Suppose that an increased risk of mortgage defaults lowers the expected profitability of banks.Then we would expect to see
A)the demand for bank stocks rise which would raise the prices of bank stocks.
B)the demand for bank stocks rise which would reduce the prices of bank stocks.
C)the demand for bank stocks fall which would raise the prices of bank stocks.
D)the demand for bank stocks fall which would reduce the prices of bank stocks.

Question

Quizplus · Accepted Answer

If there is an increased risk of mortgage defaults, this would negatively impact the profitability of banks. Investors would recognize this risk and demand for bank stocks would fall as investors look to reduce their exposure to this risk. As demand falls, the prices of bank stocks would also fall. Therefore, we would expect to see the demand for bank stocks fall, which would reduce the prices of bank stocks (choice D).

Suppose That an Increased Risk of Mortgage Defaults Lowers the Expected