Question

Question 1

Prior to the financial crisis that began in 2007, the trend of interest rates since the early 1980s was

upward trend

downward trend

no clear trend up or down

none of the above

Question 2

After the financial crisis of 2007 started, one surprise for many analysts was that many of the home mortgages defaulted at the same time. This means the loan assets were

securitized

subprime

highly correlated

regulated

Question 3

A commercial bank has loans valued at $250 and reserves valued at $50. As defined in the notes, if the minimum capital requirement is 15%, this bank must hold capital valued at least at

$25

$35

$45

none of the above

Question 4

When one bank, call it Bank A is forced to write down the value of its assets, this can have a domino effect on other banks because

most loan assets are securitized

all banks make similar types of investments

banks often borrow funds from other banks

of bank runs

Question 5

A bank has $8 that it has raised from depositors, and has promised to pay them back $8. The bank invests the $8 in a project and chooses either safe or risky. If the bank chooses safe, the revenue is $10 with probability 1. If the bank chooses risky, the revenue is $13 with probability 0.6 and $5 with probability 0.4. In this case, if the bank selects safe, the payoff for the bank is ____ and if the bank chooses risky, the exp. payoff is ____.

$2; $2

$2; $3

$4; $2

$3; $1

Answer 1

1.

Answer: Downward trend

2007 recession: It happened because of acute financial crisis worldwide. The duration of this recession was almost 19 months, starting at the end of 2007. GDP declined by 4% and unemployment rose to 11%.

Interest rate since 1980 decreased steadily. In the beginning of 1980 it was almost 20%, but at the end of 2006 it was around 5%. In between those years the rate drops.

2.

Answer: Subprime

Banks and financial institutions become bankrupt during this period because of non-recovery of loans.

3.

Total assets = Loan + Reserves = 250 + 50 = $300

Capital = Total assets × Rate of requirement

            = $300 × 15%

            = $45 (Answer)