Financial Risk Manager Part 1
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The financial crisis that began in 2007 had a significant impact on global markets. The month of August 2007 is often referred to as the first 'panic' month, marking the onset of the crisis. This period was characterized by a specific event that signaled the beginning of the crisis. Which of the following events best describes the event that characterized this "panic" month?
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A
An unprecedented spike in firms declaring bankruptcy.
B
The sudden implosion of the market for asset-backed commercial papers.
C
A historic scale of federal bail-outs dispensed to prominent U.S. institutions.
D
A sudden, sharp contraction in the foreign exchange market.
Explanation:
The collapse of the market for asset-backed commercial papers was the defining event of August 2007, marking the onset of the financial crisis. Prior to the crisis, large institutions frequently funded long-term investments through commercial papers, which are short-term loans, often unsecured. Many investors in securitized assets obtained their funding in this manner, using mortgages and other receivables as collateral. When a commercial paper matured, the borrowing institution would typically refinance it with another one, often by mobilizing repeat lenders. Conceptually, an asset-backed commercial paper program would experience a 'run' if lenders were unwilling to refinance it upon maturity. Starting from August 7, 2008, the frequency of such runs dramatically increased, and many programs found themselves unable to refinance.
Choice A is incorrect. While numerous firms did declare bankruptcy during the financial crisis, the high frequency of bankruptcy declarations did not specifically characterize the onset in August 2007. The significant rise in bankruptcy filings followed the initial liquidity crisis and continued throughout the crisis period.
Choice C is incorrect. While there were indeed record federal bail-outs during the financial crisis, these were responses to the crisis that took place after the initial 'panic' month of August 2007. Major bail-outs such as that of AIG or the creation of the Troubled Asset Relief Program (TARP) took place in late 2008.
Choice D is incorrect. The financial crisis was not marked by a contraction in the foreign exchange market, especially not in August 2007. The financial crisis primarily impacted the credit market and had more of an indirect impact on the foreign exchange market.
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