Chapter 8 Questions Why Do Financial Crises Occur and Why Are They So Damaging to the Economy?

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Ch 8 S

Chapter 8 Questions

Why Do Financial Crises Occur and Why Are They So Damaging to the Economy?

1) Financial crises

A) are major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms.

B) occur when adverse selection and moral hazard problems in financial markets become more significant.

C) frequently lead to sharp contractions in economic activity.

D) are all of the above.


2) Financial crises

A) cause failures of financial intermediaries and leave only securities markets to channel funds from savers to borrowers.

B) are a recent phenomenon that occur only in developing countries.

C) invariably lead to debt deflation. D) all of the above. E) none of the above.


3) In an advanced economy, a financial crisis can begin in several ways, including

A) mismanagement of financial liberalization or innovation. B) asset pricing booms and busts.

C) an increase in uncertainty caused by failure of financial institutions. D) all of the above.


4) What is a credit boom?

A) An explosion in a credit cycle, which can increase or decrease lending in the short-run

B) Essentially a lending spree on the part of banks and other financial institutions

C) When credit card receivables rise due to low initial interest rates

D) The signal of the end of a credit spree, with credit contracting rapidly


5) The process of deleveraging refers to

A) cutbacks in lending by financial institutions. B) a reduction in debt owed by banks.

C) both A and B. D) none of the above.

6) When asset prices fall following a boom,

A) moral hazard may increase in companies that have lost net worth in the bust.

B) financial institutions may see the assets on their balance sheets deteriorate, leading to deleveraging. C) both A and B are correct.

D) none of the above are correct.


7) During the 1800s, many U.S. financial crises were precipitated by an increase in ________, often originating in London.

A) interest rates B) housing prices C) gasoline prices D) heating oil prices


8) Stage Two of a financial crisis in an advanced economy usually involves a ________ crisis.

A) currency B) stock market C) banking D) commodities


9) Stage Three of a financial crisis in an advanced economy features

A) a general increase in inflation. B) debt deflation.

C) an increase in general price levels. D) a full-fledged financial crisis.


10) The Baa-U.S. Treasury spread was about 2% at the beginning of 1929. By December 1932, the Dow Jones Industrial Average reached a low, and the spread had increased to how much?

  • 4% B) 6% C) 8% D) 10%

  • 11) Most financial crises in the United States have begun with

    A) a steep stock market decline.

    B) an increase in uncertainty resulting from the failure of a major firm.

    C) a steep decline in interest rates. D) all of the above. E) only A and B of the above.

12) 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.

A) increasing; increasing B) increasing; decreasing

C) decreasing; increasing D) decreasing; decreasing


13) Adverse selection and moral hazard problems increased in magnitude during the early years of the Great Depression as

A) stock prices declined to 10 percent of their levels in 1929. B) banks failed.

C) the aggregate price level declined. D) a result of all of the above.

14) Leading up to the 2007-2009 Financial Crisis, the ________ process, along with computer technology, enabled the bundling of smaller loans (like mortgages) into standard debt securities.

A) liberalization B) securitization C) easing D) investment banking


15) Leading up to the 2007-2009 Financial Crisis, companies like AIG developed financial products divisions which wrote billions of dollars worth of financial insurance contracts, called ________, which later bankrupted the company.

A) REMICs B) CDOs C) credit default swaps D) call options


16) When we refer to the shadow banking system, what are we talking about?

A) Hedge funds, investment banks, and other nonbank financial firms that supply liquidity

B) The "underground" banking system used for illegal activities

C) The subsidiaries of depository institutions

D) None of the above

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