Chapter 8

Question 1

Asset price bubble

Answer 1

An increase in asset prices that
are driven above their fundamental economic
values by investor psychology

Question 2

Bank panic

Answer 2

The simultaneous failure of many banks,
as during a financial crisis

Question 3

Collateralized debt obligations

Answer 3

Securities that
pay out cash flows from subprime mortgagebacked securities.

Question 4

Credit boom

Answer 4

A lending spree when financial
institutions expand their lending at a rapid
pace.

Question 5

Credit default swaps

Answer 5

A transaction in which one party
who wants to hedge credit risk pays a fixed
payment on a regular basis, in return for a contingent payment that is triggered by a credit
event such as the bankruptcy of a particular firm
or the downgrading of the firm’s credit rating by
a credit rating agency.

Question 6

Credit spreads

Answer 6

: The risk premium: the interest rate on
bonds with default risks relative to the interest
rate on default-free bonds like U.S. Treasury
bonds.

Question 7

Debt deflation

Answer 7

: A situation in which a substantial
decline in the price level sets in, leading to a further deterioration in firms’ net worth because of
the increased burden of indebtedness.

Question 8

Deleveraging

Answer 8

When financial institutions cut back
on their lending because they have less capital.

Question 9

Financial crisis

Answer 9

A major disruption in financial markets, characterized by sharp declines in asset
prices and the failures of many financial and nonfinancial firms.

Question 10

Financial derivatives

Answer 10

Instruments that have payoffs
that are linked to previously issued securities
and are extremely useful risk-reduction tools.

Question 11

Financial engineering

Answer 11

The process of researching and
developing new financial products and services
that would meet customer needs and prove
profitable.

Question 12

Financial frictions

Answer 12

Asymmetric information problems
that act as a barrier to financial markets channeling funds efficiently from savers to households and
firms with productive investment opportunities.

Question 13

financial innovation

Answer 13

: The development of new financial products and services.

Question 14

financial liberalization

Answer 14

: The development of new financial products and services.

Question 15

fire sales

Answer 15

The quick sale of assets to raise necessary
funds.

Question 16

fundamental economic values

Answer 16

The values of assets
based on realistic expectations of the assets’
future income streams.

Question 17

haircuts

Answer 17

: Requirements that borrowers have
more collateral than the amount of the
loan

Question 18

Mortgage backed securities

Answer 18

A security that is collateralized by a pool of mortgage loans. (Also called a
securitized mortgage.)

Question 19

originate to distribute business model

Answer 19

A business model in
which the mortgage is originated by a separate
party, typically a mortgage broker, and then distributed to an investor as an underlying asset in a
security

Question 20

principal agent problem

Answer 20

A moral hazard problem
that occurs when the managers in control (the
agents) act in their own interest rather than in
the interest of the owners (the principals) due to
differing sets of incentives

Question 21

repurchase agreements

Answer 21

A form of loan in which the
borrower simultaneously contracts to sell securities and contracts to repurchase them, either on
demand or on a specified date

Question 22

securitization

Answer 22

The process of transforming illiquid
financial assets into marketable capital market
instruments.

Question 23

shadow banking system

Answer 23

A system in which bank
lending is replaced by lending via the securities
market

Question 24

structured credit products

Answer 24

Securities that are derived
from cash flows of underlying assets and are
tailored to have particular risk characteristics
that appeal to investors with different preferences.

Question 25

subprime mortgages