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Chapter 2: How Efficient and How Effective Are Markets?

Multiple Choice

1. Former Federal Reserve Chairman Alan Greenspan testified before the House Committee on Oversight and Government Reform on October 23rd, 2008 and said A) he believed Presidential candidate Barack Obama understood how to resolve problems stemming from the economic crisis of 2008.B) the market ideology that he used for forty years or more was flawed.C) Bank of America had paid too much for Merrill Lynch.D) if it were up to him, he would move the US to the gold standard and dispense with currency markets being allowed to determine the exchange value of the US dollar.E) GM and Chrysler should be bailed out by the federal government.

Ans: B

2. In the by-gone days of investment banking, before deregulation of the finance industry in the 1980’s, executives in investment banks use to call themselves “asset rich—but poor”. This was due to. A) the inflexibility of converting shares of stock into bonds. B) the high tax rates applied by the federal government to the earnings of investment banking executives. C) the difficulty of carrying partnership privileges into their retirement. D) the high interest rates in the early 1980s.E) the vesting period for executive bonuses. The partnership of the investment bank would hold the bonus for five years before turning it over to the executive.

Ans: E

3. The US government intervened in markets in the Autumn of 2008 by A) taking a 79.9 % ownership of the world’s largest insurance underwriter AIG.B) allowing large financial institutions to become bank holding companies that allowed them to seek government aid. C) suspending broadcasts of “Mad Money” starring the frenetic Jim Cramer until Cramer’s part in the Economic Crisis of 2008 could be determined. D) all of the above E) a and b above only

Ans: E

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4. An example of the federal government providing protection to private business can be seen when A) all major banks in the US received cash infusions from the Federal government in October 2008.B) the federal government allowed investment bank Lehmann Brothers to fail. C) the federal government stepped in to bail out the Ford Motor Company. D) senior executives of financial institutions received soft treatment in news analysis of the Economic Crisis of 2008 on the Public Broadcasting Service’s The News Hour with Jim Lehrer.E) the federal government refusing to use the Federal Housing Finance Agency to take over Fannie Mae and Freddie Mac – two government-sponsored entities.

Ans: A

5. From April 28th, 2008 to March 2nd, 2009, the Dow-Jones Industrial Average of stock prices for 30 large US companies A) recovered to break even. B) actually rebounded to post a 3 % increase.C) dropped 29%D) dropped more than 49 %.D) had to be discontinued for six weeks because of uncertainty in the financial markets.

Ans: D

6. Due to the increased connections between national markets today, A) the United Nations intervened in global currency markets in the Autumn of 2008. B) the effects of the meltdown in US financial markets began hitting other countries and their financial and goods markets.C) China and Russia sharply criticized the failings of capitalistic systems, such as those of the West.D) the World Trade Organization can influence interest rates in a manner similar to those of a central bank.E) car dealers in Saudi Arabia immediately decided to let prices of autos go down as they were doing in other countries of the world.

Ans: B

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7. Surprisingly to free market ideologues,_________ and __________— the two pillars of laissez-faire economics—failed to keep the markets away from the precipice of disaster.

A) Alan Greenspan and Milton Friedman B) collaterized debt obligations (CDOs) and standardized financial productsC) self-interest and competition D) futures and optionsE) Real Estate Investment Trusts (REITs) and sale-leaseback deals

Ans: C

8. An example of ________ __________ can be seen when banks perceive themselves as “too big to fail”. Such banks behave differently than if they perceived that they would have to pay the consequences for their sometimes risky actions. In the run-up to the Economic Crisis of 2008, many major financial institutions in the US took on enormous amounts of debt to amplify the gains they were making because they misperceived that the federal government would provide a bail-out for their firms if things turned bad.

A) ethical vice B) Lex Mercator C) moral hazard D) judicial imperativeE) habeas corpus

Ans: C

9. The Efficient Market Hypothesis, A) proposes that it is impossible for markets to be wrong because the price of any security represents all the information held by individuals in the market. B) works well in market bubbles.C) takes as an assumption that homo sapiens rather than automatons populate markets.D) has only recently displaced the adaptive markets hypothesis.E) was developed by Sir Richard Branson.

Ans: A

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10. When the EMH has dominated market thinking, three illusions tend to come to life and intensify over time. These are the illusions of marketA) segmenting, targeting and positioning. B) harmony, stability and predictability. C) agency, brokering, and fairness. D) equitableness, justice and objectivity.E) thinking, affect and action.

Ans: B

11. Lessons to be learned from the Great Recession include A) the complexity of markets can overwhelm elites. B) everyone lost money in the crash of the housing bubble. C) complex systems must be developed so that they are more resilient. D) all of the above.E) a and c only.

Ans: E

12. At the Federal Open Market Committee meeting on October 28 and 29, 2008, the members of the Board of Governors and the presidents of the Federal Reserve Banks provided projections for economic growth, unemployment, and inflation in 2008, 2009. This meeting occurred after 1) the federal take-over of Fannie Mae and Freddie Mac, 2) the bankruptcy of Lehman Brothers, and 3) the announcement of the $700 billion Troubled Assets Relief Program (TARP) to rescue the financial system. At this time,

A) economists for the Federal Reserve Bank fully understood what the impact of the Economic Crisis of 2008 would be. B) the top five regulators of the Security and Exchange Commission were dismissed. C) media sources, such as CNBC, broke the news of a major scandal involving Al-Queda’s ownership of major blocks of stock for Bank of America. D) Bono announced that Project Red had finally broken even in its effort to reduce HIV/AIDS.E) elite economists failed to forecast the extent of the negative impact of the Economic Crisis of 2008 on the U.S. economy.

Ans: E

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13. Former Federal Reserve Chairman Alan Greenspan offers a simple solution to prevent financial crises. He proposes that

A) the Security and Exchange Commission be vested with the same powers as the FBI.B) financial institutions should hold much more capital than they have in the past, so that they can draw on that money in times of crisis. C) C-SPAN should carry every meeting of the Federal Open Market Committee live.D) financial derivatives, such as options, futures, and standardized products, should be banned.E) firms should carry sufficient cash balances so that they do not need to enter financial markets.

Ans: B

14. A network of individuals, groups and/or entities embedded in a social matrix that are focused upon economic exchange are _________ __________. Notably, these are ubiquitous and have the primary role of putting in place assortments of goods, services, experiences, and ideas.A) agent middlemenB) functional distributorsC) marketing systemsD) segmenting systemsE) positioning elements

Ans: C

15. Resource-Advantage Theory challenges neoclassical economics’ view of

A) the trade-off between private goods and public goods. B) general equilibrium and the inherent stability of market economies.C) the inherent tension between the private sector and the public sector.D) what Adam Smith imparted in The Wealth of Nations.E) marginal utility.

Ans: B

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16. The _______ and __________ imparted to entrepreneurs and marketers in RA Theory is in marked contrast to the ___________that inevitably is imparted about firms in markets characterized by perfect competition as defined by neoclassical economics. A) accounting and finance ability; wisdomB) tactics and strategy; quality of goodsC) autonomy and personal agency; passivityD) securities and exchange; dividendE) compliance and conformity; aggressiveness.

Ans: C

17. In RA Theory, an important idea is that competition is _______ and _______. It is a constant struggle for a comparative advantage in resources that will yield a marketplace position of competitive advantage, and thus, superior financial performance. A) sporadic and recursiveB) linear and asymptoticC) nonlinear and convexD) disequilibrating and ongoingE) climactic and final

Ans: D

18. All of the following are precepts of RA Theory EXCEPTA) Demand is heterogeneous across industries, heterogeneous within industries, and dynamic.B) Resource characteristics are heterogeneous and imperfectly mobile.C) Role of management is to determine quantity and implement the production function.D) Human motivation is constrained self-interest seeking.E) Resource characteristics are heterogeneous and imperfectly mobile.

Ans: C

19. One emerging thrust in economics is the adaptive markets hypothesis (AMH). Based on evolutionary science, AMH views markets A) not as efficient in the way that EMH does, but as fiercely competitive. B) as inherently stable.C) as the elasticity of supply and demand.D) as primarily based on atomistic transactions

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E) only as formal environments such as Wall Street or the Chicago Board of Trade.

Ans: A

20. All of the following are true EXCEPT A) Markets are not perfect. B) They are always rational. C) Markets are dynamic.D) Markets are evolutionary.E) Governments will be involved in markets.

Ans: B

21. In 2006, when J. Kyle Bass sat down with investment banks dealing in exotic derivative contracts and asked what kind of home-price appreciation were they modeling they said

A) they weren’t using models to make such investment decisions.B) ‘six to eight percent a year’ in perpetuity.C) ‘five percent for the next ten years’.D) some said home prices would appreciate while others said home prices would decline.E) it depended on what the Federal Reserve Bank forecasted about interest rates.

Ans: B

True/False

26. True or False. Former Federal Reserve Chairman Alan Greenspan admitted his mistake as being he believed financial institutions would act in their own self-interest and therefore avoid risky lending that put them into so much trouble in the Autumn of 2008..

Ans: True

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27. True or False. The US government refused to allow GMAC, the auto lender, and CIT, a lender to businesses, to become bank-holding companies.

Ans: False

28. True or False. Because of the severity of the situation, the federal government’s $700 billion Troubled Assets Relief Program (TARP) legislation passed almost unanimously when it was first considered by the U.S. House of Representatives on September 28th, 2008. This was because representatives understood what Wall Street meant to the rest of the United States.

Ans: False

29. True or False. The decline in home prices in the Great Recession, actually wound up boosting the equity U.S. households had in their homes (the debt on their homes minus their value of them) by $5.1 trillion.

Ans: False

30. True or False. The earthquake in the financial and product markets around the world called the Economic Crisis of 2008 actually began in a market for goods in the U.S.—local real estate markets.

Ans: True

31. True or False. Nearly all the participants in the housing bubble were acting “in their rational self-interest.”

Ans: True

32. True or False. The EMH has proven to be a powerful idea in explaining financial market behavior in good times.

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Ans: True

33. True or False. In The Age of the Unthinkable, Joshua Cooper Ramo proposes that complex systems, despite their apparent instability, cannot come out of balance.

Ans: False

34. True or False. Perfect competition is a concrete concept that is useful to work out many managerial economic issues, but doesn’t exist in the realm of abstract theory for economics.

Ans: False

35. True or False. Neoclassical economics paints marketing practice in a dark way as market segmentation strategies are viewed as distorting consumer demand and providing lower value to consumers.

Ans: True

36. True or False. According to RA Theory, consumer information is perfect and costless.

Ans: False

37. True or False. RA Theory lines up with Service-Dominate Logic (S-D Logic) as it recommends that marketers do things with consumers and other businesses, rather than to consumers and other businesses.

Ans: True

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38. True or False. RA Theory stands to move scholars and students to machine metaphors for the economy (along with all of the accompanying associations about precision, reliability, and stability)and away from metaphors related to living and evolving ecosystems (with accompanying associations of uncertainty in the environment, and the imperative that successful actors in the environment bring resourcefulness and creativity in order to survive).

Ans: False

39. True or False. In September 2007, Bass testified before a House subcommittee investigating ratings agencies. He complemented precision of these agencies’ valuation models and cited their common interests with the investment banks for strengthening the soundness of the US financial system.

Ans: False

40. True or False. According to J. Kyle Bass, he made a very simple bet, and that very simple bet was that synthetic-CDO managers were over-levered, and they had no idea what they owned.

Ans: True

Fill-In-The-Blank

41. With the glare of television lighting, former Federal Reserve Chairman Greenspan appeared uncharacteristically chastened and a bit bewildered by the sudden downturn in US financial markets. Under hard questioning by committee Chairman Henry Waxman (D – Los Angeles), Alan Greenspan admitted that in light of a “once-in-a-century financial tsunami,” he had ___________________________.Ans: found a flaw in his market ideology.

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42. The bankruptcy of investment bank ________ __________was the largest such filing in U.S. history at $600 billion.Ans: Lehmann Brothers

43. Economists described the events of _________________as the most remarkable period of government intervention into the financial system since the Great Depression.Ans: the Fall of 2008

44. The effects of the current financial crisis shook thirty years of trust in minimally-regulated markets that had accrued in the minds of American consumer-citizens. Almost overnight, a cloud of suspicion settled over _____________ideology.Ans: free-market

45. Beyond the borders of the US in late 2008, the three banks of ____________all failed. Banks all over the world drastically cut back lending as the tumult unfolded. Ans: Iceland

46. A ____________ occurs in markets where home prices rise faster than wage levels in local real estate markets. Ans: housing bubble

47. By October 2010, China had become the top foreign investor in US Treasuries by owning $1.175 trillion of U.S. Treasury securities, while Japan claimed second by owning $882.3 billion in December 2010. All of this suggests that foreign governments enabled __________ ________in the US to remain low in the U.S. thereby partly fueling the housing bubble.

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Ans: interest rates

48. In the ________ ________ __________, it is impossible for markets to be wrong, because the price of any security represents all the information held by individuals in the market. Ans: Efficent Market Hypothesis

49. System sustainability depends on the adaptive capabilities of the system. Some systems manifest _____________in that when they are stressed, they learn and adapt. Accordingly, such systems rebound or reform themselves to be stronger and more effective than they were before they experienced stress. Ans: resilience

50. ________-________ _________challenges neoclassical economics’ view of general equilibrium and the inherent stability of market economies. Ans: Resource-Advantage Theory

Essay

51. How could some say markets are efficient and others say markets are not? Explain.Ans: varies

Those saying markets are efficient look at the way markets work in good times. Here, buyers and sellers are plentiful. Prices and market operations correspond closely to what is proposed by economic theories. Financiers on Wall Street act as if they are masters of the

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universe in good times as they tell themselves that “greed is good” and Wall Street traders “make markets efficient.” Concepts such as the Efficient Market Hypothesis, miss detecting bubbles because in the view of market efficiency markets can’t be wrong.

By comparison, those saying markets can be inefficient look at the way markets work in bad times. Here, buyers and sellers may not be plentiful. Cash may not be available to consummate deals. Financiers on Wall Street suddenly seek government protection. Such skepticism of market invulnerability appears to be warranted based on the periodic financial crises that afflict capitalist systems, such as the Economic Crisis of 2008.

In one sense, those who see markets are efficient are right in that eventually markets will correct themselves despite pricing errors they have carried for months or years and despite the amount of the pricing errors. For example, the Dow-Jones Industrial Average of stock prices for 30 large US companies went from 13,058.2 on April 28th, 2008 to 6626.94 on March 2nd, 2009—a drop of 49.24 % in less than one year. This drop occurred after the most extensive government intervention since the Great Depression. (Imagine what the drop would have been if the government had allowed markets to clear themselves.) In another sense, those who see markets as efficient are wrong when they attribute near instantaneous correction of market prices or even daily equilibrium for market prices. This latter view is commonly taken by traders on Wall Street. Not all markets are like financial markets. However, even financial markets manifest blind spots to bubbles and are subject to crashes. For skeptics of market efficiency, it would be a gross overstatement to assert that markets do not work or that markets are never efficient.

In sum, one must take into consideration the granularity of analysis when considering the issue of market efficiency. On a minute-by-minute or a daily basis, many markets (such as financial markets) manifest efficiency. However, over time, the inefficiency of these same markets can be observed.

52. Compare and contrast neoclassical economics and RA Theory. Ans: varies Similarities: Both focus on explaining market activity. Differences: Neoclassical economics assumes general equilibrium. Because of this, mathematical explanations for economic activity can be done. RA Theory assumes markets are always in disequilibrium. Accordingly, mathematical explanations are extraordinarily difficult to accomplish.

Briefly put, RA Theory challenges neoclassical economics’ view of general equilibrium and the inherent stability of market economies. While others such as Austrian economists and Keynesian economists have challenged such economic orthodoxy, Hunt and Morgan do this from the vantage point of marketing. As a result, RA Theory imparts a dramatically different role to entrepreneurs and marketers as potentially valuable contributors to the life of a society with a sometimes roiling, but never steady market-economy.

RA Theory challenges neoclassical economics’ view of general equilibrium and the inherent stability of market economies. In such a hypothetical world of perfect competition, in which general equilibrium prevails across a market economy, not only do entrepreneurs and

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marketers have a transient role, but so, too, do profits as the inexorable self-corrections of the market displace entrepreneurs, marketers and profits.

53. Regarding a five-capital approach to capitalism presented in Chapter 1, how many forms of capital accumulation can be evidenced in Bass’ story for Hayman Capital Partners?

Ans: varies Some might assert only a 1-capital approach to capitalism can be detected. They could be considered right. However, a closer examination would disclose a three-capital approach might be evident – financial, human and social.

Capital Type Example1. Financial Profits earned from trading of standardized mortgage-bond derivative

contracts.2. Physical In the market of synthetic CDOs, no ownership or accumulation of

physical goods took place.3. Human Bass and his team had to learn about synthetic derivatives and how others

in the markets modeled future prices in the housing markets of the US.4. Social 1. Bass contributed $15 million to a consumer rights group to have laws

changed to allow more favorable terms for homeowners to refinance when in bankruptcy. 2. He also helped form the Asset Backed Securities Credit Derivatives Users Association (ACDUA) that petitioned the Securities and Exchange Commission to uphold its anti-manipulation provisions. 3. Bass testified before a House subcommittee investigating bond ratings agencies.

5. Natural None evident.

54. What are lessons from the Great Recession?Ans: varies

Lesson #1: The Complexity of Markets Can Overwhelm ElitesIf the President of the United States, the best minds of the Federal Reserve Bank, the

collective intelligence of economists, and highly-paid bank CEOs do not see a crisis emerging before it is too late, how can anyone be sure modestly-paid regulators charged with managing smaller pieces of the financial system will see a looming crisis and convince others of it as well? In the housing bubble, markets allocated capital in an awful way, but there is no current reason to believe governments could do better at this task. Paul Romer, a senior fellow at the Institute for Economic Policy Research at Stanford asserts, “Every decade or so, any finite system of financial regulation will lead to systemic financial crisis”.

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Despite this bleak assessment of regulators’ ability to avert future financial crises, former Federal Reserve Chairman Alan Greenspan offers a simple solution to prevent financial crises. He proposes that financial institutions should hold much more capital than they have in the past, so that they can draw on that money in times of crisis.

Regardless of Greenspan’s belief in a simple reform, the U.S. Congress passed the Dodd-Frank Finance Reform Law in the summer of 2010. This bill, encompassing more than 2,300 printed pages, gives the government new power to seize and shut down large, troubled financial companies, like Lehman Brothers, and sets up a council of federal regulators to watch for threats to the financial system.

Lesson #2: Develop Resilience in Complex SystemsIf you have ever wondered why almost no one predicted such earth-shaking events as the

collapse of the Soviet Union, or the economic meltdown of 2008, thinkers are now emerging to explain why experts failed to predict such pivotal events. In The Age of the Unthinkable, Joshua Cooper Ramo explains both the hazards and opportunities in an increasingly dynamic world subject to sudden and sometimes radical change. In short, Ramo proposes that complex systems, despite their apparent stability, often become out of balance and become poised for sudden change. Some of these complex systems which Ramo discusses are marketing systems.

Ramo notes how some systems manifest resilience in that when they are stressed, they learn and adapt. Accordingly, such resilient systems rebound or reform themselves to be stronger and more effective than they were before they experienced stress.

Ramo views stock markets and ecosystems as complex systems. In his view, such systems have internal dynamics that defy easy description and elude prediction. Change in such complex systems often takes place not in a smooth or gradual way, but as a sequence of fast, catastrophic events. By analogy, sometimes only a light force can induce an avalanche, while in other situations only a major force can do this.

Consider the major earthquakes in Japan. In a few minutes, an advanced economy experienced significant and irreversible change. Additionally, these systems are very hard to manage or design from the outside. This is because they resist a Newtonian approach to physics in which the world can be reduced to building blocks which are assembled according to higher-order systems build on linear relations.

While not stating it explicitly, Ramo endorses an interpretive approach to improving one’s chances to sense that something is about to change in a complex system. In this case, a holistic understanding for complex systems is crucial. In addition, the observer must become extremely empathetic by connecting with the environment around oneself. Only by constantly probing and ceaselessly updating one’s worldview can one do better at understanding complex systems. This is much in line with the thoughts of Watkins and Bazerman (2003), who believe firms can improve their ability to predict disasters. According to these authors, becoming more machine-like is not the way to understand the future. Instead, thinking about the future and likely threats in a systematic way should be done using qualitative analysis of information outside the firm, as well as employee inputs. Management must then synthesize what perils might be lurking in the future.

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55. If one believes the Efficient Market Hypothesis is true, what illusions about markets will likely will be accepted over time?Ans: varies

When the EMH dominated market thinking, three illusions came to life and intensified over time as presented in Table 1 below. First, the market always generates good outcomes. This is the illusion of harmony (among buyers and sellers). Second, the market is sturdy and well grounded. This is the illusion of stability. Third, putting a price on risk through exotic financial products (such as mortgage-backed securities (MBSs), collateralized debt obligations (CDOs), and credit default swaps (CDSs)) and distributing these to those willing to bear such risks greatly reduced the chances of a systemic crisis. This is the illusion of predictability. Played out over a period of months and years, the logic of perfection permeated the talk, reading, and thinking of market actors, regulators, and observers, such as the media. In this way, the culture of Wall Street changed with few ever recognizing it. A new kind of bull market emerged imputed with bullet-proof, super-hero capabilities by almost all.Illusions When the Efficient Market Hypothesis Has Dominated Market Thinking

1. The market always generates good outcomes.2. The market is stable.3. Markets are predictable.

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testbankcollege.eutestbankcollege.eu/sample/Test-Bank-Sustainable... · Web viewFull file at 1 Chapter 2: How Efficient and How Effective Are Markets? Multiple Choice 1. Former Federal