Chapter 10 Banking and the Management of Financial Institutions

Factors Causing Financial Crises
1) A major disruption in financial markets characterized by sharp declines in asset prices and firm failures is called a A) financial crisis.

2) A financial crisis occurs when an increase in asymmetric information from a disruption in the financial system A) causes severe adverse selection and moral hazard problems that make financial markets incapable of channeling funds efficiently.

3) A serious consequence of a financial crisis is
A) a contraction in economic activity.

4) A sharp decline in the stock market means that the ________ of corporations has fallen making lenders ________ willing to lend.

A) net worth; less

5) A sharp stock market decline increases moral hazard incentives A) since borrowing firms have less to lose if their investments fail.

6) An unanticipated decline in the price level increases the burden of debt on borrowing firms but does not raise the real value of borrowing firms' assets. The result is A) that net worth in real terms declines.

7) If debt contracts are denominated in foreign currency, then an unanticipated decline in the value of the domestic currency results in A) a decline in a firm's net worth.

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8) Factors that lead to worsening conditions in financial markets include: C) the deterioration in banks' balance sheets.

9) In a bank panic, the source of contagion is the
D) asymmetric information problem.

10) A bank panic can lead to a severe contraction in economic activity due to D) a decline in lending for productive investment.

11) 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.

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B) increasing; decreasing

12) In emerging economies, government fiscal imbalances may cause fears of B) default on government debt.

9.2 Dynamics of Past U.S. Financial Crises

1) When financial institutions go on a lending spree and expand their lending at a rapid pace they are participating in a A) credit boom.

2) When the value of loans begins to drop, the net worth of financial institutions falls causing them to cut back on lending in a process called A) deleveraging.

3) When financial intermediaries deleverage, firms cannot fund investment opportunities resulting in A) a contraction of economic activity.

4) A credit boom can lead to a(n) ________ such as we saw in the tech stock market in the late 1990s. A) asset-price bubble

5) Many 19th century U.S. financial crises were started by
A) spikes in interest rates.

6) Most U.S. financial crises have started during periods of ________ either after the start of a recession or a stock market crash. A) high uncertainty

7) If uncertainty about banks' health causes depositors to begin to withdraw their funds from banks, the country experiences a(n) A) banking crisis.

8) Debt deflation occurs when
A) an economic downturn causes the price level to fall and a deterioration in firms' net worth because of the increased burden of indebtedness.

9) A substantial decrease in the aggregate price level that reduces firms' net worth may stall a recovery from a recession. This process is called A) debt deflation.

10) A possible sequence for the three stages of a financial crisis in the U.S. might be ________ leads to ________ leads to ________. A) asset price declines; banking crises; unanticipated decline in price level 11) The economy recovers quickly from most recessions, but the increase in adverse selection and moral hazard problems in the credit markets caused by ________ led to the severe economic contraction known as The Great Depression. A) debt deflation

9.3 The Subprime Financial Crisis of 2007-2008

1) Financial innovations that emerged after 2000 in the mortgage markets included all of the following except A) adjustable-rate mortgages.

2) ________ is a process of bundling together smaller loans (like mortgages) into standard debt securities. A) Securitization

3) A ________ pays out cash flows from subprime mortgage-backed securities in different tranches, with the highest-rated tranch paying out first, while lower ones paid out less if there were losses on the mortgage-backed securities. A) Collateralized debt obligation (CDO)

4) The growth of the subprime mortgage market led to
A) increased demand for houses and helped fuel the boom in housing prices.

5) The originate-to-distribute business model has a serious ________ problem since the mortgage broker has little incentive to make sure that the mortgagee is a good credit risk. A) principal-agent

6) Mortgage brokers often did not make a strong effort to evaluate whether the borrower could pay off the loan. This created a A) severe adverse selection problem.

7) Agency problems in the subprime mortgage market included all of the following except A) homeowners could refinance their houses with larger loans when their homes appreciated in value.

8) When housing prices began to decline after their peak in 2006, many subprime borrowers found that their mortgages were "underwater." This meant that A) the value of the house fell below the amount of the mortgage.

9) Although the subprime mortgage market problem began in the United States, the first indication of the seriousness of the crisis began in A) Europe.

10) Like a CDO, a structured investment vehicle pays off cash flows from pools of assets, however, rather than long-term debt the structured investment vehicle backs A) commercial paper.

11) Which investment bank filed for bankruptcy on September 15, 2008 making it the largest bankruptcy filing in U.S. history? A) Lehman Brothers

12) The largest bank failure in U.S. history was ________ which went into receivership by the FDIC on September 25, 2008. A) Washington Mutual

13) Credit market problems of adverse selection and moral hazard increased as a result of all of the following except A) increase in housing market prices.

14) The Economic Recovery Act of 2008 had several provisions to promote recovery from the subprime financial crisis. These provisions included all of the following except A) guaranteed all the deposits of the commercial banks.

15) The government bailout of troubled financial institutions occurred in the
U.S. and many other countries. Which country saw their banking system collapse requiring the government to take over its three largest banks? A) Iceland

9.4 Dynamics of Financial Crises in Emerging Market Economies

1) Financial crises generally develop along two basic paths: A) mismanagement of financial liberalization/globalization and severe fiscal imbalances.

2) In emerging market countries, the deterioration in bank's balance sheets has more ________ effects on lending and economic activity than in advanced countries. A) negative

3) The mismanagement of financial liberalization in emerging market countries can be understood as a severe ________. A) principal/agent problem

4) Factors likely to cause a financial crisis in emerging market countries include A) fiscal imbalances.

5) The two key factors that trigger speculative attacks on emerging market currencies are A) deterioration in bank balance sheets and severe fiscal imbalances.

6) Severe fiscal imbalances can directly trigger a currency crisis since A) investors fear that the government may not be able to pay back the debt and so begin to sell domestic currency.

7) In emerging market countries, many firms have debt denominated in foreign currency like the dollar or yen. A depreciation of the domestic currency A) results in increases in the firm's indebtedness in domestic currency terms, even though the value of their assets remains unchanged. 8) A sharp depreciation of the domestic currency after a currency crisis leads to A) higher inflation.

9) The key factor leading to the financial crises in Mexico and the East
Asian countries was A) a deterioration in banks' balance sheets because of increasing loan losses.

10) Factors that led to worsening conditions in Mexico's 1994-1995 financial markets include C) increased uncertainty from political shocks.

11) Factors that led to worsening financial market conditions in East Asia in 1997-1998 include A) weak supervision by bank regulators.

12) Factors that led to worsening conditions in Mexico's 1994-1995 financial markets, but did not lead to worsening financial market conditions in East Asia in 1997-1998 include A) rise in interest rates abroad.

13) Argentina's financial crisis was due to
C) fiscal imbalances.

14) A feature of debt markets in emerging-market countries is that debt contracts are typically ________. A) very short term

15) The economic hardship resulting from a financial crises is severe, however, there are also social consequences such as A) increased crime.

16) Before the South Korean financial crisis, sales by the top five chaebols (family-owned conglomerates) were A) nearly 50% of GDP.

17) The chaebols encouraged the Korean government to open up Korean financial markets to foreign capital. The Korean government responded by A) allowing unlimited short-term foreign borrowing but maintained quantity restrictions on long-term foreign borrowing by financial institutions.

18) At the time of the South Korean financial crisis, the government allowed many chaebol owned finance companies to convert to merchant banks. Finance companies ________ allowed to borrow abroad and merchant banks ________. A) were not; could borrow abroad

19) At the time of the South Korean financial crisis, the merchant banks were A) almost virtually unregulated.


Updated: Dec 12, 2023
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Chapter 10 Banking and the Management of Financial Institutions. (2016, May 19). Retrieved from

Chapter 10 Banking and the Management of Financial Institutions essay
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