The contagious effect:
A)stems from the positive correlation in FI returns
B)results when interest rate risk increases credit risk and liquidity risk exposures
C)occurs when liquidity risk problems at bad banks damage well-run banks
D)is completely eliminated by government provided deposit insurance against bank runs

Question

Quizplus · Accepted Answer

The contagious effect refers to the spread of risk and problems from one organization or institution to another. In the case of the banking system, this can occur when liquidity risk problems at poorly run banks impact well-run banks through a loss of confidence in the entire system. This can cause depositors to withdraw funds from otherwise sound institutions, leading to broader economic challenges. While government-provided deposit insurance can help mitigate this risk, it may not completely eliminate it. The other options (A, B, and D) do not fully capture the concept of the contagious effect.

The Contagious Effect