Money Market Instruments and the 2008 Financial Crisis Quiz
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Questions and Answers

What are the characteristics of securities in money markets?

  • High liquidity, small denominations, high default risk, and short time to maturity
  • High liquidity, large denominations, low default risk, and short time to maturity (correct)
  • Low liquidity, small denominations, high default risk, and long time to maturity
  • Low liquidity, large denominations, low default risk, and long time to maturity
  • Why do money markets have a distinct cost advantage over banks?

  • Banks have reserve requirements and interest rate regulations (correct)
  • Money markets are less regulated than banks
  • Banks have higher default risk compared to money markets
  • Money markets offer higher interest rates to depositors
  • What is the purpose of money markets for investors?

  • A platform for high-risk speculative trading
  • A source of long-term investment opportunities
  • A place for warehousing surplus funds for short periods of time (correct)
  • A source of funding for large-scale infrastructure projects
  • Why do corporations and the US use money markets?

    <p>To solve cash-timing problems due to unsynchronized cash inflows and outflows</p> Signup and view all the answers

    What was the trend of the 3-month T-bill rate in the 40s and 50s?

    <p>Very low</p> Signup and view all the answers

    What happened to people's behavior when interest rates rose?

    <p>They moved to money markets for higher returns</p> Signup and view all the answers

    What are the characteristics of borrowers from money markets?

    <p>They seek low-cost temporary funds</p> Signup and view all the answers

    Which money market instrument involves bank-issued securities documenting a deposit and specifying the interest rate and maturity date?

    <p>Negotiable certificates of deposit</p> Signup and view all the answers

    What is the typical range of maturities for Treasury bills?

    <p>28 days to 12 months</p> Signup and view all the answers

    Which entity controls interest rates through open-market operations?

    <p>Federal Reserve System</p> Signup and view all the answers

    What is the primary function of federal funds in the money market?

    <p>To meet reserve requirements for banks</p> Signup and view all the answers

    What does expansionary monetary policy involve?

    <p>Buying government securities in the bond/money market</p> Signup and view all the answers

    What was the primary factor influencing the collapse of Lehman Brothers?

    <p>High repo haircuts</p> Signup and view all the answers

    What did the LIBOR scandal impact?

    <p>The cost of mortgages and loans</p> Signup and view all the answers

    What is the primary function of Commercial Paper?

    <p>To provide short-term financing for corporations</p> Signup and view all the answers

    What was the role of Asset-backed commercial paper (ABCP) in the 2008 financial crisis?

    <p>It led to a run on ABCPs and played a key role in the crisis</p> Signup and view all the answers

    What is the main purpose of securitization?

    <p>To turn non-tradable financial contracts into tradable instruments</p> Signup and view all the answers

    What is the primary function of Commercial Mortgage Backed Securities (CMBS)?

    <p>To allow banks to earn money by pooling mortgages and selling them to SPVs</p> Signup and view all the answers

    What is maturity transformation, and why is it considered risky?

    <p>It involves using short-term deposits for long-term loans, posing risk due to potential mismatch in interest rates</p> Signup and view all the answers

    What was the outcome of Money Market Mutual Funds (MMMFs) investing in ABCPs during the 2008 crisis?

    <p>It led to liquidity problems when the housing market trust decreased</p> Signup and view all the answers

    What is the significance of Banker's Acceptances in international trade?

    <p>They are important for international trade, allowing for contingent payments and an active secondary market until maturity</p> Signup and view all the answers

    What is the main purpose of money markets?

    <p>To provide a low-cost source of funds for short-term funding.</p> Signup and view all the answers

    Why are Eurodollars considered short-term financing instruments?

    <p>They have maturities ranging from 1 day to 1 year.</p> Signup and view all the answers

    What is the formula for calculating the annualized discount rate for a T-bill purchased for $10,000 maturing in 270 days and sold for $9,360?

    <p>$\left(\frac{F-P}{F}\right) \times \frac{360}{n}$</p> Signup and view all the answers

    What is the main advantage of negotiable certificates of deposit for businesses?

    <p>High liquidity and easy buy/sell options.</p> Signup and view all the answers

    In a T-bill auction with a par value of $2.1 billion for 91-day T-bills, who will get the bills if only competitive bids are accepted?

    <p>Bidders offering the highest price (lowest yield).</p> Signup and view all the answers

    Why are banker's acceptances considered ideal for foreign transactions?

    <p>They provide assurance of payment from reputable banks.</p> Signup and view all the answers

    What is the London Interbank Offered Rate (LIBOR) based on?

    <p>Estimates submitted by leading banks in London.</p> Signup and view all the answers

    What is the primary reason for the creation of the Eurodollar market?

    <p>To prevent potential seizure of US dollar deposits by the US government.</p> Signup and view all the answers

    What makes commercial paper a short-term financing option for businesses and finance companies?

    <p>It has maturities of up to 207 days.</p> Signup and view all the answers

    What is the typical maturity range for securities in money markets?

    <p>1 year or less</p> Signup and view all the answers

    What creates additional expenses for banks in handling short-term loans and deposits?

    <p>Reserve requirements</p> Signup and view all the answers

    Why did people move to money markets in the 70s and 80s when interest rates rose?

    <p>For higher return</p> Signup and view all the answers

    What is the primary purpose of money markets for investors?

    <p>Warehousing surplus funds for short periods</p> Signup and view all the answers

    What are the characteristics of borrowers from money markets?

    <p>Low-cost source of temporary funds</p> Signup and view all the answers

    What was the trend of the 3-month T-bill rate in the 40s and 50s?

    <p>Very low</p> Signup and view all the answers

    Why do corporations and the US use money markets?

    <p>For timing of cash inflows and outflows</p> Signup and view all the answers

    What is the primary function of Asset-backed commercial paper (ABCP) in the money market?

    <p>Providing short-term financing for companies</p> Signup and view all the answers

    What is the main purpose of securitization in the context of money markets?

    <p>Turning non-tradable financial contracts into tradable instruments</p> Signup and view all the answers

    What was the outcome of Money Market Mutual Funds (MMMFs) investing in ABCPs during the 2008 crisis?

    <p>Liquidity problems when the housing market trust decreased</p> Signup and view all the answers

    What is the typical range of maturities for Treasury bills?

    <p>28 days to 12 months</p> Signup and view all the answers

    What is the significance of Banker's Acceptances in international trade?

    <p>Allowing for contingent payments and an active secondary market until maturity</p> Signup and view all the answers

    What is the primary function of repurchase agreements in the money market?

    <p>Conducting monetary policy by buying/selling Treasuries</p> Signup and view all the answers

    What is the primary function of Commercial Paper in the money market?

    <p>Providing short-term financing for companies</p> Signup and view all the answers

    What was the main impact of the LIBOR scandal?

    <p>Influencing the cost of mortgages and loans</p> Signup and view all the answers

    What was the role of Commercial Mortgage Backed Securities (CMBS) in the 2008 financial crisis?

    <p>Another way for banks to earn money by pooling mortgages and selling them to SPVs</p> Signup and view all the answers

    What is the primary reason for the collapse of Lehman Brothers?

    <p>High repo haircuts</p> Signup and view all the answers

    What is the primary reason for the lack of trust in Money Market Mutual Funds (MMMFs) after the 2008 crisis?

    <p>The Reserve Primary Fund breaking the buck in 2008</p> Signup and view all the answers

    What is the primary function of negotiable certificates of deposit in the money market?

    <p>Documenting a deposit and specifying the interest rate and maturity date</p> Signup and view all the answers

    What is the main purpose of federal funds in the money market?

    <p>Short-term funds transferred between financial institutions</p> Signup and view all the answers

    What is the key function of the Federal Reserve in controlling interest rates?

    <p>Open-market operations</p> Signup and view all the answers

    Which of the following money market securities is issued by non-US banks?

    <p>Negotiable Certificates of Deposits</p> Signup and view all the answers

    What is the main advantage of negotiable certificates of deposit for businesses?

    <p>Easy to buy and sell</p> Signup and view all the answers

    What is the typical range of maturities for Eurodollars?

    <p>Up to 1 year</p> Signup and view all the answers

    What is the formula for calculating the annualized discount rate for a T-bill purchased for $10,000 maturing in 270 days and sold for $9,360?

    <p>$\frac{(F-P)}{F} \times \frac{360}{n}$</p> Signup and view all the answers

    What is the main purpose of money markets for investors?

    <p>Low-risk, short-term investment options</p> Signup and view all the answers

    What is the primary function of Commercial Paper in the money market?

    <p>Short-term financing for businesses and finance companies</p> Signup and view all the answers

    What is the main reason for the creation of the Eurodollar market?

    <p>To avoid US regulations on interest rates</p> Signup and view all the answers

    What was the trend of the 3-month T-bill rate in the 40s and 50s?

    <p>Steadily decreasing</p> Signup and view all the answers

    What is the main advantage of Banker's Acceptances for foreign transactions?

    <p>Reduced risk of non-payment in international trade</p> Signup and view all the answers

    Study Notes

    Money Market Instruments and the 2008 Financial Crisis

    • Libor rates were manipulated by banks, including Barclays, with encouragement from the Bank of England
    • Commercial Paper is unsecured short-term debt sold directly to investors, with a significant increase in use in the early 1980s
    • Asset-backed commercial paper played a key role in the 2008 financial crisis, leading to a run on ABCPs
    • Securitization involves turning non-tradable financial contracts into tradable instruments, such as ABCPs
    • Commercial Mortgage Backed Securities (CMBS) is another way for banks to earn money by pooling mortgages and selling them to SPVs
    • Maturity transformation, the act of banks using short-term deposits for long-term loans, is risky and was a factor in the 2008 crisis
    • Diversification did not work well after 2008, as the complexity and lack of understanding led to a run on ABCPs
    • Banks issued bad loans and made money with fees, transferring risk to investors
    • The 2008 crisis was caused by bad loans, maturity transformation, wrong pricing models, and the failure of diversification
    • Money Market Mutual Funds invested in ABCPs, leading to liquidity problems when the housing market trust decreased
    • The Reserve Primary Fund breaking the buck in 2008 led to a lack of trust in MMMFs and problems for the real economy
    • Banker's Acceptances are important for international trade, allowing for contingent payments, and an active secondary market until maturity

    Money Market Instruments and Functions

    • Money market instruments include stocks, bonds, cash, and short-term instruments like Treasury bills, federal funds, commercial paper, LIBOR, Eurodollar, and repurchase agreements
    • Key participants in money markets include the US Treasury Department, the Federal Reserve System, commercial banks, businesses, investment companies, finance companies, and insurance companies
    • The Federal Reserve controls interest rates through open-market operations, with the current target interest rate around 5.25-5.5%
    • Expansionary monetary policy involves the Fed buying government securities in the bond/money market, increasing the money supply and lowering interest rates
    • Treasury bills have maturities ranging from 28 days to 12 months and are commonly discounted, providing a return through capital appreciation
    • Treasury bills are auctioned to dealers every Thursday, with both competitive and non-competitive bids influencing the price paid, and the interest rate on T-bills is typically close to the inflation rate
    • Federal funds are short-term funds transferred between financial institutions, usually for one day, and are used by banks to meet reserve requirements
    • Repurchase agreements are similar to the federal funds market but involve nonbanks, with the Fed using this market to conduct monetary policy by buying/selling Treasuries
    • The collapse of Lehman Brothers was influenced by high repo haircuts, which resulted in the firm not being able to get enough cash
    • Negotiable certificates of deposit are bank-issued securities that document a deposit and specify the interest rate and maturity date, with maturities typically between 1 and 4 months
    • The LIBOR scandal involved banks estimating how much interest they would have to pay to borrow cash, impacting the cost of mortgages and loans
    • The LIBOR scandal led to government intervention to save banks and revealed the impact of borrowing costs on the financial sector

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    Description

    Test your knowledge of money market instruments and their role in the 2008 financial crisis with this quiz. Explore concepts such as Libor rates, commercial paper, asset-backed commercial paper, securitization, commercial mortgage backed securities, maturity transformation, diversification, bad loans, money market mutual funds, and banker's acceptances.

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