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How can asymmetric information lead to a bank panic?
Answer: Depositors cannot judge the quality of their banks' loan portfolios. So, when they hear
about a failed financial institution, they may worry about the safety of their deposits and begin to
withdraw their funds from their bank. Even healthy institutions can go under if enough deposits
are withdrawn quickly.
Diff: 3 Type: SA Page Ref: 190
Skill: Recall
Objective List: 9.1 Discuss the factors that lead to financial crises
How do increases in interest rates play a role in promoting financial crises?
Answer: Students should discuss the increase in adverse selection, the decline in lending, the
decline in investment and aggregate economic activity, and the effects on cash flow.
Diff: 2 Type: SA Page Ref: 183
Skill: Recall
Objective List: 9.1 Discuss the factors that lead to financial crises
What triggered the ABCP saga in Canada?
Answer: The ABCP saga was triggered when investors in the Canadian ABCP market declined
to roll over maturing notes because of concerns about exposure to the U.S. subprime mortgage
sector in the underlying assets.
Diff: 2 Type: SA Page Ref: 197
Skill: Applied
Objective List: 9.3 Discuss the most recent financial crisis
Describe an asset-price bubble.
Answer: An asset-price bubble is a term which describes asset prices (in the stock market or real
estate) that have been driven above their fundamental economic values by investor psychology.
Diff: 2 Type: SA Page Ref: 184
Skill: Recall
Objective List: 9.2 Explain how increases in adverse selection and moral hazard cause financial
crises
What is debt deflation?
Answer: Debt deflation occurs when a decline in price levels leads to deterioration in firms' net
worth because of the increased burden of indebtedness.
Diff: 2 Type: SA Page Ref: 185
Skill: Recall
Objective List: 9.2 Explain how increases in adverse selection and moral hazard cause financial
crises