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Chapter 6: Q.7 (page 188)

What is a key function of credit-rating agencies? Do credit-rating agencies always provide reliable information? What was the role of credit-rating agencies in the sub-prime crisis of 2008?

Short Answer

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Credit rating agencies were established to provide data to lenders, which allow them have more information about who they are giving money to. The credit-rating agencies are independent and must be accurate to maintain their reputation and trustworthiness. In the 2008 sub-prime crisis the credit-rating agencies had financial incentive to rate low quality borrowers as better than they were.

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Explanation

Credit rating agencies were established to provide data to lenders, which allow them have more information about who they are giving money to. The credit-rating agencies are independent and must be accurate to maintain their reputation and trustworthiness. In the 2008 sub-prime crisis the credit-rating agencies had financial incentive to rate low quality borrowers as better than they were.

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Most popular questions from this chapter

Prior to 2008, mortgage lenders required a house inspection to assess a home’s value and often used the same one or two inspection companies in the same geographical market. Following the collapse of the housing market in 2008, mortgage lenders required a house inspection, but this inspection was arranged through a third party. How does the pre-2008 scenario illustrate a conflict of interest similar to the role that credit-rating agencies played in the global financial crisis?

Following a policy meeting on March 19,2009the Federal Reserve made an announcement that it would purchase up to $300billion of longer-term Treasury securities over the following six months. What effect might this policy have on the yield curve?

If a yield curve looks like the one shown in the figure below, what is the market predicting about the movement of future short-term interest rates? What might the yield curve indicate about the market’s predictions for the inflation rate in the future?

“According to the expectations theory of the term structure, it is better to invest in one-year bonds, reinvested over two years, than to invest in a two-year bond if interest rates on one-year bonds are expected to be the same in both years.” Is this statement true, false, or uncertain?

If yield curves, on average, were flat, what would this say about the liquidity (term) premiums in the term structure? Would you be more or less willing to accept the expectations theory?

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