herding.

Question 21

To prevent future financial crises like the stock market crash of 1929, in the 1930s Congress:

A) passed the Glass-Steagall Banking Act.
B) passed the Bubble Act.
C) passed the Hastings Banking Act.
D) formed the Congressional Budget Office (CBO).

Question 22

How many years did it take the stock market to recover back to the value of September 1929?

A) 3
B) 10
C) 25
D) 54

Question 23

From 1922 to 1929, the total value of the stock market:

A) more than tripled.
B) decreased by nearly 50 percent.
C) decreased by nearly 90 percent.
D) stayed the same.

Question 24

The stock market crash of 1929 led to:

A) the burst of the South Seas bubble.
B) the Great Depression.
C) the Great Recession.
D) Black Thursday.

Question 25

From 1929 to 1932, the total value of the stock market:

A) stayed the same.
B) more than tripled.
C) more than quadrupled.
D) decreased by nearly 90 percent.

Question 26

Leveraging investments based on irrational expectations:

A) can lead to gradually deflating financial bubbles.
B) can exacerbate financial crises.
C) explains the success of companies like Lehman Brothers.
D) All of these are true.

Question 27

When your broker sees that you are in danger of running through your money and forces you to sell your stock and use the money to pay back your loan, the broker is making a:

A) margin call.
B) leverage call.
C) stock sales call.
D) futures call.

Question 28

Stock markets in England were started in the late _______ century.

A) seventeenth
B) sixteenth
C) eighteenth
D) nineteenth

Question 29

The Great Depression was characterized by:

A) unemployment above 25 percent.
B) the Roaring Twenties.
C) accelerated economic growth.
D) firms rapidly expanding their borrowing rates.

Question 30

Which of the following describes a margin call?

A) A broker forces a person in danger of running through their money to sell their stock and use the money to pay back their loan.
B) A market reaches a tipping point, and policy-makers have to decide whether to intervene and prop up struggling financial institutions.
C) Prices on future values of a stock are forecasted to be lower than current prices.
D) Prices on future values of a stock are forecasted to be higher than current prices.

Question 31

What contributed to the financial crash in 1929?

A) Widespread purchasing of stocks on margin
B) International unrest
C) A decline in the productivity of U.S. manufacturing
D) Government regulation.

Question 32

The stock that created a bubble in the late 1600s belonged to:

A) the South Seas Company.
B) the East India Company.
C) His Majesty's Company.
D) the Mediterranean Company.

Question 33

If you gained 7 percent on $100 worth of stock in a 3x margin account, then you would gain:

A) $7.
B) $21.
C) $107.
D) $300.

Question 34

Margin calls are more likely to happen when markets are:

A) crashing.
B) expanding.
C) stable.
D) volatile.

Question 35

Which of the following is not an action taken by Congress in the 1930s to prevent future financial crises?

A) Passage of the Glass-Steagall Banking Act
B) Formation of the SEC
C) Formation of the FDIC
D) Passage of the Federal Reserve Act

Question 36

The overall drop in stock prices that began in 1929 and continued through 1932 was due to:

A) increased government regulation of the stock market.
B) a panicked, massive sale of stocks that caused stock prices to plummet.
C) growing signs of tension in Europe.
D) the decline in many firms' profitability.

Question 37

The stock market crash of 1929 may have been avoided if:

A) investors had acted rationally.
B) investors had placed more money in savings.
C) firms had been more objective in their decision making.
D) the U.S. government had stayed with the gold standard.

Question 38

The English Parliament passed the _______ to regulate companies that traded stock publicly.

A) Leverage Act
B) Bubble Act
C) Company Act
D) Anti-Corruption Act

Question 39

The case of the South Seas Bubble is primarily an example of:

A) leverage.
B) irrational exuberance.
C) austerity.
D) the efficient market hypothesis.

Question 40

One of the first issuances of stock was offered by the:

A) East India Company.
B) South Seas Company.
C) London Exchange Company.
D) North Seas Company.

Question 41

In an effort to prevent future financial crises like the stock market crash of 1929, in the 1930s Congress:

A) formed the FDIC.
B) passed the Bubble Act.
C) formed the Federal Reserve Bank.
D) passed the American Anti-Corruption Act.

Question 42

Tranching allows packages of reliable, low-risk mortgages to be sold to _______ and higher-risk subprime mortgages to___________.

A) risk-averse investors; risk-loving investors
B) risk-loving investors; risk-averse investors
C) national banks; local banks
D) local banks; the government

Question 43

Subprime mortgage loans:

A) are made to borrowers with low credit scores.
B) have interest rates that are lower than the prime rate.
C) are made to borrowers with higher than average credit scores.
D) have lower interest rates than those in the general market.

Question 44

What effect did the introduction of securitization have on the economy?

A) Banks could more safely assume subprime mortgage loans.
B) The government was able to promote a sense of security in the banking industry.
C) Banks could more safely leverage their investments.
D) Borrowers felt better about taking out subprime loans.

Question 45

After World War II, home values:

A) fell immediately.
B) steadily increased alongside economic expansion, but decreased during times of recession.
C) seemed immune to the business cycle.
D) were eroded by high inflation.

Question 46

A mortgage loan made to a borrower with a low credit score is called a:

A) prime mortgage.
B) high-service loan.
C) bundled financial loan.
D) subprime mortgage.

Question 47

Which of the following is not a contributor to the development of the housing bubble?

A) People expected housing prices would continue to rise.
B) Leveraging more of a home's value became easier, putting buyers further into debt.
C) Mortgage lenders had lost some incentive to properly assess the risk of lending.
D) Homeowners lacked confidence in the institutions that made their loans.

Question 48

When the housing market bubble burst, many people found that:

A) they owed more on their mortgage loans than their house was now worth.
B) it was much easier to sell their home.
C) the value of their homes exceeded what they owed on their mortgage loans.
D) only a limited number of houses were available for sale.

Question 49

Local banks could pass the risk involved in holding mortgage debts on to an investor with a higher risk tolerance using:

A) mortgage-backed securities.
B) leveraged securities.
C) leveraged investments.
D) government-backed securities.

Question 50

The housing bubble refers to:

A) housing prices rising much more quickly than other prices in the economy.
B) a sudden sell-off of houses in major metropolitan areas.
C) an unexplained shortage of labor in construction, inflating the cost of new homes.
D) consumers buying homes and land in rural areas to take advantage of lower prices.

Question 51

Securitization is the practice of:

A) packaging individual debts into a single uniform asset that can be easily bought and sold.
B) guaranteeing government repayment of risky home loans made to individuals with lower credit.
C) borrowing based on expected future earnings.
D) backing a security with a riskless asset.

Question 52

The practice of packaging individual debts into a single uniform asset that can be easily bought and sold is called:

A) leveraging.
B) securitization.
C) federally-backed financing.
D) bundled risk.

Question 53

Banks became more willing to make subprime loans because of:

A) securitization.
B) leveraging.
C) hedging.
D) herd behaviour.

Question 54

Mortgage-backed securities are:

A) tradable assets made up of packages of individual mortgages.
B) investments based on the equity of people's homes.
C) purchased assets based on the leveraged value of people's homes.
D) securities that are most often purchased by homeowners.

Question 55

The sudden explosion of cheap and readily available mortgages encouraged people to:

A) buy bigger and more expensive homes.
B) buy homes in areas with lower prices.
C) become more risk-averse.
D) invest more in bonds.

Question 56

Securitization of mortgages:

A) pooled high-risk mortgages together, which raised their price.
B) allowed investors to profit from the mortgage payments without being exposed to risk.
C) pooled the risk of mortgages, allowing high-risk mortgages to be more safely sold to investors.
D) helped the government guarantee the values of real estate.

Question 57

The relative financial stability following the Great Depression was ended by:

A) World War II.
B) the Great Crash.
C) stagflation.
D) the Great Recession.

Question 58

The reforms introduced by Congress in the 1930s led to:

A) the Great Depression.
B) relative financial stability for over 70 years.
C) a decline that lasted for 25 years.
D) a very quick recovery.

Question 59

The practice of dividing packages of debts into slices, each with different risk and return characteristics, is called:

A) leveraging.
B) bundling.
C) pooling.
D) tranching.

Question 60

Which of the following is not a reason why subprime lending gained popularity before the Great Recession?

A) Investing in a home was seen as the safest investment one could make.
B) Subprime mortgages were seen as a relatively safe investment.
C) The value of homes had not fallen for over 60 years.
D) Subprime mortgages encouraged those with risky credit to make a safe investment.

Question 61

As the housing market took off in the early 2000s:

A) household debt decreased.
B) the growth in household debt slowed.
C) the growth in household debt accelerated.
D) household debt stayed roughly comparable to historical levels.

Question 62

In the early 2000s, credit ratings of mortgage backed securities turned out to be:

A) too low, which led many investors to them during the financial crisis.
B) accurate, but investors ignored the risk.
C) too high, as many securities contained far riskier loans than initially realized.
D) volatile, as it is hard to assess the risk of these securities.

Question 63

The percent of disposable income that consumers have to pay for their debt is called:

A) a debtor's mark.
B) debt service.
C) the cost of debt.
D) debt accountability.

Question 64

Leading to the collapse of the housing bubble, inflated home values caused consumers to:

A) save less and spend more.
B) spend less and save more.
C) work less and save less.
D) save more through savings accounts and bonds.

Question 65

Consumers were able to assume an increasing amount of household debt during the 2000s because:

A) low interest rates made borrowing easier.
B) real wages increased dramatically.
C) interest rates were so high that people found it very easy to save their extra income.
D) the U.S government made it easier for people to declare bankruptcy.

Question 66

The level of household debt incurred over the two decades leading up to the 2008 crisis was only sustainable if:

A) interest rates remained low and housing prices remained high.
B) interest rates and housing prices both remained high.
C) interest rates and housing prices both remained low.
D) interest rates remained high and housing prices remained low.

Question 67

Debt service is the amount:

A) of time and energy banks spend creating loans.
B) of interest that needs to be paid over the life of a loan.
C) of national debt, expressed as a percent of GDP.
D) that consumers have to pay for their debts.

Question 68

Which of the following was not an effect of the U.S. housing market crash?

A) Lenders stopped making loans.
B) Many banks went bankrupt due to homeowners not paying their mortgages.
C) The U.S. economy tipped into the Great Recession.
D) all Homeowners profited upon selling their houses.

Question 69

Before the housing bubble, investment banks on Wall Street made money by:

A) buying as many loans as possible to create mortgage-backed securities.
B) relying on banks to sell as few high-risk mortgages as possible.
C) ensuring local banks were making good loans.
D) offering low interest loans to those with very good credit.

Question 70

A decrease in housing prices during the Great Recession meant that:

A) borrowers owed less on their loans.
B) the government earned less revenue in taxes.
C) borrowers with risky loans couldn't refinance into friendlier terms.
D) None of these are true.

Question 71

Which of the following contributed to the development of the housing bubble?

A) The recency effect caused homes to be undervalued.
B) Herd instinct caused everyone to believe home prices would continue to fall.
C) Securitization removed much of the risk from sellers of subprime mortgages.
D) All of these contributed to the housing bubble.

Question 72

During the housing bubble, homeowners:

A) had limited access to credit.
B) were only offered conservative, low-risk mortgages.
C) had high debt service on their mortgages.
D) had a high leverage on their homes.

Question 73

The tools that were intended to allocate funds and spread risk more efficiently in the housing market made it:

A) easier to keep everyone fully informed.
B) more difficult to keep everyone fully informed.
C) easier to understand the true risk involved with these assets.
D) more difficult to justify buying mortgage-backed securities over other low-risk assets.

Question 74

78_. Over the two decades leading up the 2008 crisis, _______ interest rates meant that consumers could take on _______ debt without significantly increasing the amount of debt service they had to pay.

A) falling; more
B) rising; more
C) falling; less
D) rising; less

Question 75

During most of the 1990s and 2000s, interest rates:

A) decreased sharply.
B) decreased slowly.
C) increased sharply.
D) stayed constant.

Question 76

Historically, household debt in the United States had been _______ from the Great Depression to the early 2000s, when it started to _______.

A) rising steadily; increase even more
B) rising steadily; decline
C) constant; increase
D) constant; decline

Question 77

The housing bubble occurred because:

A) the supply of homes dried up, causing fears of shortages.
B) herd instinct caused everyone to stop buying homes.
C) the recency effect altered people's perceptions of home values.
D) All of these are true.

Question 78

How were incentives misaligned during the housing crisis?

A) Wall Street assessed risk, but local banks earned a commission on each mortgage sold.
B) Wall Street relied on local banks to assess risk, but local banks earned a commission on each mortgage sold.
C) Wall Street earned a commission on each security sold, but local banks relied on Wall Street to assess risk.
D) Wall Street earned a commission on each mortgage sold and relied on local banks to assess risk.

Question 79

Homeowners who are "underwater":

A) possess a mortgage worth more than their house.
B) possess a mortgage with lower interest rates for the first few years of the loan.
C) have a debt-to-income ratio that is higher than FHA guidelines.
D) own a house that requires substantial renovations before it can move to a traditional loan.

Question 80

Leading to the collapse of the housing bubble, inflated home values created a(n):

A) increase in aggregate supply, which decreased the overall price level.
B) increased sense of wealth, which increased aggregate demand.
C) decreased sense of wealth, which decreased aggregate demand.
D) decrease in aggregate supply, which caused inflation.