Chapter 9

Question 1

Financial Frictions

Answer 1

asymmetric information problems that act as a barrier to efficient allocation of capital are often described by economics

Question 2

Financial Crisis

Answer 2

occurs when information flows in financial markets experience a particularly large disruption, with the result that financial frictions increase sharply and financial markets stop functioning

Question 3

Sequence of Events in a Financial Crisis

Answer 3

1. Initiation of Financial Crisis
2. Banking Crisis
3. Debt Deflation

Question 4

Credit Boom

Answer 4

financial institutions go on a lending spree

Question 5

Deleveraging

Answer 5

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

Question 6

Asset-Price Bubble

Answer 6

the rise of asset prices above their fundamental economic values

Question 7

Bank Panic

Answer 7

multiple banks fail simultaneously

Question 8

Fire Sales

Answer 8

selling off all assets quickly

Question 9

Debt Deflation

Answer 9

when a substantial unanticipated decline in the price level sets in, leading to a further deterioration in firms net worth because of the increased burden of indebtedness

Question 10

Credit Spread

Answer 10

difference between the interest rate on loans to households and businesses and the interest rate on completely safe assets

Question 11

Securitization

Answer 11

the process of transforming illiquid financial assets into marketable capital market instruments

Question 12

Subprime Mortgages

Answer 12

mortgages for borrowers with less than stellar credit records

Question 13

Mortgage-Backed Securities

Answer 13

securities that cheaply bundle and quantify the default risk of the underlying high-risk mortgages

Question 14

Financial Engineering

Answer 14

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

Question 15

Structured Credit Products

Answer 15

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 16

Originate-to-Distribute Model

Answer 16

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 17

Principle-Agent Problem

Answer 17

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

Question 18

Credit Default Swaps

Answer 18

financial insurance contracts that provide payments to holders of bonds if they default

Question 19

Shadow Banking System

Answer 19

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

Question 20

Repurchase Agreements

Answer 20

an arrangement whereby the Fed, or another party, purchases securities with the understanding that the seller will repurchase them in a short period of time, usually less than a week

Question 21

Haircuts

Answer 21

the excess amount of collateral above the amount of the loan

Question 22

Emerging Market Economics

Answer 22

economics in an earlier stage of market development that have recently opened up to the flow of goods and services and capital from the rest of the world

Question 23

Financial Globalization

Answer 23

the process of economies opening up to flows of capital and financial firms from other nations

Question 24

Cash Flows

Answer 24

the difference between cash receipts and cash expenditures

Question 25

Sequence of Events in Emerging Market Financial Crisis

Answer 25

1. Initiation of financial crisis
   a) mismanagement of financial liberalization/globalization
   b) severe fiscal imbalances
2. Currency crisis
3. Full-fledged financial crisis

Question 26

Speculative Attack

Answer 26

speculators engage in massive sales of currency

Question 27

Currency Mismatch

Answer 27

when emerging market economies denominate many debt contracts in foreign currency, while their assets are denominated in domestic currency