1. An illiquid financial asset is one that can easily be used to buy goods and services. _____ (True/False)
2. Creation of _____ following the Great Depression has greatly reduced the likelihood of runs on banks today.
3. Financial intermediaries reduce the risk of assets through _____.
4. If a financial intermediary buys loans from a mortgage company and then packages them to sell in the financial markets, this is known as _____.
5. Understanding Banks. How can a bank invest in illiquid loans (say, lend depositors savings to home buyers over 25 years) and still provide liquid deposits (give depositors their savings when they ask for it)?
6. A Leverage Example. Suppose you purchased an asset for $1000. The asset is risky and can either increase in value to $1,200 or fall in value to $900. Let s look at the effects of leverage on your returns to this investment.
a. Suppose you did not borrow any money, but put in your own $1000 to purchase the asset. What percent gain would you make if the asset increased and what percent loss would you experience if the asset fell in value?
b. Now, suppose you borrowed $950 to purchase the asset. What is your percentage gain or loss on your investment now?
7. Ninja Loans. During the housing boom, overeager lenders were said to have made ninja loans that is, loans to individuals with no income, job, or assets. How did ninja loans contribute to the securitization crisis in financial markets in 2007 and 2008?
8. Savings and Loans and Risk. Traditionally, savings and loan institutions made loans only for home mortgages and held on to those mortgages. At one point, this was viewed as a safe way of doing business. However, it became a risky way of doing business for U.S. savings and loans in the 1970s. Explain why making loans only for housing and holding on to the mortgages may be very risky. Why does this risk provide a rationale for securitization?
9. Mutual Funds. Why does it make sense for individual investors to invest in mutual funds (which invest in a wide range of stocks), rather than in just a few individual companies?