Financial Risk Manager Part 1

The bankruptcy of Lehman Brothers Holdings Inc. led to a run on the reserve primary money market funds after one large fund "broke the buck". Lehman Brothers was a significant player in the financial markets, with a substantial investment in mortgage-backed securities (MBSs). By 2007, the firm had amassed an MBS portfolio worth over $85 billion. However, in the first half of 2008, Lehman Brothers suffered massive losses due to a decline in the value of its commercial real estate assets. This led to the firm filing for bankruptcy in September 2008 after reporting a loss of$3.5 billion and a 42% plunge in its stock value.

Following the bankruptcy filing, there was a run on the reserve primary money market funds when one large fund "broke the buck". This term refers to a situation where the net asset value of a money market fund falls below $1, indicating a loss of principal. This occurred when the money market fund announced losses of$785 million in the commercial papers of Lehman Brothers. The announcement led to a loss of investor confidence in money market funds, triggering large-scale withdrawals from these funds. This was the immediate effect of Lehman Brothers' bankruptcy declaration.

Choice A is incorrect. The bankruptcy of Lehman Brothers did not lead to other large institutional investors declaring bankruptcy as well. While the event did cause a significant shock in the financial markets, it did not directly result in a domino effect of bankruptcies among other large institutions.

Choice B is incorrect. The Federal Reserve did not inject capital into Lehman Brothers after its bankruptcy declaration. In fact, the Federal Reserve and other government authorities made a conscious decision not to bail out Lehman Brothers, which was a significant departure from their previous actions during the financial crisis.

Choice C is incorrect. Although the collapse of Lehman Brothers contributed to an overall loss of confidence in financial markets, it was not specifically tied to a crisis of confidence in mortgage-backed securities. The issues with mortgage-backed securities were already well underway by the time Lehman declared bankruptcy.