Hey FRMers,
I wanted to make the case, as I have before, for making sure you use the Wiley notes along with the Wiley questions. I wrote them as a seamless product and it is important to use both as Rais mentioned yesterday. Here is why. Here is something from the new 2017 Part I program: Notice I don’t use questions just to tell you if you got something right or wrong but I also use the answer choice explanations as a teaching tool as well in addition to look out for ways GARP may trip you up. I do this almost universally through Part I and Part II. Just a freebie to let you know about my thought process and how I think my approach is fundamentally different than anything else. Also, I write from the perspective of someone with 15 years experience actually trading these markets. I encourage you to try the free trial and check it all out.
Let me know if you need anyting.
-Christian
The financial crisis was a world wide event and several governments around the world acted both unilaterally and collectively to manage the crisis in their countries. Which following action is correctly paired with a policy response by a country or central bank, what does that response actually mean, and what short term impact could it have?
A. Interest rate change - This government policy shift has a broad range of impacts from lowering the cost of credit, reducing the interest cost of using other tools available at the federal reserve. Typically the short term impact here is limited because it takes time for the policy shift to spread through the market.
B. Asset purchases - this central bank policy action can have almost an immediate short term impact because it can lift impaired assets off a bank’s balance sheet, increasing confidence in that bank’s counter parties and reducing a potential run on the bank.
C. Liquidity Support - this government stabilization policy move can also have near immediate impact as governments offer longer funding terms, higher credit lines or lower reserve requirements all which free up liquidity to support impaired asset prices on the balance sheet.
D. Recapitalization - This government policy choice can consist of a capital injection directly to an institution via common stock or preferred equity and can have an immediate impact on an institution’s credit quality and significantly reduce the potential for a run on the bank.
Answer: D
Be ready on exam day for questions like this that all seem right. What is going to get you passed the test is recognizing when multiple statements are made in answer choices that conflict with each other or answer choices that are partially wrong. In this case, many times the distinction is whether the policy shift was by a central bank or a government and often times they can seem very similar.
For answer A, this is a central bank move not a “government” policy shift. Keep in mind central banks, in theory, are independent financial institutions from their governments and act under a mandate of controlling inflation or financial stability. Governments, legislators, can also take actions as they did during the crisis. For the remainder of A, the answer is largely true.
For B, an asset purchase program is a policy move by a government and can include individual asset purchases, asset guarantees, etc. So B is wrong because this is not a central bank activity, although it does have an immediate impact. C is wrong because liquidity support in the form of changing reserve requirements, longer funding terms are all central bank actions, not choices legislators will make.
For C, Liquidity support is a central bank policy tool so that is incorrectly matched with a government policy description. All of the rest is true. I could never go into this level of connection across learning objectives and topics in the notes where I focus only on that exact learning objective as asked by GARP. That’s the big difference.