Chapter 32, Problem 1P

To determine

Concept Introduction:

Vicious Cycle of Deleveraging:

It is referred to as the situation when a fall in asset price compels the person to sell his asset to repay the loans.

Bonds:

It is a type of promise or contract to pay in the future with certain limitations and conditions specified at the time of issuing the bond.

Financial Crisis:

When there is excessive loss in the nominal value of assets then the situation is termed as financial crisis. The major financial crisis after the Great Depression of 1920 occurred in 2008.

Explanation of Solution

a. Selling of commercial building by a university.

• This is not an example of vicious circle of deleveraging. It is because university is selling many commercial buildings not due to fall in price but to invest and upgrade its university.
• Price of its assets has not fallen below the critical level compelling him to sell it. Therefore, it is not an example of vicious circle of deleveraging.

Conclusion:

Thus, selling of commercial building to upgrade the university is not an example of vicious circle of deleveraging.

b. Selling of art collection by a company.

• This is an example of vicious circle of deleveraging. It is because company is selling a large and valuable art collection as other assts price on its balance sheet have fallen below a critical level, forcing creditors to call in their loans to the company because of provisions written into the contracts.
• Price of its assets has fallen below the critical level compelling him to sell it. Therefore, it is an example of vicious circle of deleveraging.

Conclusion:

Thus, selling of valuable art is an example of vicious circle of deleveraging.

c. Issuing more stock to pay off debt.

• This is not an example of vicious circle of deleveraging. It is because the company is issuing bond to make repayment of debt.
• Price of its assets has not fallen below the critical level compelling him to sell it. Therefore, it is not an example of vicious circle of deleveraging.

Conclusion:

Thus, issuing stock for repayment is not an example of vicious circle of deleveraging.

d. Shadow bank sells its holding of corporate bond.

• This is an example of vicious circle of deleveraging. It is because company is selling the holding of corporate bond because falling asset prices have led to default on the terms of its loan with the creditors.
• Price of its assets has fallen below the critical level compelling him to sell it. Therefore, it is an example of vicious circle of deleveraging.

Conclusion:

Thus, selling of holding of corporate bond is an example of vicious circle of deleveraging.