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Chapter 32: Problem 1

Which of the following are not examples of a vicious cycle of deleveraging? Explain. a. Your university decides to sell several commercial buildings in the middle of town in order to upgrade buildings on campus. b. A company decides to sell its large and valuable art collection because other asset prices 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 original loan contract. c. A company decides to issue more stock in order to voluntarily pay off some of its debt. d. A shadow bank must sell its holdings of corporate bonds because falling asset prices have led to a default on the terms of its loans with some creditors.

Short Answer

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a. Selling commercial buildings to upgrade campus buildings b. Selling an art collection to meet loan contract provisions c. Issuing more stock to voluntarily pay off debt d. Shadow bank selling corporate bonds due to falling asset prices Answer: a, c

Step by step solution

01

a. Selling commercial buildings to upgrade campus buildings

In this case, the university is selling assets (commercial buildings) to upgrade its campus buildings. There is no indication that the university is selling these buildings to pay off any debt, or that the sale is causing asset prices to drop. Therefore, this is not an example of a vicious cycle of deleveraging.
02

b. Selling an art collection to meet loan contract provisions

Here, the company is selling its art collection because asset prices on its balance sheet have fallen below a critical level, forcing creditors to call in their loans. This indicates that the company is selling the art collection to pay off the debt, and this selling could potentially lead to further decline in asset prices. Thus, this is an example of a vicious cycle of deleveraging.
03

c. Issuing more stock to voluntarily pay off debt

In this scenario, the company is issuing more stock to pay off its debt voluntarily. This approach does not involve selling any assets, and so it cannot lead to a decline in asset prices. As a result, this is not an example of a vicious cycle of deleveraging.
04

d. Shadow bank selling corporate bonds due to falling asset prices

The shadow bank has to sell its corporate bond holdings because falling asset prices have led to a default on the terms of its loans with some creditors. This indicates that it is selling assets to pay off its debt, and this selling can cause prices to drop further, leading to more selling and more debt. Therefore, this is an example of a vicious cycle of deleveraging. In conclusion, options a and c are not examples of a vicious cycle of deleveraging.

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Most popular questions from this chapter

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