Question

During the financial crisis of 2007-2008, the Fed engaged in lending to certain large non-bank financial firms in the private sector.
Which of the statements describes the reasoning behind the Fed's decision to engage in this type of non-traditional lending?

a) The Fed wanted to make a higher than normal return on their investment.
b) The Fed wanted to limit the interest rate risk inherent among financial institutions.
c) The Fed wanted to limit the systemic risk inherent among financial institutions.
d) The Fed wanted to limit the inflation risk inherent among financial institutions.

Answer 1

Answer: D. The Fed wanted to limit the inflation risk inherent among financial institutions.

Explanation: An alternative lender, or non-traditional lender, is a loan provider, often a short-term loan lender that is often not heavily regulated by state or federal agencies. ... Secured loans typically have lower interest rates than unsecured non-traditional loans because they minimize the lender's risk of loss.

Answer 2

Answer:

b) The Fed wanted to limit the interest rate risk inherent among financial institutions.

Explanation:

Financial crisis occurs when values of financial institution or assets drop rapidly, which often coincides with stock market crashes, investor asset withdrawal and banking panics. There is always a recession after financial crisis because of the drop in asset value.

The 2007-2008 financial crisis was caused by the deregulation of the financial sector that permits banks to engage in hedge fund trading with derivatives. To solve the financial crisis, the Fed deployed a variety of strategies and tactics to coax rates downward to stimulate the economy, some of the strategies employed by the Fed were:

i)  Interest rate cuts

ii) Targeted assistance to ailing financial institutions

iii) Quantitative easing (or Large-Scale Asset Purchases)

iv) Forward guidance about interest rates