LOS b: Illustrate how the default rate on a 2/28 adjustable rate subprime mortgage changes as debt creation journeys from conservative hedging activities, to more speculative activities, and finally to a Ponzi scheme phase.

Q1. According to the concept of liquidity and its measure of the “appetite for risk”, which of the following would be apt to have the highest level of liquidity in the economy?

A)   Ponzi unit.

B)   Hedge unit.

C)   Speculative unit.

Q2. With respect to the Minsky framework, if a given period is characterized by a dramatic increase in the 2/28 adjustable rate subprime mortgages and their default rate, this would best be explained by:

A)   a long period of economic stability immediately before the period.

B)   economic instability right before the period.

C)   a very brief period of economic stability immediately before the period.

Q3. With respect to the Minsky framework, an increase in the proliferation of 2/28 adjustable rate subprime mortgages would most likely be associated with which of the following phases?

A)   Ponzi unit.

B)   Hedge unit.

C)   Speculative unit.

Q4. In the journey of subprime mortgages from conservative hedging activities, to more speculative activities, and then to a Ponzi scheme phase, the point of distinction between the speculative activities and Ponzi scheme phase concerns:

A)   property values.

B)   interest rates.

C)   mortgage terms.

LOS b: Illustrate how the default rate on a 2/28 adjustable rate subprime mortgage changes as debt creation journeys from conservative hedging activities, to more speculative activities, and finally to a Ponzi scheme phase. fficeffice" />

Q1. According to the concept of liquidity and its measure of the “appetite for risk”, which of the following would be apt to have the highest level of liquidity in the economy?

A)   Ponzi unit.

B)   Hedge unit.

C)   Speculative unit.

Correct answer is A)

The Ponzi unit is associated with the greatest appetite for risk. Therefore, investors and borrowers would be interacting to generate the most liquidity.

Q2. With respect to the Minsky framework, if a given period is characterized by a dramatic increase in the 2/28 adjustable rate subprime mortgages and their default rate, this would best be explained by:

A)   a long period of economic stability immediately before the period.

B)   economic instability right before the period.

C)   a very brief period of economic stability immediately before the period.

Correct answer is A)

The paradox of the Minsky framework is that the longer the economy has been stable, the more likely it is that the marginal unit of debt moves from hedge to speculative to Ponzi.

Q3. With respect to the Minsky framework, an increase in the proliferation of 2/28 adjustable rate subprime mortgages would most likely be associated with which of the following phases?

A)   Ponzi unit.

B)   Hedge unit.

C)   Speculative unit.

Correct answer is A)

In the Ponzi phase, the asset cash flow cannot cover either the principal or interest. By 2006, the marginal unit of debt was a Ponzi unit in ffice:smarttags" />U.S. mortgage markets, as evidenced by the proliferation of the 2/28 adjustable rate subprime mortgage.

Q4. In the journey of subprime mortgages from conservative hedging activities, to more speculative activities, and then to a Ponzi scheme phase, the point of distinction between the speculative activities and Ponzi scheme phase concerns:

A)   property values.

B)   interest rates.

C)   mortgage terms.

Correct answer is A)

In the speculative activities phase, the assumption of home buyers is that property values will be stable. In the Ponzi scheme phase, the assumption of home buyers is that property values will increase. Both phases assume that interest rates will not rise and that mortgage terms will not worsen.

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