Intermediaries Financial Crisis/Risk Management Questions

Question 1

Financial crises (3)

Answer 1

• are major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms.
• occur when adverse selection and moral hazard problems in financial markets become more significant.
• frequently lead to sharp contractions in economic activity.

Question 2

When asset prices fall following a boom, (2)

Answer 2

• moral hazard may increase
• assets may deteriorate, leading to deleveraging.

Question 3

Debt deflation refers to

Answer 3

a decline in net worth as price levels fall while debt burden remains unchanged.

Question 4

What is a collateralized debt obligation?

Answer 4

A tranche of an SPV that has been setup based on default risk

Question 5

Factors that lead to worsening conditions in financial markets include

Answer 5

bank panics.

Question 6

Most financial crises in the United States have begun with (2)

Answer 6

• a steep stock market decline.
• an increase in uncertainty resulting from the failure of a major firm.

Question 7

In addition to having a direct effect on increasing adverse selection problems, increases in interest rates also promote financial crises by ________ firms’ and households’ interest payments, thereby ________ their cash flow.

Answer 7

increasing; decreasing

Question 8

The impact of the 2007-2009 financial crisis was widespread, including (3)

Answer 8

• the first major bank failure in the UK in over 100 years.
• the failure of Bear Stearns, the fifth-largest U.S. investment bank.
• the bailout of Fannie Mae and Freddie Mac by the U.S. Treasury.

Question 9

This semester, the Fed ____________ its target rate by _____________ basis points.

Answer 9

cut; 25

Question 10

A financial crisis is characterized by ______, liquidity shortages, and broad economic impact.

Answer 10

asset price drops

Question 11

The main factor that differentiates a market crash from a financial crisis is how ______ and exposed the
financial system is

Answer 11

leveraged

Question 12

A ____________ occurs when a country’s currency faces a sudden devaluation, causing purchasing
power to fall and the real cost of foreign-denominated debt to increase

Answer 12

currency crisis

Question 13

. Fisher’s ________ theory explains how falling nominal prices increase the real costs of debt, which
can create a downward spiral for asset prices.

Answer 13

Debt-Deflation

Question 14

. The Global Financial Crisis was a run on the _______________ sector.

Answer 14

Shadow Banking

Question 15

. __________ are a type of shadow bank that finance risky investments primarily with loans from their
prime brokers.

Answer 15

Hedge Funds

Question 16

. Bear Stearns and Lehman Brothers became insolvent not because of a traditional bank run with deposit
withdrawals, but because they couldn’t ______________.

Answer 16

roll over repurchase agreements (repo)

Question 17

The main reason cited for not bailing out Lehman Brothers was ________.

Answer 17

moral hazard

Question 18

________ are the intermediary that was bailed out for the first time during the GFC and
again during the COVID-19 panic.

Answer 18

Money Market Mutual Funds

Question 19

Much of the post-crisis regulation has been levied on banks and not _________.

Answer 19

shadow banks

Question 20

Specialization in lending helps reduce asymmetric information through developed expertise, but it has the downside
of reducing natural _______.

Answer 20

diversification

Question 21

. _______ is when the borrower has access to a revolving line of on-demand credit. It is set up in
advance so the borrower has flexible access to credit when they eventually need it.

Answer 21

Loan Commitment

Question 22

___________ analysis is focused on near-term changes in profits, while ________________ analysis focuses on changes in asset values.

Answer 22

Income Gap; Duration Gap

Question 23

When doing income gap analysis, we assume that rates on fixed-rate commercial loans with under 1 year remaining
in maturity _________, while rate on checkable deposits _________.

Answer 23

change; don’t change

Question 24

Counter-intuitively, when doing duration gap analysis, the duration on checkable deposits is often _____ the
duration on savings deposits.

Answer 24

higher

Question 25

Forward contracts and futures contracts are similar in that they are an agreement by two parties to engage in a financial transaction at a future point in time. ______ contracts, however, are standardized and traded on exchanges.

Answer 25

Futures

Question 26

___________ involve the exchange of one set of variable interest payments for another set of fixed interest payments, all denominated in the same currency

Answer 26

Interest rate swaps

Question 27

In 2023, _____ was fully replaced by _________ as the world’s dominant contracting interest rate, particularly for new U.S. dollar contracts, which offers greater transparency and is based on observable market transactions rather than estimates submitted by banks.

Answer 27

LIBOR; SOFR

Question 28

Of the four major job categories at commercial banks (excluding tellers), _______ require the most knowledge of risk management.

Answer 28

analysts

Question 29

A _________ can occur when a country experiences sudden outflows of investor capital, while a __________ occurs when a country does not meet its outstanding debt obligations

Answer 29

currency crisis; sovereign debt crisis

Question 30

_______ theory of financial crises states that in boom times, investors borrow to purchase assets, which pushes prices up, and in bust times, investors sell assets to pay off debt, pushing asset prices down.

Answer 30

The leverage cycle

Question 31

The three key shadow banks – largely supported by the traditional banking sector – that were at the center of the 2008 Global Financial Crisis were structured investment vehicles (SIVs), money market funds (MMFs), and __________.

Answer 31

hedge funds (HFs)

Question 32

________ attempts to quantify the change that an intermediary will experience to their net income following changes to interest rates, while ______ attempts to quantify the change in the intermediary’s net asset value following changes to interest rates.

Answer 32

Income gap analysis; duration gap analysis

Question 33

A financial derivative in which two parties agree to exchange one stream of future interest payments for another, typically involving one party to pay a fixed rate while the other pays a floating rate, is called ___________.

Answer 33

an interest rate swap

Question 34

Banks face the problem of ________ in loan markets because bad credit risks are the ones most likely to seek bank loans.

Answer 34

adverse selection

Question 35

From the standpoint of ________, specialization in lending is surprising but makes perfect sense when one considers the ________ problem.

Answer 35

diversification; adverse selection

Question 36

A bank's commitment (for a specified future period of time) to provide a firm with loans up to a given amount at an interest rate that is tied to a market interest rate is called

Answer 36

a line of credit

Question 37

Compensating balances (3)

Answer 37

- are a particular form of collateral commonly required on commercial loans. - are a required minimum amount of funds that a borrower (i.e., a firm receiving a loan) must keep in a checking account at the bank. - allow banks to monitor firms' check payment practices, which can yield information about their borrowers' financial conditions.

Question 38

If a bank has more rate-sensitive assets than rate-sensitive liabilities, then a(n) ________ in interest rates will ________ bank profits.

Answer 38

increase; increase

Question 39

If First National Bank has a gap equal to a negative $30 million, then a 5 percentage point increase in interest rates will cause profits to

Answer 39

decline by $1.5 million.

Question 40

If a bank has a duration gap of 2 years, then a fall in interest rates from 6 percent to 3 percent will lead to

Answer 40

a rise in the market value of its net worth of 5.66 percent.

Question 41

If a rise in interest rates causes the market value of a bank's net worth to rise, then the bank must have a

Answer 41

negative duration gap.

Question 42

An interest-rate forward contracts that involves the future sale of a debt instrument would specify which of the following? (4)

Answer 42

- the actual debt instrument that will be delivered - the amount that will be delivered - the price - the date

Question 43

By selling short a futures contract of $100,000 at a price of 115, you are agreeing to deliver ________ face value securities for ________.

Answer 43

$100,000; $115,000

Question 44

The purpose of the Commodity Futures Trading Commission is to do all of the following except

Answer 44

establish minimum prices for futures contracts.

Question 45

Futures differ from forwards because they are

Answer 45

marked to market daily

Question 46

An option that gives the owner the right to sell a financial instrument at the exercise price within a specified period of time is a(n)

Answer 46

put option.

Question 47

A call option gives the seller the ________ to ________ the underlying security.

Answer 47

obligation; sell

Question 48

If you buy an option to sell Treasury futures at 115, and at expiration the market price is 110

Answer 48

the put will be exercised.

Question 49

A swap that involves the exchange of a set of payments in one currency for a set of payments in another currency is a(n)

Answer 49

currency swap.