Question 1

Rating agencies were exposed to a conflict of interest because:

Accepted Answer

A) credit rating agencies were rating securities and investing in those securities. 
B) credit rating agencies used ratings to sell securities. 
C) the clients of credit rating agencies used ratings to sell securities. 
D) investors did not want rating downgrades. 
E) credit rating agencies were paid by the firms who created the securities being rated. E

Question 2

These entities worked as second-party consolidators by purchasing loans and reselling them to investors.

Accepted Answer

A) The Federal National Mortgage Association (Fannie Mae)and the Federal Home Loan Mortgage Corporation (Freddie Mac) 
B) Structured investment vehicles (SIVs) 
C) Credit rating agencies 
D) Investment banks 
E) All of the above A

Question 3

Goldman Sachs' GSAMP Trust was able to create AAA-rated securities by:

Accepted Answer

A) separating the mortgage portfolio into tranches and assigning the tranches to share risks of default equally. 
B) not disclosing the risks clearly. 
C) guaranteeing or protecting some tranches. 
D) separating the mortgage portfolio into tranches and assigning the A-1, A-2, and A-3 tranches last in order, after the M-1 to M-7 and B-1 to B-3 tranches, to suffer losses if a default occurred. 
E) All of the above D

Question 4

The 1933 Glass-Steagall Act precluded banks from:

Accepted Answer

A) practicing subprime lending. 
B) selling insurance. 
C) underwriting insurance generating more than 10% of total bank income. 
D) underwriting securities generating more than 10% of total bank income. 
E) underwriting any securities.

Question 5

Early in 2008, mark-to-market accounting provisions caused the banks to:

Accepted Answer

A) revalue their portfolio downwards. 
B) be in jeopardy of falling below the regulatory capital requirements. 
C) restrict new loans. 
D) All of the above 
E) a and c only

Question 6

According to former Federal Reserve chairman Alan Greenspan, the Fed became concerned about subprime lending in 2000; however:

Accepted Answer

A) the global demand for mortgage-backed security ended in 2005. 
B) the quality of mortgage products began to deteriorate in 2005. 
C) the global demand for mortgage-backed security started in 2003. 
D) the quality of mortgage products began to deteriorate in 2003. 
E) the global demand for mortgage-backed security ended in 2008.

Question 7

Investors relied on the judgment of credit rating agencies because:

Accepted Answer

A) credit rating agencies were supposed to be experts in evaluating credit risk. 
B) the information directly available to investors on mortgage pools was insufficient 
C) credit rating agencies were supposed to do their due diligence and do a thorough review before rating a given security. 
D) All of the above 
E) a and c

Question 8

Which of the following is not an example of aggressive lending practices that contributed to the subprime crisis?

Accepted Answer

A) Mortgagors were not required to make any down payment at the inception of the loan. 
B) Loans were given to people with poor credit histories. 
C) Loans were given to people with no income. 
D) A borrower could get a second mortgage and use it as down payment. 
E) None of the above

Question 9

These regulators were aware of the problem of "predatory real estate financing" and tried to blow the whistle in 2003.

Accepted Answer

A) The Security and Exchange Commission and the Federal Reserve Board 
B) Iowa and North Carolina state attorneys 
C) The Office of the Comptroller of the Currency and the Office of Thrift Supervision 
D) Federal banking regulators 
E) None of the above

Question 10

A fundamental problem with Goldman Sachs' GSAMP Trust was that:

Accepted Answer

A) loans were given to people with poor credit histories. 
B) homeowners' equity in the securitized mortgages was less than 1%, on average. 
C) loans were given to people with no income. 
D) a sizeable portion of the securitized loans had little or no documentation. 
E) All of the above

Question 11

The movie The Big Short is the story of a few clever investors who realized that security markets were about to crash, and they:

Accepted Answer

A) invested in CDOs. 
B) invested in CDSs. 
C) invested in NCDSs. 
D) sold stocks short. 
E) bought gold.

Question 12

Late in 2008, the International Accounting Standards Board allowed firms to:

Accepted Answer

A) reclassify devaluated financial assets, delaying the recognition of losses. 
B) estimate the value of the portfolio if there was no ready market for a derivative portfolio. 
C) reduce their capital requirements. 
D) accelerate the recognition of losses through mark-to-market accounting. 
E) None of the above

Question 13

In simple terms, the securitization process is:

Accepted Answer

A) a way to sell structured investment vehicles (SIVs). 
B) a way for mortgage lenders to sell accounts receivable to public investors. 
C) a way to create high-yield investments with little risk. 
D) All of the above 
E) a and c only

Question 14

Mark-to-market accounting is usually related to all of the following items, except :

Accepted Answer

A) derivatives and financial instruments. 
B) the long-term cash flows of a firm. 
C) the short-term taxes payable of a firm. 
D) the short-term cash flows of a firm. 
E) the immediate recognition of unrealized gains and losses.

Question 15

Some observers claim that the U.S. Federal Reserve Board encouraged the housing and credit bubbles by:

Accepted Answer

A) not regulating subprime mortgages. 
B) cutting interest rates. 
C) enforcing mark-to-market accounting. 
D) a and b 
E) a and c

Question 16

Mark-to-market accounting is incorrectly characterized as being:

Accepted Answer

A) relevant for management compensation purposes. 
B) relevant for valuation purposes. 
C) relevant to investors. 
D) sometimes misleading. 
E) responsible for the subprime lending fiasco.

Question 17

In simple terms, a mortgage-backed security is:

Accepted Answer

A) a portfolio of mortgages sold to investors through publicly issued bonds. 
B) a contract that transfers the ownership of a lender's mortgages receivable. 
C) a contract that transfers the risk of noncollection from mortgage originators to other investors. 
D) All of the above 
E) a and c only

Question 18

Mortgage-backed securities lost their value when:

Accepted Answer

A) the underlying assets lost their value. 
B) borrowers (the mortgagees)walked away without a real obligation to repay. 
C) mortgage originators went bankrupt. 
D) a and b 
E) b and c

Question 19

The 1999 Gramm-Leach-Bliley Act allowed banks to:

Accepted Answer

A) engage in subprime lending. 
B) sell insurance. 
C) become more involved in investment bank activities. 
D) underwrite government bonds. 
E) choose between commercial and investment bank activities.

Exam 8: Subprime Lending Fiascoethics Issues