Q&A Hero

Q: In late 2008, the average risk premium rose because A) investors feared a revival of inflation. B) large tax increases in the United States reduced corporate profits and led to fears of increased defaults. C) of the financial crisis. D) of fraud in the market for municipal bonds.

Q: The government provides deposit insurance; this insurance protects: A. large corporate deposit accounts, but only the amounts that exceed the $250,000 deductible.B. depositors for up to $250,000 should a bank fail.C. the deposits of banks in their Federal Reserve accounts.D. the deposits that people have, but only for federally chartered banks.

Q: During the financial crisis of 2007-09, the prices of U.S. Treasury securities A) rose and the price of corporate bonds declined. B) fell relative to the prices of corporate bonds. C) remained in the same relative position to the prices of corporate bonds. D) were frozen by order of the federal government.

Q: The government's role of lender of last resort is directed to: A. large manufacturing firms that employ thousands of people.B. depositors; this is role the government plays when they insure depositors' balances in banks that fail.C. developing countries that are trying to build their financial systems.D. banks that experience sudden deposit outflows.

Q: A flight to quality refers to a shift by savers from A) bonds and into stocks. B) stocks and into gold or other precious metals. C) bonds and into real assets, such as real estate. D) low-quality bonds and into high-quality bonds.

Q: The financial system is inherently more unstable than most other industries due to the fact that: A. while in most other industries customers disappear at a faster rate, in banking they disappear slowly so the damage is done before the real problem is identified.B. banks deal in paper profits, not in real profits.C. a single firm failing in banking can bring down the entire system; this isn't true in most other industries.D. there is less competition than in other industries.

Q: If lenders anticipate no changes in liquidity, information costs, and tax differences, the yield on a risky security should be A) greater than that on a safe security and the price of a risky security should also be greater than that of a safe security. B) less than that on a safe security and the price of a risky security should also be less than that of a safe security. C) greater than that on a safe security and the price of a risky security should be lower than that of a safe security. D) less than that on a safe security and the price of a risky security should be greater than that on a safe security.

Q: The government regulates bank mergers, sometimes denying the proposed merger. Often the reason given for the denial is to protect small investors. What are small investors being protected from? A. with a larger bank the bank is likely to take greater risk and may fail.B. in order to pay for the merger, the bank may seek higher returns putting the depositors' funds at greater risk.C. mergers can increase the monopoly power of banks and the bank may seek to exploit this power by raising prices and earning unwarranted profits.D. bank runs hurt larger banks more than smaller banks.

Q: The default risk premium fluctuates mainly A) because bond rating agencies tend to be inconsistent in their ratings of bonds. B) because risk-neutral investors will often become risk-averse as time passes. C) because taxes tend to rise over the long run. D) as new information about a borrower's creditworthiness becomes available.

Q: An economic rationale for government protection of small investors is that: A. large investors can better afford losses.B. many small investors cannot adequately judge the soundness of their bank.C. there is inadequate competition to ensure a bank is operating efficiently.D. banks are often run by unethical managers who will often exploit small investors.

Q: Which of the following statements about junk (high-risk) bonds is true? A) They never outperform treasury bonds since they're too risky. B) The price of junk bonds increase as their perceived risk increases. C) They tend to perform best during recessions. D) One can profit by owning them if market perceptions of their risk decline.

Q: The reasons for the government to get involved in the financial system include each of the following, except: A. to protect the bank's monopoly position.B. to protect investors.C. to ensure the stability of the financial system.D. to protect bank customers from monopolistic exploitation.

Q: Which of the following bond ratings by Moody's Investors Service would NOT be considered to be below investment grade? A) Baa B) Ba C) B D) All of these ratings are considered below investment grade.

Q: Recession can cause widespread bank crises for all of the following reasons except: A. there is less business investment as banks make fewer loans.B. borrowers' default rates increase.C. bank capital increases.D. the negative effect on banks' balance sheets.

Q: Which of the following is the lowest rating given to an investment-grade bond by Moody's? A) Aa B) A C) Baa D) B

Q: Deflation can cause widespread bank crises for all of the following reasons except: A. a decline in the value of borrowers' net worth but not their liabilities.B. borrowers' default rates increase.C. bank balance sheets deteriorate as the level of economic activity decreases.D. information asymmetry problems decrease during deflationary periods.

Q: Which of the following is the highest bond rating assigned by Moody's Investors Service? A) Aaa B) A C) B D) Baa

Q: Bank panics have often begun as a result of: A. rumors only.B. real economic events only.C. both rumors and real economic events.D. neither rumors nor economic events.

Q: Bond ratings A) are published annually by the federal government and are based largely on information contained in corporate tax returns. B) are published annually by the federal government and are based on publicly available information. C) are published monthly by the federal government and are based on publicly available information. D) are published by private bond-rating agencies.

Q: Bank failures tend to occur most often during periods of: A. stock market run ups when, like many companies, banks tend to be overvalued.B. high inflation when the fixed rate loans of many banks cause their real returns to decrease.C. recessions when many borrowers have a difficult time repaying loans and lending activity slows.D. wars and other civil unrest.

Q: Which of the following assigns widely-followed bond ratings? A) Standard & Poor's Corporation B) Securities and Exchange Commission C) Federal Reserve D) IBM

Q: The reason that a run on a single bank can turn into a bank panic that threatens the entire financial system is: A. information asymmetries.B. moral hazard.C. the lack of regulation.D. the increased reliance on web-based funds transfers.

Q: Investors often pay professional analysts to gather and monitor information on the creditworthiness of borrowers because A) federal law requires it. B) most investors are risk neutral. C) the cost of acquiring information about a borrower's creditworthiness can be high. D) doing so increases the net-of-tax yield on most investments.

Q: It is difficult for depositors to know the true health of banks because: A. regulations prohibit banks making their financial statements publicly available.B. the financial statements of banks are too difficult for most people to understand.C. most of the information on bank loans is private and based on sophisticated models.D. banking is competitive and financial records of banks are not divulged to prevent competitor banks from having an advantage.

Q: The default risk premium is A) relevant only for securities issued by very small companies. B) the additional yield a saver requires for holding a bond with some default risk. C) zero for corporate bonds, but quite substantial for corporate stock. D) constant across the business cycle.

Q: When healthy banks fail due to widespread bank panics, those who are likely to be hurt are: A. government regulators.B. households and small businesses.C. the FDIC.D. the Federal Reserve.

Q: The default risk premium is measured A) by an index published monthly by the Securities and Exchange Commission. B) by an index published monthly by The Wall Street Journal. C) as the difference between the yield on a non-Treasury security and the yield on a U.S. Treasury security of the same maturity. D) as the difference between the nominal yield on the security and the real after-tax yield on the security.

Q: The federal government is concerned about the health of the banking system for many reasons, the most important of which may be: A. banks are where government bonds are traded.B. a significant number of people are employed in the banking industry.C. many people earn the majority of their income from interest on bank deposits.D. banks are of great importance in enabling the economy to operate efficiently.

Q: U.S. Treasury securities A) are considered risk free because their prices never change. B) have been defaulted on several time in U.S. history. C) are considered default-risk-free instruments. D) have a large default risk premium.

Q: A bank run involves: A. illegal activities on the part of the bank's officers.B. a bank being forced into bankruptcy.C. a large number of depositors withdrawing their funds during a short time span.D. a bank's return on assets being below the acceptable level.

Q: Which of the following is considered a default-risk-free instrument? A) a three-month commercial paper issued by GE B) a share of stock issued by Google C) a three-month Treasury bill D) a ten-year bond issued by Intel

Q: Contagion is: A. the failure of one bank spreading to other banks through depositors withdrawing of funds.B. the phenomenon that if one bank loan defaults it will cause other bank loans to default.C. the rapid contraction of investment spending that occurs when interest rates are increased by the Federal Reserve.D. the rapid inflation that results from the printing of money.

Q: Default risk A) is the probability that a borrower will not pay in full the promised coupon or principal. B) exists only for the bonds of small corporations. C) is also known as market risk. D) is zero for bonds issued by cities and states.

Q: What matters most during a bank run is: A. the number of loans outstanding.B. the solvency of the bank.C. the liquidity of the bank.D. the size of the bank's assets.

Q: Which of the following is a possible impact of a global savings glut on a small open economy? A) interest rate would increase B) interest rate would decrease C) domestic savings would increase D) domestic investment would increase

Q: Rumors of a bank failing, even if not true, can become a self-fulfilling prophecy because: A. customers will not want to obtain loans from this bank.B. equity investors will not be able to sell the bank's stock.C. regulators will scrutinize the bank heavily looking for something wrong.D. depositors will rush to the bank to withdraw their deposits and the bank under normal situations would not have sufficient liquid assets on hand.

Q: Consider an open economy that is a net borrower (like the United States). What would be the impact of a shift to a closed economy? A) domestic interest rates would decline B) domestic savings would decline C) domestic investment would decline D) net borrowing would increase

Q: Empirical evidence points to the fact that financial crises: A. are newsworthy but have no impact on economic growth.B. have a negative impact on economic growth only for the year of the crisis.C. have a negative impact on economic growth for years.D. can have a positive impact on economic growth as weak borrowers are weeded out.

Q: How can a global savings glut affect the United States? A) It can reduce the world real interest rate, thus encouraging borrowing by Americans. B) It can increase the world real interest rate, thus encouraging saving by Americans. C) It can reduce the supply of loanable funds for the United States. D) It can reduce the demand for loanable funds for the United States.

Q: Discuss the case for a "super-regulator" in the context of what you have learned about "regulatory competition."

Q: Suppose that a small economy that had previously been closed becomes open. If its real interest rate had previously been below the world real interest rate, we would expect that A) the country's real interest rate would remain below the world level. B) the country would become a net lender abroad. C) the country would become a new borrower abroad. D) the amount of loanable funds supplied in the country would decline.

Q: The FDIC used to charge all banks the same rate for insurance on deposits. From what you have learned, what problems did this create for not only the FDIC but for well-run banks?

Q: Since Germany is a large open economy, the increase in German borrowing and investment in what was formerly East Germany in the early 1990s resulted in A) a decline in the world real interest rate. B) a shift to the right in the German supply of loanable funds curve. C) an increase in the real interest rate in the United States. D) a shift to the left in the German demand for loanable funds curve.

Q: We saw in the text that regulations, specifically deposit insurance and the Basel Accord (of 1988), can create moral hazard. Explain.

Q: In a large open economy, A) domestic lending and borrowing decisions have no impact on the world real interest rate. B) an increase in the domestic supply of loanable funds would lower the world real interest rate. C) the domestic equilibrium real interest rate is determined independently of foreign borrowing and lending. D) an increase in the domestic demand for loanable funds would lower the world real interest rate.

Q: Discuss the ramifications of the FDIC reducing deposit insurance limits to $25,000.

Q: The equilibrium real interest rate in Belgium will be A) generally above the world real interest rate. B) generally below the world real interest rate. C) equal to the world real interest rate. D) determined by the equilibrium between desired domestic saving and desired domestic investment.

Q: What is meant by the problem of time consistency in the conduct of financial system policy?

Q: A small open economy A) is unable to affect the world real interest rate by its borrowing and lending decisions. B) will always be a net borrower from abroad. C) will always be a net lender abroad. D) is almost never able to borrow abroad.

Q: The CAMELS criteria to evaluate the health of banks by supervisors is not made public. Make a case for one making this information public and a case for keeping it private.

Q: In an open economy, desired domestic lending A) must equal desired domestic borrowing. B) must equal desired domestic borrowing plus the amount of international lending. C) is always greater than desired domestic borrowing. D) is always less than desired domestic borrowing.

Q: Define the components of the CAMELS criteria and explain how a CAMELS rating is calculated.

Q: The world real interest rate is A) set annually by a special commission at the United Nations. B) set annually by a special commission at the International Monetary Fund. C) determined in the international capital market. D) determined daily on the New York Stock Exchange.

Q: Identify at least two problems a borrower would face if banks were not required to disclose the information that they are currently required to make available.

Q: An open economy is one that A) has a large government sector. B) lends and borrows in the international capital market. C) produces mainly agricultural goods. D) produces mainly manufactured goods.

Q: What were the positive effects of the 1988 Basel Accord? What were its shortcomings?

Q: During a period of economic expansion, when expected profitability is high, A) the demand curve for bonds shifts to the left. B) the supply curve of bonds shifts to the right. C) the equilibrium interest rate falls. D) the equilibrium price of bonds rises.

Q: What was the primary motivation behind the creation of the 1988 Basel Accord?

Q: The Federal Reserve issues a report indicating that future inflation will be higher than had previously seemed likely. As a result A) the supply curve for bonds shifts to the right. B) the demand curve for loanable funds shifts to the left. C) the equilibrium interest rate falls. D) the equilibrium price of bonds rises.

Q: If we lived in an economy where interest rates were highly volatile, would you expect the maximum asset to capital ratio that a regulator would allow to increase or decrease and why?

Q: Which of the following is the most likely explanation of Japan's very low market interest rates in the early 2000s? A) expected deflation B) an increasing budget deficit C) an increasing trade surplus D) an increase in corporate profits

Q: Why are banks restricted in the assets that they can own? For example, why do you think banks are prohibited from owning common stock?

Q: In 2008, the liquidity of mortgage-backed securities declined significantly. Make use of a graph of the bond market to show how this affected the price of mortgage-backed securities.

Q: Explain how bank regulators seem to face a bit of a paradox regarding preventing monopoly power by banks and spurring competition.

Q: In November 2012, concern was raised about Spain's sovereign debt. Make use of a graph of the bond market to show how this would affect the price of Spanish bonds.

Q: Besides regulating banks, the government also regulates nondepository financial institutions, such as insurance companies. Consider a property casualty insurance company; why would the government need to regulate them?

Q: Assess the impact on the bond market of the rise in Internet trading of stocks.

Q: What potential problems are created by regulatory competition?

Q: Which of the following is NOT a likely impact on the bond market if corporations become convinced that a robust economic recovery is underway? A) increased demand for bonds B) increased supply of bonds C) lower bond prices D) higher interest rates

Q: What three strategies are employed by government officials to ensure that the risks created by the government safety net are contained?

Q: If bond investors think they lack enough details to evaluate the likelihood of defaults on certain bonds, this will result in higher: A) expected return B) liquidity C) information costs D) expected inflation

Q: What is the link between the safety net provided by the government to the financial industry and the relatively heavy regulation of the same industry by the government?

Q: As a result of low interest rates on CDs and the perceived riskiness of alternative investments following the financial crisis of 2007-2009, the bond market was affected in all of the following ways EXCEPT: A) higher demand for bonds B) higher real interest rates C) lower nominal interest rates D) higher price of bonds

Q: You are the head of finance for a very large corporation located in a relatively small town. At a local chamber of commerce meeting, the president of the local bank asks you why you keep the corporation's bank accounts in a very large mid-western bank and not in his local bank. From a risk reduction perspective, how could you answer his question?

Q: Which of the following is NOT a reason that interest rates remained low despite high budget deficits following the financial crisis? A) increased demand for U.S. government bonds B) the perceived riskiness of alternative investments such as stocks C) low interest rates on CDs and similar short-term assets D) increases in expected inflation

Q: Explain why the ratio of assets to capital increased dramatically for commercial banks from the 1920s to the present.

Q: Other things equal, an increase in the tax on dividends is likely to result in all of the following EXCEPT: A) higher expected return on bonds relative to stocks B) increased demand for bonds C) lower interest rates D) higher interest rates

Q: Imagine a situation where the deposits at state chartered banks would be insured by a state insurance fund and deposits at nationally chartered banks would be insured by FDIC. How would you expect both depositors and banks would react?

Q: An increase in the tax rate on dividends, other things equal, is likely to result in a(n): A) increased demand for bonds due to an increase in the expected return on bonds relative to stocks B) increased supply of bonds due to an increase in the expected return on bonds relative to stocks C) reduced demand for bonds due to a decrease in the expected return on bonds relative to stocks D) reduced demand for bonds due to an increase in the expected return on bonds relative to stocks

Q: You have a retirement account in a bank that has failed. The balance in your account is $330,000. Does it make a difference to you if FDIC uses the payoff method or the purchase-and-assumption method for resolving this insolvency? Explain.