Assume that securitization combined with borrowing and irrational exuberance in
ID: 1231712 • Letter: A
Question
Assume that securitization combined with borrowing andirrational exuberance in Hyperville have driven up the value
of existing financial securities at a geometric rate, specifi-
cally from $2 to $4 to $8 to $16 to $32 to $64 over a six-year
time period. Over the same period, the value of the assets
underlying the securities rose at an arithmetic rate from $2
to $3 to $4 to $5 to $6 to $7. If these patterns hold for
decreases as well as for increases, by how much would the
value of the financial securities decline if the value of the
underlying asset suddenly and unexpectedly fell by $5?
Explanation / Answer
From the pattern in the value of assets and securitiesIf asset value falls from $7 by $5, it has a value of 7-5 = $2at the asset value of $2, the security is valued at 2$So security will fall from 64 to 2This would be by 64-2/64 *100% = 96.875%