1. During the height of the real estate boom in 2006, brokers offered loans with
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Question
1. During the height of the real estate boom in 2006, brokers offered loans with
little concern about whether or not the borrowers could make the payments. The brokers were
then able to sell the loans to investors for a high fee. Which of the following best describes this
scenario?
A. The brokers were acting in their own self-interest and not in the interest of the investors.
This is an example of the moral hazard problem.
B. The brokers were acting in their own self-interest and not in the interest of the investors.
This is an example of the adverse selection problem.
C. The borrowers acted in their own self-interest and not in the interest of the brokers. This
is an example of the moral hazard problem.
D. The borrowers acted in their own self-interest and not in the interest of the brokers. This
is an example of the adverse selection problem.
2. According to the Consumer Financial Protection Bureau, millions of Americans
do not have credit enough credit history to create a credit score. These consumers often face
the worst credit terms. Which of the following best describes why?
A. Without a credit score, lenders cannot tell high risk borrowers from low risk borrowers.
Lenders treat all borrowers as high risk. This is an example of the moral hazard problem.
B. Without a credit score, lenders cannot tell high risk borrowers from low risk borrowers.
Lenders treat all borrowers as high-risk. This is an example of the adverse selection
problem.
C. When making loans to borrowers without a credit score, lenders act in their own self
interest and not the interest of the borrower. This is an example of the moral hazard
problem.
D. When making loans to borrowers without a credit score, lenders act in their own self
interest and not the interest of the borrower. This is an example of the adverse selection
problem.
3.
Which balance sheet item generates the most revenue for banks?
A. Loans
B. Treasury securities
C. Reserves held at the Federal Reserve
D. Vault cash
E. Equity Securities
4.) Sally takes $1000 in currency and deposits it in a savings account at First
National Bank. The value of the deposit is
A. an asset for First National Bank and a liability for Sally.
B. an asset for First National Bank and an asset for Sally.
C. a liability for First National Bank and an asset for Sally.
D. a liability for First National Bank and a liability for Sally.
5. If interest rates on all types of assets increase, the present value of a banks’
current portfolio of loans . At the same time, the profitability of future loans .
A. rises/rises
B. falls/falls
C. falls/rises
D. rises/falls
6. Bank runs were fairly common in the United States prior to the Great Depression.
Which of the following best describes why bank runs no longer occur?
A. Capital requirements have increased and banks are much less likely to fail.
B. The Federal Reserve will loan any bank that needs liquidity funds to satisfy withdrawal
requests.
C. The Federal Deposit Insurance Corporation (FDIC) insures all deposits below $250,000.
D. The Glass Steagall act separated commercial banks from investment banking and insurance
companies, making banks far less likely to fail.
E. The Riegle-Neal Interstate Banking act of 1994 allowed
15 years ago,
A. the top 10 biggest banks were larger and there were more banks in total.
B. the top 10 biggest banks were smaller and there were more banks in total.
C. the top 10 biggest banks were smaller and there were fewer banks in total.
D. the top 10 biggest banks were larger and there were fewer banks in total.
Explanation / Answer
In this case the brokers have acted in their own self-interests and not in the interests of the investors. This is an example of moral hazard problem as the brokers have failed to act in good faith by engaging in risky behaviour of providing loans to the borrowers without assessing their ability of repayment of these loans. Option A is the correct option, i.e. without credit score lenders treat all borrowers as high risk borrowers and hence, sanction loans with strict terms and conditions thus, consumers face worse credit terms. Thus, this is an example of moral hazard problem. Banks are generally involve in providing loans and receiving deposits to the individuals and organizations. Thus, the highest proportion of total revenue of a bank is generated from loans. Sally deposits $1,000 to First National Bank is an asset for Sally, i.e. investment to Sally and a liability for the First Notational Bank as the bank is liable to Sally for the amount of deposit made by her, i.e. $1,000. The present value of a banks’ current portfolio of loan falls whereas the profitability of future loans rises. This is because the current portfolio of loan will continue to provide interests at the low rates despite the increase of interest rates. Due to increase in capital requirements it is less likely that banks will fail hence, the option A is correct. 15 years ago the top ten biggest banks were smaller and the number of total banks were fewer than the number of total banks at present.
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