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Hull: Options, Futures, and Other Derivatives, Ninth Edition

Chapter 8: Securitization and the Credit Crisis of 2007


Multiple Choice Test Bank: Questions

1. Which of the following tends to lead to an increase in house prices?

A. An increase in interest rates


B. Regulators specifying a maximum level for the loan-to-value ratio on
mortgages
C. Banks reducing the minimum FICO score that borrowers are required to
have
D. An increase in foreclosures

2. Which of the following is true of a non-recourse mortgage?

A. The house buyer, if unable to make payments, can lose all his or her
possessions
B. The house buyer has an American-style put option on the house
C. The house buyer has a European-style put option on the house
D. The lender is less likely to lose money on the mortgage

3. Which of the following is NOT true

A. The bonus structure at banks can lead to short-term horizons for


decision making
B. Securitization involves the transfer of risk
C. The term agency costs describes the situation where the incentives
of two parties in a business relationship are not perfectly aligned
D. Correlations decrease in stressed market conditions

4. Suppose that ABSs are created from portfolios of subprime mortgages


with the following allocation of the principal to tranches: senior 80%,
mezzanine 10%, and equity 10%. (The portfolios of subprime
mortgages have the same default rates.) An ABS CDO is then created
from the mezzanine tranches with the same allocation of principal.
Losses on the mortgage portfolio prove to be 16%. What, as a percent
of tranche principal, are losses on the mezzanine tranche of the ABS
A.
B.
C.
D.

50%
60%
80%
100%

5. Suppose that ABSs are created from portfolios of subprime mortgages


with the following allocation of the principal to tranches: senior 80%,
mezzanine 10%, and equity 10%. (The portfolios of subprime
mortgages have the same default rates.) An ABS CDO is then created
from the mezzanine tranches with the same allocation of principal.
Losses on the mortgage portfolio prove to be 16%. What, as a percent
of tranche principal, are losses on the mezzanine tranche of the ABS
CDO
A. 50%

B. 60%
C. 80%
D. 100%

6. Suppose that ABSs are created from portfolios of subprime mortgages


with the following allocation of the principal to tranches: senior 80%,
mezzanine 10%, and equity 10%. (The portfolios of subprime
mortgages have the same default rates.) An ABS CDO is then created
from the mezzanine tranches with the same allocation of principal.
Losses on the mortgage portfolio prove to be 16%. What, as a percent
of tranche principal, are losses on the senior tranche of the ABS CDO
A.
B.
C.
D.

50%
60%
80%
100%

7. AIG lost money because


A.
B.
C.
D.

It
It
It
It

bought tranches created from mortgages


invested heavily in real estate
invested heavily in the stock market
insured AAA tranches of ABS CDOs

8. Which of the following survived the crisis without declaring bankruptcy or


being taken over by another financial institution?
A. Bear Stearns
B. Morgan Stanley
C. Lehman Brothers
D. Merrill Lynch

9. What are teaser rates


A.
B.
C.
D.

Interest
Interest
Interest
Interest

rates
rates
rates
rates

that appear lower than they are


that depend on LIBOR
on mortgages with a very long amortization period
that apply only for the first two or three years

10. Which of the following describes the waterfall typically used for mortgages

pre-crisis?
A. A distribution of cash flows to tranches with priority given to tranche
with the highest rating
B. A distribution of cash flows to tranches in proportion to their
outstanding principals
C. A distribution of losses to tranches so that tranches bear losses in
proportion to their outstanding principals
D. None of the above

11. In 2008 the TED spread reached a high of


A. About 150 basis points
B. About 250 basis points
C. About 450 basis points

D. About 550 basis points

12. Which of the following were introduced before the credit crisis that started in
2007
A.
B.
C.
D.

Basel II
Dodd-Frank
Basel III
Requirements for living wills

13. Which of the following is true as the correlation between mortgage defaults
increases?
A. Equity tranches are almost certain to incur losses
B. Senior tranches become more likely to incur losses
C. The expected number of defaults increases
D. Equity tranches are unaffected

14. Which of the following describes the S&P/Case-Shiller index?


A.
B.
C.
D.

A stock market index


An index of interest rates on mortgages
An index of house prices
An index showing the dollar amount of mortgages granted each month

15. Suppose that ABSs are created from portfolios of subprime mortgages
with the following allocation of the principal to tranches: senior 85%,
mezzanine 10%, and equity 5%. (The portfolios of subprime mortgages
have the same default rates.) An ABS CDO is then created from the
mezzanine tranches with the same allocation of principal. How high can
losses on the mortgages be before the mezzanine tranche of the ABD
CDO bears losses?
A.
B.
C.
D.

5.0%
5.5%
6.0%
6.5%

16. Suppose that ABSs are created from portfolios of subprime mortgages
with the following allocation of the principal to tranches: senior 85%,
mezzanine 10%, and equity 5%. (The portfolios of subprime mortgages
have the same default rates.) An ABS CDO is then created from the
mezzanine tranches with the same allocation of principal. How high can
losses on the mortgages be before the senior tranche of the ABS CDO
bears losses?
A.
B.
C.
D.

5.5%
6.0%
6.5%
7.0%

17. Suppose that ABSs are created from portfolios of subprime mortgages
with the following allocation of the principal to tranches: senior 94.5%
(rated AAA), mezzanine 0.1% (rated BBB), and equity 5% (rated C) .
The portfolios of subprime mortgages have the same default rates. An
ABS CDO is then created from the mezzanine tranches. Which of the
following is true?
A.
B.
C.
D.

The ABS CDO tranches


The ABS CDO tranches
The ABS CDO tranches
The ABS CDO tranches
tranches are so thin

should have ratings ranging from AAA to C


should all be rated BBB
should all be rated C
are almost worthless because the mezzanine

18. Which of the following describes regulatory arbitrage?

A. Finding a way of reducing capital requirements without changing the


risks being taken
B. Buying products that are not subject to regulation
C. Shorting products that are not subject to regulation
D. Trading with the government

19. Which of the following describes a subprime mortgage?


A.
B.
C.
D.

The
The
The
The

rate of interest is less than the prime rate of interest


loan-to-value ratio is below average
life of the mortgage is less than 25 years
credit risk is high

20. Which of the following would be described by the term liar loan?

A. A situation where the lender concealed information from the borrower


B. A situation where the lender lied to the borrower about the interest
rate
C. A situation where the borrower lied about the his or her income
D. None of the above