Dealing with Financial Crises — Does the World Need a New Intl. Financial Architecture? 335
Chapter Fourteen
Dealing with Financial Crises —
Does the World Need a New
International Financial Architecture?
True/False
1. The international institutions, government and nongovernmental organizations and the policies that govern activity in the international markets are collectively called the international financial architecture.
Ans: True
Dif: E
2. By the end of the last century, over 70% of FDI inflows went to developed economies.
Ans: True
Dif: E
3. Since the later 1980s growth in FID has exceeded growth in global capital flows.
Ans: False
Dif: E
4. If a firm in one country absorbs the assets of a firm in another country this is called a cross-border acquisition.
Ans: False
Dif: M
5. Increases in cross-border mergers and acquisitions account for much of the recent increase in international portfolio investment.
Ans: False
Dif: M
6. Since the early 1990s, overall private capital flows to emerging economies have fallen dramatically because of the many financial crises in emerging economies.
Ans: False
Dif: M
7. Economists have found that attracting foreign savings to a country is bad because it substitutes for local savings and allows domestic residents to overspend.
Ans: False
Dif: M
8. In the context of capital flows, moral hazard implies that a borrower is likely to employ the funds raised in a risky manner if the borrower believes that either the government or the IMF will bail them out if they get into financial difficulty.
Ans: True
Dif: M
9. Government licensing requirement for doctors are an example of a policy distortion.
Ans: True
Dif: D
10. If a nation’s financial sector is no longer able to allocate funds to the most productive projects it will first lead to financial instability and absent any correction will eventually and inevitably lead to some form of financial crisis regardless of any capital controls in place.
Ans: True
Dif: D
11. International portfolio investment is defined as investing 10% of the portfolio or more in investments in different countries.
Ans: False
Dif: M
12. The economic problems in Mexico, Thailand, Russia, Argentina and elsewhere in the 1990s and early 2000s could have been avoided if portfolio investment had not been allowed prior to the crises.
Ans: False
Dif: D
13. The economic problems in Mexico, Thailand, Russia, Argentina and elsewhere in the 1990s and early 2000s were caused by a loss of confidence in the soundness of these countries’ economic and political policies in light of the riskiness of investments made in these countries.
Ans: True
Dif: M
14. Controls on capital outflows are more effective than controls on capital inflows at limiting financial crises in most cases.
Ans: False
Dif: E
15. Although there is little agreement on the need for capital controls among developing nations, most economist would agree that once a nation’s financial sector development is reasonably complete, the optimal level of controls is to have no restrictions on cross-border capital flows.
Ans: True
Dif: E
16. The IMF sets each member nation’s quota subscription based on that country’s gold reserves.
Ans: False
Dif: E
17. If a country obtains an IMF loan with low conditionality then the country must conform to specific IMF ordered criteria in order to receive the full loan amount.
Ans: False
Dif: E
18. The World Bank is actually composed of five different institutions that are designed to assist developing nations.
Ans: True
Dif: E
19. Ex-ante IMF conditionality refers to conditions a country must meet before an IMF loan is granted and ex-post IMF conditionality refers to conditions imposed after a loan is granted, which if violated, will require the borrowing country to immediately repay the loan to the IMF.
Ans: False
Dif: D
20. Africa has the world’s poorest nations and receives the bulk of World Bank lending year after year.
Ans: False
Dif: M
21. Credit ratings of bonds in emerging economies are usually useful predictors of financial crises and should normally be part of any early warning system.
Ans: False
Dif: M
22. The extent of financial development in a country is not likely to result in reasonable growth rates in a country’s standard of living when a country does not have effective legal systems, property rights and suffers from endemic corruption.
Ans: True
Dif: E
23. Although many proposals for improving the performance of the IMF have been put forth in recent years, the IMF and the World Bank have not really changed their policies much.
Ans: True
Dif: M
24. A speculative attack on currency is likely to be more disruptive in a country that allows its exchange rate to float.
Ans: False
Dif: M
Multiple Choice
1. The acquisition of foreign assets by a domestic agent that results in 10% ownership or more is called
A) portfolio investment.
B) cross-border merger.
C) cross-border acquisition.
D) foreign direct investment inflow.
E) foreign direct investment outflow.
Ans: E
Dif: M
2. A cross-border merger occurs when one company __________ the assets of another company and a cross-border acquisition occurs when one company __________ the assets of another company.
A) absorbs; purchases
B) purchases; absorbs
C) sells; absorbs
D) absorbs; sells
E) purchases; sells
Ans: A
Dif: E
3. In developed economies foreign capital outflows can allow
I. domestic investment to continue when local sources of funds are not available.
II. domestic savers opportunities to diversify internationally.
III savers to potentially earn higher rates of return than available in local markets.
A) I only
B) I and II only
C) II and III only
D) I and III only
E) I, II and III
Ans: C
Dif: E
4. In developing economies foreign capital inflows can spur development by
I. lowering the cost of capital for investments.
II. increasing the amount of funds available for investments.
III. reducing the risk of local investments.
A) I only
B) I and II only
C) II and III only
D) I and III only
E) I, II and III
Ans: B
Dif: M
5. There are many possible financial market imperfections but they all stem from which one of the following?
A) adverse selection
B) asymmetric information
C) moral hazard
D) contagion
E) herding behavior
Ans: B
Dif: M
6. Contagion stems from
I. asymmetric information.
II. herding behavior.
III. adverse selection.
A) I only
B) I and II only
C) II and III only
D) I and III only
E) I, II and III
Ans: B
Dif: M
7. If the public believes that the IMF will bail out a country if it engages in unsound macroeconomic policies the IMF is contributing to the __________ problem.
A) adverse selection
B) overreaction
C) moral hazard
D) contagion
E) herding behavior
Ans: C
Dif: E
8. Which one of the following would not be considered a policy distortion?
A) The government imposes a tariff to protect a local industry.
B) Because of past IMF behavior bailing out similar countries in trouble, lenders believe there is little risk to investing in this country, even if gets in trouble.
C) The government backs all loans made to specific private industries which policymakers are trying to promote.
D) The central bank intervenes heavily in the currency markets to fix the value of the currency in order to attract FDI.
E) Interest rates rise in a country due to higher inflation expectations.
Ans: E
Dif: E
9. A financial crisis is a breakdown in a country’s financial system. In developing economies this will usually result in
I. a crisis in the domestic banking industry.
II. a large drop in the value of the domestic currency.
III. an inability to repay foreign debt denominated in other currencies.
IV. large changes in foreign portfolio investment.
A) I and II only
B) III and IV only
C) I, II and III only
D) I, III and IV only
E) I, II, III and IV
Ans: E
Dif: M
10. Advantages of placing your money with an intermediary rather than investing in capital markets directly include all but which of the following?
A) Intermediaries pool investors’ funds which reduces the cost of investing to individual savers.
B) Intermediaries offer higher rates of return to savers than are available on capital market investments.
C) Intermediaries assess the riskiness of capital market investments so that savers don’t have to.
C) Intermediaries regularly monitor the performance of the firms that issue capital market investments so that savers don’t have to.
E) Intermediaries pool investor risks, thereby reducing the overall risk to the individual saver.
Ans: B
Dif: M
11. As compared to FDI, foreign portfolio investment tends to __________ than FDI.
A) have a longer maturity
B) have a higher rate of return
C) be more volatile
D) have more foreign ownership control
E) be more costly to acquire
Ans: C
Dif: E
12. Foreign capital inflows to developing economies are about equal to _______ of developing nation’s output.
A) 1%
B) 3%
C) 5%
D) 10%
E) 15%
Ans: B
Dif: M
13. Probably the key critical difference between FDI and portfolio investment that affects a country’s stability is the
A) degree of foreign ownership.
B) difference in maturity and ease of reversibility.
C) degree of foreign control.
D) cost.
E) rate of return.
Ans: B
Dif: M
14. The international financial crises of the 1990s and early 2000s occurred because of
A) an overreliance of developing economies on FDI.
B) an overreliance of developing economies on foreign portfolio investment.
C) an overreliance of developing economies on foreign capital flows.
D) a loss of confidence in the stability of the given developing economy.
E) all of the above
Ans: D
Dif: M
15. If a developing economy decides to limit foreign capital flows it will probably hinder economic growth the least if it limits all
A) foreign capital flows.
B) FDI inflows.
C) FDI outflows.
D) foreign portfolio investment inflows.
E) foreign portfolio investment outflows.
Ans: D
Dif: D
16. Once an economy’s financial sector is developed, economic growth can be optimized and stabilized by limiting
A) no foreign capital flows.
B) all FDI inflows.
C) all FDI outflows
D) all foreign portfolio investment inflows.
E) all foreign portfolio investment outflows.
Ans: A
Dif: M
17. The two main institutions at the center of the world’s financial architecture are the
A) IMF and the BIS.
B) World Bank and the EBRD.
C) United Nations and the WTO.
D) IMF and the World Bank.
E) U.S. Federal Reserve Bank and the European Central Bank.
Ans: C
Dif: E
18. The pool of funds deposited by IMF member which are used to lend to member countries and determine voting shares are called
A) the quota subscription.
B) special drawing rights.
C) conditionality funds.
D) standby arrangements.
E) contingency funds.
Ans: A
Dif: E
19. When the IMF provides loans to a troubled country it may apply conditions which the country must meet to get the loan. If the IMF applies high conditionality this means the country has
A) agreed to comply with specific IMF provisions.
B) agreed to repay all prior loans.
C) agreed to generally comply with IMF suggestions.
D) a very limited time in which to repay the loan.
Ans: A
Dif: E
20. IMF funding designed to provide assistance when a country is experiencing difficulties from temporary declines in exports and problems in paying for food imports are arranged through the IMF’s
A) External Fund Facility.
B) Poverty Reduction and Growth Facility.
C) Compensatory Financing Facility.
D) Supplemental Reserve Facility.
E) Contingent Credit Lines.
Ans: C
Dif: M
21. The loan program where the IMF provides funds to assist when a country is experiencing a sudden, disruptive financial crisis due to a loss of market confidence is called the
A) External Fund Facility.
B) Poverty Reduction and Growth Facility.
C) Compensatory Financing Facility.
D) Supplemental Reserve Facility.
E) Contingent Credit Lines.
Ans: D
Dif: M
22. Which institution specializes in long term lending to developing nations?
A) IMF
B) World Bank
C) WTO
D) BIS
E) Global Poverty Reduction Bank
Ans: B
Dif: E
23. Which one of the following institutions is not part of the World Bank?
A) International Development Association
B) International Finance Corporation
C) Export-Import Bank
D) Multinational Investment Guarantee Agency
E) International Center for Settlement of Investment Disputes
Ans: C
Dif: M
24. Which one of the following World Bank institutions promotes FDI in developing nations by offering political risk insurance to lenders and other investors?
A) International Development Association
B) International Finance Corporation
C) Export-Import Bank
D) Multinational Investment Guarantee Agency
E) International Center for Settlement of Investment Disputes
Ans: D
Dif: M
25. Which of the following statements about IMF conditionality are correct?
I. The IMF does not make the loan conditions public.
II. An IMF announcement that loan conditions have not been met often results in a worsening of the financial crisis
III. The IMF appears to prefer to use high conditionality on loans.
A) I only
B) I and II only
C) II and III only
D) I and III only
E) I, II and III
Ans: B
Dif: M
26. Which one of the following statements about World Bank lending is incorrect?
A) By major region of the world, Africa receives the lowest amount of World Bank lending even though Africa has the world’s poorest nations.
B) World Bank lending often competes with private lending sources.
C) The World Bank’s official mission is to provide funds to developing nations that cannot attract private capital.
D) Eastern Europe now receives the greatest percentage of World Bank funds.
E) World Bank lending that competes with private lending sources is an example of a policy distortion.
Ans: D
Dif: M
27. Which of the following statements about speculative attacks on currency are correct?
I. A speculative attack can only occur if the exchange rate is fixed at a level inconsistent with economic fundamentals.
II. The moral hazard problem can lead to a speculative attack.
III. Speculative attacks can occur in countries with fixed exchange rates at any time when enough traders perceive that the central bank cannot or will not maintain the currency peg.
A) I only
B) I and II only
C) II and III only
D) I and III only
E) I, II and III
Ans: C
Dif: M
28. According to the text there is a strong __________ relationship between the EMBI spread and __________.
A) direct; financial instabilities
B) direct; financial crises
C) inverse; capital flows
D) inverse; moral hazard problems
E) direct; speculative attacks
Ans: C
Dif: M
29. Although many recent proposals differ, most proposals contain some common features about revamping the existing international financial architecture. The typical common features include all but which one of the following?
A) More information made public by multinational lenders and borrowers.
B) Create a global lender of last resort.
C) Better financial and accounting standards used on granting loans.
D) Increased use of high conditionality on IMF loans.
E) Increased use of ex-ante conditionality on IMF loans.