Review Questions

Question 1

True or false: Funding liquidity risk is typically measured via bid-ask spreads.

Answer 1

False

Question 2

What is an asset’s liquidity risk related to ?

Answer 2

How quickly and cheaply one can sell the asset.

Question 3

true or false: Banks do maturity transformation by investing funds raised through share issues into long term assets.

Answer 3

false

Question 4

True or false: Banks do maturity transformation by investing funds raised through securitizations into deposits.

Answer 4

False

Question 5

True or false: Banksmakemoneybysettinginterestratesondepositsthatareabithigherthaninterest on mortgage loans.

Answer 5

False

Question 6

How did banks in trouble manage to survive during the subprime crisis

Answer 6

government support

Question 7

True or false: Credit risk includes default risk and recovery risk.

Answer 7

true

Question 8

true or false: Banks are not exposed to market risk.

Answer 8

true

Question 9

True or false: Securities are either subject to credit risk or market risk.

Answer 9

false

Question 10

True or false: Market risk includes currency and commodity risks.

Answer 10

true

Question 11

True or false: A 25 standard deviation in asset prices is large but likely.

Answer 11

false

Question 12

True or false: Shortmemorybiasmayresultfromtheapplicationofstatisticalmodelsthatgive more weight to recent observations

Answer 12

True

Question 13

True or false: Hyperbolic discounting is caused by small bonuses.

Answer 13

False

Question 14

Often financial crises happen because of what 3 things?

Answer 14

1) Low interest rates create incentives for excessive lending.
2) Underwriting standard deteriorate.
3) Overconfidence.

Question 15

True or false: During the subprime crisis mortgage defaults caused banks to restrict lending. Less lending reduced the risk in the system and as a result also sovereign risk went down.

Answer 15

False

Question 16

True or false: Sovereign risk is not directly linked to retail and corporate default risk.

Answer 16

False

Question 17

When does leverage amplify profit or losses?

Answer 17

For profit in good times
For losses in bad times

Question 18

What does leverage show?

Answer 18

Relationship between debt and equity capital

Question 19

True or false: Pass-through securitisations can produce AAA securities through tranching.

Answer 19

False

Question 20

True or false: With tranching, losses from the original pool of assets are used to decrease the value of the lowest rated tranches first.

Answer 20

True

Question 21

True or false: With tranching, gains from the original pool of assets are distributed starting from the lowest rated tranche.

Answer 21

False

Question 22

What is the problem with CDO-squared securities?

Answer 22

It is difficult to assess their risk

Question 23

True or false: During the subprime crisis, banks were largely unaffected by the subprime market because they had transferred the associated risk to other investors via securitisations.

Answer 23

false

Question 24

True or false: It is incredible that CDOs caused trouble during the subprime crisis as they are simple products whose risks are easy to understand and measure.

Answer 24

false

Question 25

True or false: Re-securitisations are subject to a lower level of counterparty risk than simple securitisations.

Answer 25

False

Question 26

What happened to banks that used securitisations to transfer risk from the banking book to the trading book?

Answer 26

They were penalised by most stock markets