Tutorial Questions #8

ECON7200

1. How can the bursting of an asset-price bubble in the stock market help trigger a

financial crisis?

2. Why are deposit insurance and other types of government safety nets important to the

health of the economy?

3. Do you think that eliminating or limiting the amount of deposit insurance would be a

good idea? Explain your answer.

4. If casualty insurance companies provided fire insurance without any restrictions,

what kind of adverse selection and moral hazard problems might result?

5. What are the costs and benefits of a too-big-to-fail policy?

6. How does bank chartering reduce adverse selection problems? Does it always work?

7. How do disclosure requirements help limit excessive risk taking by banks?

8. Why might more competition in financial markets be a bad idea? Would restrictions

on competition be a better idea? Why or why not?

MCQs

1. Depositors lack of information about the quality of bank assets can lead to

A) bank panics.

B) bank booms.

C) sequencing.

D) asset transformation.

2. The contagion effect refers to the fact that

A) deposit insurance has eliminated the problem of bank failures.

B) bank runs involve only sound banks.

C) bank runs involve only insolvent banks.

D) the failure of one bank can hasten the failure of other banks.

3. A system of deposit insurance

A) attracts risk-taking entrepreneurs into the banking industry.

B) encourages bank managers to decrease risk.

C) increases the incentives of depositors to monitor the riskiness of their bank's asset

portfolio.

D) increases the likelihood of bank runs.

4. Deposit insurance is only one type of government safety net. All of the following are types

of government support for troubled financial institutions EXCEPT

A) forgiving tax debt.

B) lending from the central bank.

C) lending directly from the government's treasury department.

D) nationalizing and guaranteeing that all creditors will be repaid their loans in full.

5. In May 1991, the FDIC announced that it would sell the government's final 26% stake in

Continental Illinois, ending government ownership of the bank that it had rescued in 1984.

The FDIC took control of the bank, rather than liquidate it, because it believed that

Continental Illinois

A) was a good investment opportunity for the government.

B) could be the Chicago branch of a new governmentally-owned interstate banking system.

C) was too big to fail.

D) would become the center of the new midwest region central bank system.

6. The chartering process is especially designed to deal with the ________ problem, and

regular bank examinations help to reduce the ________ problem.

A) adverse selection; adverse selection

B) adverse selection; moral hazard

C) moral hazard; adverse selection

D) moral hazard; moral hazard

7. Who has regulatory responsibility when a bank operates branches in many countries?

A) It is not always clear.

B) the WTO

C) the U.S. Federal Reserve System

D) the first country to submit an application

8. Moral hazard is an important concern of insurance arrangements because the existence of

insurance

A) provides increased incentives for risk taking.

B) is a hindrance to efficient risk taking.

C) causes the private cost of the insured activity to increase.

D) creates an adverse selection problem but no moral hazard problem.

9. Which of the following is NOT a reason financial regulation and supervision is difficult in

real life?

A) Financial institutions have strong incentives to avoid existing regulations.

B) Unintended consequences may happen if details in the regulations are not precise.

C) Regulated firms lobby politicians to lean on regulators to ease the rules.

D) Financial institutions are not required to follow the rules.

10. When financial institutions go on a lending spree and expand their lending at a rapid pace

they are participating in a

A) credit boom.

B) credit bust.

C) deleveraging.

D) market race.