Business & Professional Ethics for Directors, Executives & Accountants, 6e

Multiple Choice Questions

Chapter 8 Subprime Lending Fiasco Ethics Issues
1) Some observers claim that the U.S. Federal Reserve Board encouraged the housing and credit bubbles
by:
a.
b.
c.
d.
e.

Not regulating subprime mortgages

Cutting interest rates
Enforcing mark to market accounting
(a) and (b)
(a) and (c)

ANSWER: d
2) According to former Federal Reserve Chairman Alan Greenspan, the Fed became concerned about
subprime lending in 2000, however:
a.
b.
c.
d.
e.

the global demand for mortgage-backed security ended in 2005

the quality of mortgage products began to deteriorate in 2005
the global demand for mortgage-backed security started in 2003
the quality of mortgage products began to deteriorate in 2003
the global demand for mortgage-backed security ended in 2008

ANSWER: b
3) The 1933 Glass-Steagall Act precluded banks from:
a.
b.
c.
d.
e.

Subprime lending
Selling insurance
Underwriting insurance generating more than 10% of total banking income
Underwriting securities generating more than 10% of total banking income
Underwriting any securities

ANSWER: d
4) Which of the following is not an example of aggressive lending practices contributing to the
subprime crisis?
a.
b.
c.
d.
e.

Mortgagors were not required to make any down-payment at the inception of the loan
Loans were given to people with poor credit histories
Loans were given to people with no income
A borrower could get a second mortgage and use it as down-payment
None of the above

ANSWER: a
5) In simple terms, a mortgage-backed security is:
Business & Professional Ethics for Directors, Executives & Accountants, 5e,
L.J. Brooks & P. Dunn, Cengage Learning, 2010

a. A portfolio of mortgages sold to investors through publicly issued bonds

b. A contract that transfers ownership of a lenders mortgages receivable
c. A contract that transfers the risk of non-collection from mortgage originators to other
investors
d. All of the above
e. (a) and (c) only
ANSWER: d
6) In simple terms, the securitization process is:
a.
b.
c.
d.
e.

A way to sell Structured Investment Vehicles (SIVs)

A way to sell accounts receivable by mortgage lenders to public investors
A way to create high-yield investments with little risk
All of the above
(a) and (c) only

ANSWER: b
7) Mortgage-backed securities lost their value when:
a.
b.
c.
d.
e.

The underlying assets lost their value

Borrowers (the mortgagees) walked away without real obligation to repay
Mortgage originators went bankrupt
(a) and (b)
(b) and (c)

ANSWER: d
8) These entities worked as second party consolidators, purchasing loans and reselling them to investors:
a. Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage
Corporation (Freddie Mac)
b. Structured Investment Vehicles (SIVs)
c. Credit rating agencies
d. Investment banks
e. All of the above
ANSWER: a
9) Rating agencies were exposed to a conflict of interest because:
a.
b.
c.
d.
e.

Credit rating agencies were rating securities and investing in those securities
Credit rating agencies used ratings to sell securities
Clients of the credit rating agencies used ratings to sell securities
Investors do not want rating downgrades
Credit rating agencies were paid by the firms who created the securities being rated

ANSWER: e
Business & Professional Ethics for Directors, Executives & Accountants, 5e,
L.J. Brooks & P. Dunn, Cengage Learning, 2010

10) These regulators were aware of the problem and tried to blow the whistle in 2003:
a.
b.
c.
d.
e.

Security and Exchange Commission and Federal Reserve Board

Iowa and North Carolina State Attorneys
Office of the Comptroller of the currency and Office of Thrift Supervision
Federal banking regulators
None of the above

ANSWER: b
11) A fundamental problem with Goldman Sachs GSAMP Trust was that:
a.
b.
c.
d.
e.

Loans were given to people with poor credit histories

Homeowners equity in the securitized mortgages was less than 1 percent on average
Loans were given to people with no income
58 percent of the securitized loans had little or no documentation
All of the above

ANSWER: e
12) A fundamental problem with Goldman Sachs GSAMP Trust, impeding Goldmans ability to
foreclose on defaulted mortgages was that:
a.
b.
c.
d.
e.

Homeowners equity in the securitized mortgages was less than 1 percent

40 percent of the securitized loans had little or no documentation
Investors relied on Goldman Sachs
The underlying assets were second mortgages
The mortgages were allocated into thirteen tranches with different risk characteristics

ANSWER: d
13) Goldman Sachs GSAMP Trust was able to create AAA rated securities by:
a. Separating the mortgage portfolio into tranches and assigning the tranches to share risks of
default equally.
b. Not disclosing the risks clearly
c. Guaranteeing or protecting some tranches
d. Separating the mortgage portfolio into tranches and designating the A-1, A-2, and A-3
tranches last in order, after the M-1 to M-7 and B-1 to B-3 tranches, to suffer losses if a
default occurred
e. All of the above
ANSWER: d
14) Investors relied on the judgment of credit rating agencies because:
a. Credit rating agencies are supposed to be the experts in evaluating credit risk
b. Information directly available to investors on mortgage pools was insufficient
c. Credit rating agencies are supposed to perform a thorough due diligence before rating a given
security
d. All of the above
Business & Professional Ethics for Directors, Executives & Accountants, 5e,
L.J. Brooks & P. Dunn, Cengage Learning, 2010

e. (a) and (c)

ANSWER: d
15) Early in 2008, mark-to-market accounting provisions caused the banks to:
a.
b.
c.
d.
e.

Revalue their portfolio downwards

Be in jeopardy of falling below the regulatory capital requirements
Restrict new loans
All of the above
(a) and (c) only

ANSWER: d
16) Late in 2008, the International Accounting Standards Board allowed firms to:
a.
b.
c.
d.
e.

Reclassify devaluated financial assets delaying recognition of losses

Estimate the value of the portfolio if there is no ready market for a derivative portfolio
Reduce their capital requirements
Accelerate the recognition of losses through mark-to-market accounting
None of the above

ANSWER: a
17) The 1999 Gramm-Leach-Billey Act allowed banks to:
a.
b.
c.
d.
e.

Engage in subprime lending

Sell insurance
Become more involved in investment bank activities
Underwrite government bonds
Choose between commercial and investment bank activities

ANSWER: c
18) Mark-to-market accounting is usually related to all of the following items, except:
a.
b.
c.
d.
e.

Derivatives and financial instruments

Firms long term cash flows
Firms short term taxes payable
Firms short term cash flows
Immediate recognition of unrealized gains and losses

ANSWER: d
19) Mark-to-market accounting is incorrectly characterized as:
a.
b.
c.
d.
e.

Relevant for management compensation purposes

Relevant for valuation purposes
Relevant to investors
Sometimes misleading
Responsible for the subprime lending fiasco
Business & Professional Ethics for Directors, Executives & Accountants, 5e,
L.J. Brooks & P. Dunn, Cengage Learning, 2010

ANSWER: e
20) An issue with mark-to-market accounting when there is a highly depressed market is that:
a. Depressed values could be only temporary, portfolios are likely to re-gain value, and thus
current unrealized losses are overstated
b. Depressed values could be not only temporary, portfolios are likely to re-gain value, and thus
current losses are overstated
c. Depressed values could be only temporary, portfolios are not likely to re-gain value, and thus
current losses are understated
d. Depressed values could be only temporary, portfolios are not likely to re-gain value, and thus
current non-realized gains are overstated
e. Depressed values could be only temporary, portfolios are likely to re-gain value, and thus
current non-realized losses are understated
ANSWER: a

Business & Professional Ethics for Directors, Executives & Accountants, 5e,
L.J. Brooks & P. Dunn, Cengage Learning, 2010