Learning outcomes: Explain the roles of incentives and regulatory arbitrage in the outcome of the crisis. Apply the key lessons learned by risk managers to the scenarios provided.
Questions:
510.1. “Agency costs” is a term used to describe the costs in a situation where the interests of two parties are not perfectly aligned. In the events leading up to the Global Financial Crisis (CFC; aka, credit crisis), which of the following was a source of agency cost?
a. Home appraisers seeking loan-to-value ratios
b. Rating agencies paid by issuers
c. Annual (end-of-year) bonuses
d. All of the above
510.2. According to Hull , many factors contributed to the crisis that started in 2007. One of the problems was so-called regulatory arbitrage. Which of the following enabled regulatory arbitrage?
a. Capital requirements were different for the banking book than for the trading book
b. BBB-rated corporate bonds had different credit quality characteristics than BBB-rated tranches of asset-backed securities (ABS)
c. Mortgage loan servicing regulations differed by state
d. An employee's annual bonus was legally due to the employee even if the financial institution's investment in ABS CDO instruments failed over the long run
510.3. The Global Financial Crisis was clearly multivariate in cause and effect. Consequently, there are many lessons to draw from the crisis. According to Hull, each of the following is a lesson except which is inaccurate?
a. Correlations always increase in stressed markets
b. Recovery rates decline with default rates increase
c. Investors should not rely on ratings
d. Traders should be paid salaries but not bonuses
Answers here:
Questions:
510.1. “Agency costs” is a term used to describe the costs in a situation where the interests of two parties are not perfectly aligned. In the events leading up to the Global Financial Crisis (CFC; aka, credit crisis), which of the following was a source of agency cost?
a. Home appraisers seeking loan-to-value ratios
b. Rating agencies paid by issuers
c. Annual (end-of-year) bonuses
d. All of the above
510.2. According to Hull , many factors contributed to the crisis that started in 2007. One of the problems was so-called regulatory arbitrage. Which of the following enabled regulatory arbitrage?
a. Capital requirements were different for the banking book than for the trading book
b. BBB-rated corporate bonds had different credit quality characteristics than BBB-rated tranches of asset-backed securities (ABS)
c. Mortgage loan servicing regulations differed by state
d. An employee's annual bonus was legally due to the employee even if the financial institution's investment in ABS CDO instruments failed over the long run
510.3. The Global Financial Crisis was clearly multivariate in cause and effect. Consequently, there are many lessons to draw from the crisis. According to Hull, each of the following is a lesson except which is inaccurate?
a. Correlations always increase in stressed markets
b. Recovery rates decline with default rates increase
c. Investors should not rely on ratings
d. Traders should be paid salaries but not bonuses
Answers here:
