Capital Markets and Financial Institutions How to Survive Them Answer. In this post you will get Quiz & Assignment Answer Of Capital Markets and Financial Institutions How to Survive Them
Capital Markets and Financial Institutions How to Survive Them
Offered By ”Moscow Institute of Physics and Technology”
Week- 1
1 – Moral hazard, adverse selection, and the adventures of the greedy monopolist bank
1.
Question 1
In choosing investment projects, unobservability is likely to result in:
1 point
- a. High risk projects get driven out of the market
- b. Low NPV projects get driven out of the market
- Both “a” and “b”
- Neither “a” nor “b”
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2.
Question 2
The adverse selection problem can be alleviated by the following actions:
1 point
- Raising the minimum requirements for the project owner’s financing
- Pledging the project owner’s personal property as collateral
- Hiring an independent auditor
- All of the above
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3.
Question 3
The presence of moral hazard in insurance leads to the following:
1 point
- In some cases the complete insurance becomes unrealistic
- The insurance with a deductible is much cheaper than the complete insurance
- All of the above
- The cost of complete insurance increases
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4.
Question 4
Hiring an outside specialist for monitoring in order to alleviate the adverse selection problem leads to the following:
1 point
- Potential collusion between the borrower and the lender
- The increase in the effective cost of financing
- Creation of adverse incentives for the borrowers’ irresponsible behavior
- Sending incredible signals to the borrower
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5.
Question 5
Suppose that in our analysis of adverse selection in credit markets (Lecture 1.9, Handout 1.2) the greedy monopolist bank may distinguish the borrowers by the type. What interest rate would the bank charge for the loans to the Type 2 borrowers?
1 point
- Just below 125%
- Just above 50%
- Just below 50%
- Just above 125%
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6.
Question 6
Suppose that in our analysis of adverse selection in credit markets (Lecture 1.9, Handout 1.2) the greedy monopolist bank may distinguish the borrowers by the type and charges different face values for the loan of $8 million to the borrowers of each type. What would be the maximum expected cash flow to the bank per one borrower?
1 point
- Just below $10.67m
- Just below $11.33m
- Just below $10.00m
- Just below $11.00m
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7.
Question 7
Suppose the borrower has 2 projects available. The projects’ cash flows are given below (the H and L states are equally probable):
State H L
Project 1 15 15
Project 2 18 3
To finance either project the amount to be borrowed is $8 million. The bank charges the face value of the loan F > $8m (compare to the discussion in Lecture 1.11 and in Handout 1.2). At what F the borrower chooses Project 1?
1 point
- F > 18
- 15 < F < 18
- 12 < F < 15
- F < 12
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8.
Question 8
For the terms given in Question 7, at what F the borrower chooses Project 2?
1 point
- F > 18
- 12 < F < 18
- 8 < F < 12
- F < 8
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9.
Question 9
For the terms given in Question 7, what face value of the loan will the bank charge to maximize the bank’s expected cash flow?
1 point
- Just below 10
- Just below 12
- Just below 15
- Just below 18
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10.
Question 10
For the terms given in Question 7, due to what problem raising the face value of the loan does not necessarily result in the increase of the bank’s expected cash flow?
1 point
- Moral hazard
- Adverse selection
- Both problems
- Can’t say
Week- 2
2 – Debt contracts and the anatomy of bank financing
1.
Question 1
In an equity type financing we may observe the following:
1 point
Expected cash flows for the investor are uncertain
Collusion between the entrepreneur and the investor occurs
The investor receives the fixed amount of money
The entrepreneur and the investor manage the project together
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2.
Question 2
Debt contract with liquidation helps alleviate the moral hazard problem by means of:
1 point
Co-insurance
Restoring observability through monitoring
The right incentives for the borrower
All of the above
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3.
Question 3
Suppose that in our analysis of financing by means of debt contracts and monitoring (Lecture 2.3, Handout 2.1) the probability of the low state has grown to 25% (expected cash flows in both high and low state have not changed). What would be the face value of the $6m loan if the cost of monitoring is $50,000?
1 point
$6.50m
$6.00m
$6.25m
$6.40m
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4.
Question 4
Suppose that in our analysis of bank financing (Lectures 2.3 – 2.6, Handouts 2.1 – 2.2) the probability of the low state has grown to 30% (expected cash flows in both high and low state have not changed). What would be the face value for the borrowers of the $6m loan in the case of debt contract with liquidation?
1 point
$8.57m
$6.42m
$7.27m
$6.79m
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5.
Question 5
Suppose that in our analysis of bank financing (Lectures 2.3 – 2.6, Handouts 2.1 – 2.2) the probability of the low state has grown to 30% (expected cash flows in both high and low state have not changed). What would be the minimum interest that would satisfy the depositors?
1 point
9.89%
9.62%
7.87%
8.33%
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6.
Question 6
If the bank pays the minimum interest to the depositors (see Question 5), and if the terms for the borrowers are the same as in a corresponding debt contract with liquidation, how much money would the bank make if the cost of monitoring is $20,000 for each project?
1 point
$1.96m
$2.17m
$2.06m
$2.43m
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7.
Question 7
Suppose that in our analysis of bank financing (Lectures 2.3 – 2.6, Handouts 2.1 – 2.2) the probability of the low state has grown to 30% (expected cash flows in both high and low state have not changed). What is the maximum interest rate that the bank can afford to pay the depositors?
1 point
10.14%
11.89%
14.63%
13.10%
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8.
Question 8
If the bank pays the maximum interest rate to the depositors (see Question 7), and if the terms for the borrowers are the same as in a corresponding debt contract with liquidation, how much money would the bank make if the cost of monitoring is $20,000 for each project?
1 point
$1.79m
$1.71m
$1.87m
$2.06m
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9.
Question 9
If the bank pays the minimum interest to the depositors (see Question 5), how could the bank improve the terms for the borrowers – namely, what is the minimum face value for the loan of $6m that the bank could offer to the borrowers?
1 point
$9.19m
$8.00m
$8.57m
$8.19m
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10.
Question 10
If the face value for the borrowers is reduced to the minimum (see Questions 5 and 9), how much money would the bank make if the cost of monitoring is still $20,000 for each project?
1 point
$1.52m
$1.19m
$1.39m
$1.32m
Week- 3
3 – Asset transformation – “black boxes” and “red triangles”
1.
Question 1
If the consumption level of an economic agent grows, his expected utility of consumption:
1 point
Can’t say
Does not change
Increases
Decreases
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2.
Question 2
In our analysis of asset transformation (Lecture 3.2, Handout 3.1), suppose that the probability of the early withdrawal grew to 30%, while the promised amounts in the case of holding a “red triangle” have changed to $1.15 at t = 1 and $1.90 at t = 2. The parameters of the illiquid asset (“black box”) stay the same. Will rational investors prefer the “red triangle” to the “black box”?
1 point
Depositors are indifferent with respect to both assets
Yes
No
Can’t say
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3.
Question 3
In terms of Question 2 will the bank afford to offer a “red triangle”?
1 point
No
Can’t say
Yes, but the bank just breaks even
Yes, the bank will also make a profit
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4.
Question 4
In our model of asset transformation (Lecture 3.2, Handout 3.1), suppose that the probability of the early withdrawal is stochastically distributed from 10% to 30%. The promised amounts for a “red triangle” are $1.15 at t = 1 and $1.90 at t = 2, for the “black box” stay at $1 and $2. Will rational investors prefer the “red triangle” to the “black box”?
1 point
Depositors are indifferent with respect to both assets
No
Yes
Can’t say
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5.
Question 5
Suppose that a “red triangle” promises the holder to pay $1.15 at t = 1 and $1.90 at t = 2, while the “black box” still pays $1 at t = 1 and $2 at t = 2 (recall Lecture 3.2, Handout 3.1). At what probability of early withdrawals will rational depositors be indifferent with respect to the “black box” and the “red triangle”?
1 point
11.70%
15.30%
13.87%
10.67%
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6.
Question 6
In terms of Question 5 (i.e. at the minimum amount of early withdrawals at which the depositors switch from “black boxes” to “red triangles” rounded up to the proper integer number), how much money will the bank make?
1 point
$3.80
$4.40
$5.00
$2.75
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7.
Question 7
In our analysis of asset transformation (Lectures 3.2 – 3.4, Handouts 3.1 – 3.2), suppose that the probability of the early withdrawal is now 25% while the promised amount in the case of holding a “red triangle” at t = 1 has changed to $1.30. The parameters of the illiquid asset (“black box”) are the same. What is the maximum amount that the bank can promise to pay the holders of the “red triangle” at t = 2?
1 point
$1.917
$1.763
$1.833
$1.793
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8.
Question 8
In terms of Question 7 will rational investors prefer the “red triangle” to the “black box”?
1 point
Depositors are indifferent with respect to both assets
Yes
No
Can’t say
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9.
Question 9
Suspension of convertibility is not a very effective tool for the prevention of bank runs if:
1 point
Depositor preferences with respect to liquidity are likely to change over time
Suspension of convertibility is announced post factum
The percentage of early withdrawals is stochastic
All of the above is observed
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10.
Question 10
Deposit insurance has the following drawbacks:
1 point
It works poorly if the percentage of early withdrawals is uncertain
It provokes the unexpected moves of depositors
It provides incentives for the irresponsible behavior of the bank
None of the above
week- 4
4 – From the Great Depression to Bank 3.0
1.
Question 1
Deposit insurance is not effective in preventing bank runs if:
1 point
Banks use suspension of convertibility
A special agency is created to manage the claims of insured depositors
Both small and large deposits are insured completely
Deposits below a certain level are insured partially
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2.
Question 2
The depth and protraction of the Great Depression were, in part, due to:
1 point
The excessive activity of the Federal Reserve
The entrepreneurs’ apathy
The growth in cost of credit intermediation
All of the above factors
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3.
Question 3
In order to solve the problems of the S&L industry it was necessary to:
1 point
Allow to clean up the balance sheets of the problem S&L’s within 3 years
Determine the S&L’s equity level on the basis of market value of assets
Broaden the participation of the local authorities in the S&L supervision
Close down S&L’s when their capital would become negative
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4.
Question 4
The deposit insurance premia go down if:
1 point
Capital requirements are relaxed
Capital requirements become tighter
The bank’s asset risk grows
Interest rates on bank loans increase
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5.
Question 5
The level of the bank’s risk increases if:
1 point
Interest rates on bank loans decrease
Interest rates on bank deposits decrease
The share of financial derivatives as percentage of assets goes up
The bank shareholders put up additional capital
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6.
Question 6
The partial insurance of the bank liabilities:
1 point
Solves the problem of bank runs
Provides for efficient monitoring from the bank borrowers
Enhances the government’s willingness to allow massive bankruptcies
Provokes the free rider problem in the case of many creditors
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7.
Question 7
One of the main causes of the huge scale of the S&L crash was:
1 point
The existence of S&L’s in all states of the US
Massive fraud on the side of top managers of S&L’s
Too weak regulation
The absence of incentives to close down “zombie” S&L’s
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8.
Question 8
The Bank 3.0 concept states that in a modern bank:
1 point
The role of bank employees in the sale of bank products increases
The bank’s office stops offering banking services
The interaction with clients is implemented when it is convenient to clients
Deposit insurance becomes irrelevant
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9.
Question 9
In providing mortgage loans at Bank 3.0 the process of monitoring is implemented by:
1 point
The bank’s specialists
Becomes irrelevant
Is not implemented at all
The bank’s clients through the social media
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10.
Question 10
The obstacle on the path of a bank becoming Bank 3.0 is:
1 point
A week IT-platform that does not provide for the efficient digestion of the big data
The excessively conservative policy of the top management
Inadequate regulatory environment
All the above problems
Week- 5
5 – Investment banking practices
1.
Question 1
The invention of new financial instruments and active market making in them by investment banks leads to:
1 point
The greater deregulation in the area of investment banking
Fast “copying” of the instrument by competitor banks
Decrease in overall speculative appetite due to the improved market efficiency
A monopoly of the bank-inventor for the instrument
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2.
Question 2
In arranging underwriting, investment banks often invite their international colleagues as partners in underwriting syndicates, sharing with them the commission and other corresponding income. The main goal of this arrangement usually is:
1 point
The enhancement of the pool of potential investors
High ethical standards of the investment banking business
The inability to attract international investors without international partners
The opportunity to circumvent prohibitive regulation rules and procedures
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3.
Question 3
A research department at an investment bank provides for:
1 point
The development of the new financial instruments
The constant monitoring of the issuers
Investment recommendations for the bank’s clients
All of the above
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4.
Question 4
Consider the following “winner’s curse” situation (see Lecture 5.4 and Handout 5.2). Suppose that the placement price is $100; also, with probability 40%, the value of the issue is $120, and in other cases – just $70. Suppose further that in the case of high value each investor will receive only 80% of the shares bid for. At what price would uninformed investors buy the shares?
1 point
$90.2
$87.4
$89.3
$85.7
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5.
Question 5
A company plans the shelf registration of securities. It is most likely that:
1 point
The company plans to issue convertible bonds
The company plans to issue bonds
This is an industrial company
The company plans to issue common stock
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6.
Question 6
In arranging an IPO, the US companies usually prefer:
1 point
Fully underwritten offers
The choice depends on the issue volume
Rights issues
Shelf registration of the issue
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7.
Question 7
In choosing an investment bank for an IPO, the US companies usually prefer:
1 point
Running a tender to save on the cost of the issue
Direct negotiations with the investment bank on the terms of the issue
The choice of the contract depends on characteristics of the stock issued
None of the above
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8.
Question 8
A group of companies А engaged in firm commitment IPO’s while a group of companies B organized IPO’s using a best efforts method. The weighted average underpricing for the group A amounted to 30%, whereas for the group B – 45%. We know that in case of firm commitment the risk incurred by the investment bank is higher; therefore, the bank should require a greater discount. How does that correspond to the above data?
1 point
The mentioned groups are just exceptions form the general rule
If the companies from group B engaged in firm commitment IPO’s, the weighted average underpricing would exceed 45% (in the absolute value)
If the companies from group A engaged in best efforts IPO’s, the weighted average underpricing would exceed 45% (in the absolute value)
The group А companies would not succeed in arranging IPO’s using best efforts
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9.
Question 9
As a rule, the following agents are not the clients of investment banks:
1 point
Investors buying the issues of newly placed securities
Investors engaged in high frequency trading (HFT)
The companies – issuers of securities
The government
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10.
Question 10
The active trading in the newly introduced derivative financial instrument by the investment bank usually does not contribute to:
1 point
The liquidity of other derivative financial instruments in the market
The long-term monopoly of the bank-inventor for the instrument
A potential conflict of interest among the divisions of the investment bank
The growth in the volume of trading in the instrument by other investors
Week- 6
Final Test
1.
Question 1
Suppose that the risk-free rate is zero, and all agents are risk-neutral.
There are two mutually exclusive equally probable outcomes – high (H) and low (L). There are two mutually exclusive projects – Project 1 и Project 2. Each project requires the initial investment of $15m. The projects’ cash flows are as follows:
Outcome H L
Project 1 $30m 0
Project 2 $22m $22m
There are also two kinds of borrowers – conservative and risk-taking. Conservative investors may choose between Projects 1 and 2, while risk-taking borrowers have only Project 1. The borrowers cannot be distinguished when they come to a bank for a loan.
A. Find the face value of the loan that the bank will charge. Which project will the borrower choose?
Let the face value of the loan F = 12. Which project will the conservative borrower take? Will the bank recover its investment?
2 points
Project 2, the bank will not recover its investment
Project 1, the bank will recover its investment
Project 2, the bank will recover its investment
Project 1, the bank will not recover its investment
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2.
Question 2
In terms of Question 1,
A. Find the face value of the loan that the bank will charge. Which project will the borrower choose?
Let the face value of the loan now 12 < F < 22. What will the face value be?
2 points
$16m
$15m
$14m
$13m
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3.
Question 3
In terms of Question 1,
A. Find the face value of the loan that the bank will charge. Which project will the borrower choose?
Which project will the conservative borrower now take?
2 points
Project 2
The conservative borrower is indifferent with respect to the projects
Project 1
Can’t say
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4.
Question 4
In terms of Question 1,
A. Find the face value of the loan that the bank will charge. Which project will the borrower choose?
If both types of borrowers choose Project 1, what face value will the bank charge?
2 points
$28m
$24m
$16m
$20m
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5.
Question 5
In terms of Question 1,
B. Repeat your calculation supposing that the borrower’s equity is $9m, and he needs to borrow just $6m.
Let the face value of the loan F = 6. Which project will the conservative borrower take? Will the bank recover its investment?
2 points
Project 2, the bank will not recover its investment
Project 1, the bank will not recover its investment
Project 2, the bank will recover its investment
Project 1, the bank will recover its investment
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6.
Question 6
In terms of Question 1,
B. Repeat your calculation supposing that the borrower’s equity is $9m, and he needs to borrow just $6m.
Let the face value of the loan now 6 < F < 22. What will the face value be?
2 points
$10m
$7m
$9m
$8m
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7.
Question 7
In terms of Question 1,
C. Can you relate the intuition behind your answers to the role of bank capital requirements in bank regulation?
With the growth of equity portion in project financing the following occurs:
2 points
The risk of the low outcome is pushed to the bank
The risk of the low outcome stays with the borrower
Can’t say
The risk of the low outcome is the same for the borrower and the bank
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8.
Question 8
In terms of Question 1,
C. Can you relate the intuition behind your answers to the role of bank capital requirements in bank regulation?
If the bank capital is small, then:
2 points
The risk of low outcomes is pushed to the government
Can’t say
The risk of low outcomes stays with the bank
The risk of low outcomes is pushed to the depositors
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9.
Question 9
Suppose that the risk-free rate is zero, and all agents are risk-neutral.
There are two mutually exclusive equally probable outcomes – high (H) and low (L). The firm has two mutually exclusive projects – Project 1 и Project 2. Each project requires the initial investment of $15m. The projects’ cash flows are as follows:
Outcome H L
Project 1 $36m 0
Project 2 $22m $22m
Suppose the borrower has $3m in equity, and needs to borrow $12m. The competitive bank that can lend this amount does not observe the choice of the project by the borrower at the point of granting a loan but does obtain the true information on the cash realization (i.e., which outcome did take place).
A. Find the face value of the loan that the bank will charge. Which project will the borrower choose?
Let the face value of the loan F = 12. Which project will the borrower choose?
2 points
Project 1
Can’t say
The borrower is indifferent with respect to the projects
Project 2
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10.
Question 10
In terms of Question 9,
A. Find the face value of the loan that the bank will charge. Which project will the borrower choose?
For the project chosen in 2.1, what will be the face value of the loan?
2 points
$16m
$28m
$24m
$20m
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11.
Question 11
In terms of Question 9,
B. Now suppose that the bank can convert its loan into a 50% share of the borrower’s realized cash flow. Determine the face value of the loan. Which project will the borrower choose? Will the bank exercise its option?
Let the face value of the convertible bond is F = 12. At what borrower’s cash flow CF will the bank convert its bond?
2 points
$18m < СF < $24m
СF < $12m
СF > $24m
$12m < СF < $18m
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12.
Question 12
In terms of Question 9,
B. Now suppose that the bank can convert its loan into a 50% share of the borrower’s realized cash flow. Determine the face value of the loan. Which project will the borrower choose? Will the bank exercise its option?
What will be the bank cash flows from Projects 1 and 2 in the high outcome?
2 points
$12m and $12m
$18m and $12m
$16m and $12m
$24m and $18m
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13.
Question 13
In terms of Question 9,
B. Now suppose that the bank can convert its loan into a 50% share of the borrower’s realized cash flow. Determine the face value of the loan. Which project will the borrower choose? Will the bank exercise its option?
Which project will the borrower choose?
2 points
Project 2
Project 1
The borrower is indifferent with respect to the projects
Can’t say
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14.
Question 14
In terms of Question 9,
B. Now suppose that the bank can convert its loan into a 50% share of the borrower’s realized cash flow. Determine the face value of the loan. Which project will the borrower choose? Will the bank exercise its option?
Will the bank exercise its option?
2 points
Can’t say
No
Yes
The bank is indifferent
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15.
Question 15
After interest rates rose sharply in the late 1970’s, it would not have been difficult even for the outside investors in the market to conclude that the net worth of some of the S&L’s was negative. However, the stocks of these “zombie” S&L’s with negative net worth were still trading at positive prices. Can you provide an explanation for this phenomenon?
Why did the market participants believe that “zombie” S&L’s had some time to go?
2 points
The decisions whether to close down “zombie” S&L’s were made on the basis of the book value of its assets
The market participants were wrong
The decisions whether to close down “zombie” S&L’s were made on the basis of the market value of its assets
Regional regulators lobbied the close-down of “zombie” S&L’s
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16.
Question 16
In terms of Question 15,
There existed a positive probability that during this remaining “time to go” the mentioned “zombie” S&L’s would be able to solve their problems by taking:
2 points
Low risk, but not very profitable projects
High risk, but very profitable projects
Low risk, but very profitable projects
High risk, but not very profitable projects
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17.
Question 17
In terms of Question 15,
How can answers to Questions 3.1 and 3.2 help explain the positive prices for the stocks of “zombie” S&L’s?
3 points
The lack of massive investigations of fraud in the industry contributed to the overall speculative sentiment
A shift for market value reporting would improve their financial perspectives
There is no sensible explanation to this phenomenon
Successful realization of profitable projects could bring “zombie” S&L’s back in the black
Peer-graded Assignment: Analysis of liquidity creation by a bank
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