money and banking

Question 1

what is barter system

Answer 1

direct exchange of goods against goods without the use of money

Question 2

drawbacks of barter system

Answer 2

1. lack of double coincidence of wants
2. lack of a common measure of value
3. lack of a standard for deferred payment
4. difficulty of storage of wealth
5. lack of divisibility

Question 3

state the primary and secondary function of money

Answer 3

primary function: acts as a medium of exchange
measure of value
secondary function: standard of deferred payments
storage value

Question 4

what is legal tender money

Answer 4

money that has legal sanction by the government behind it. it is issued by the government and no person can refuse it. the government issued an order in what can become legal tender money

Question 5

two types of legal money and explain in brief

Answer 5

1. limited legal tender money: money which can be accepted only until a certain limit by law
2. unlimited legal tender money: money which has no limit to the quantity offered in payment

Question 6

what are fiat money and fiduciary money?

Answer 6

fiat money: money which is issued by the order of the government to act as money (legal tender)
fiat money: is usually circulated at the time of crisis. since it is issued without any backing it cannot be converted into anything but
fiduciary money: money accepted as money based on trust that the issuer commands

Question 7

components of money supply

Answer 7

money supply: total stock of money in circulation held by the public at any point in time
1) currency held by the public: (fiat money) money under law which must be accepted
2) demand deposit with commercial banks: any deposit account on which a cheque can be written
can be transferred from one person to another on demand
money supply = currency held outside the bank + demand deposit of the banks

Question 8

sources of money supply

Answer 8

i) RBI
ii) government

Question 9

if there deficient supply in the economy people will have high purchasing power. defend or refute the statement

Answer 9

the statement made is false.
if people have high purchasing power it will be due to the excess supply of money in the economy. the economy will fall to the vicious cycle of inflation
if there is a deficient supply of money in the economy then the purchasing power will decrease leading to depression in the economy

Question 10

full bodied money is money whose value and commodity value are

Answer 10

equal in the market

Question 11

demand deposit account include

Answer 11

saving demand deposit
current account deposit

Question 12

medium exchange function: func of money has solved which issue of the barter system

Answer 12

lack of double coincidence of want

Question 13

effect of a rise in the general price of the economy price level
p. it will lead to a rise in the value of money
q. it will lead to a rise in the demand for money
effects: a) inflation in the economy
b) deflation in the economy

Answer 13

it will lead to a rise in the demand for money. this will lead to inflation

Question 14

money supply bears ___________ relation with the rate of inflation in the economy

Answer 14

positive or direct relation

Question 15

money supply is measured ______________ of time

Answer 15

period of time

Question 16

assertion (a) demand deposits are considered a convenient mode of payment for the execution of even high-value transaction
reason (r) demand deposits are withdrawable against cheques but not at the demand of debtors and creditors
give a reason to the answer

Answer 16

assertion is correct but reason is wrong as demand deposits can be withdrawn on the demand of creditors and debtors

Question 17

assertion (a) cheques are fiduciary money
reason (r) they are issued by the government

Answer 17

only assertion is correct

Question 18

currency created by the central bank (RBI) is called as bank money defend of refute

Answer 18

the statement is false because currency related to the RBI is called
high-power money
high-power money: total liability of the monetary authority of the country, RBI the monetary base or high-power money
these are liabilities: to refund deposits on demand
bank money: (credit money) money whose face value is more than the commodity value

Question 19

fiat money is the same as fiduciary money. defend your answer

Answer 19

fiat money is money backed by the order of the government whereas fiduciary money is money backed by mutual trust between payer and payee

Question 20

what are primary deposits

Answer 20

initial cash deposits by the public with the commercial banks

Question 21

central bank is the bank of issue. defend

Answer 21

the central bank is given a monopoly of issuing currency to secure control over the volume of currency and credit
the bank issues currency on the basis of minimum legal reserve ratio:

Question 22

state the role played by the central bank as the lender of last resort (3m)

Answer 22

during emergencies, commercial banks fail to meet their depositors due to liquidity crises. this they approach the RBI to secure loans from it
(i) by rediscounting eligible securities and bills of exchange
(ii) providing loan against their securities

Question 23

brief any 4 functions of the central bank

Answer 23

1. issue of currency: issue of currency to control the deposits and the credit volume through means of minimum reserve system
2. banker to the government: the RBI is a banker to the government like the commercial banks are a banker to the public. keeps their cash balances in the current account in the central bank
3. lender of last resort: during emergencies, if they are not able to fulfil their obligation to the depositors they can approach the RBI for a loan
4. control of credit and money supply: control credit and money supply to monetary policy

Question 24

what is monetary policy

Answer 24

policy of the central bank to control the money supply and credit in the economy

Question 25

define bank rate

Answer 25

rate at which the central bank lends money to the commercial banks by discounting the bills of exchange

Question 26

what is repo rate

Answer 26

rate at which central bank lends money to the commercial bank

Question 27

actions of the RBI when there is excess demand in respect to
1) bank rate
2) repo rate
3) reverse repo rate

Answer 27

1) bank rate: in case of excess demand the RBI increases the bank rate to increase the cost of borrowing. it discourages the borrowers from taking loan which reduces credit creation
2) rep rate: increase rate to increase the cost of borrowings——–> forces the commercial banks to increase their lending rates
3. reverse repo rate: increases reverse repo rate ——> commercial banks to park their surplus funds ——> reduces fund availability and lending capacity —-> aggregate fall in demand

Question 28

difference between bank rate and repo rate

Answer 28

repo rate is the short-term lending of the central bank and short-term interest rate
bank rate is long-term lending by the RBI on long-term interest rates

Question 29

what is open market operations and what how does RBI use it during inflation

Answer 29

buying and selling of government securities and bonds in the open market by the central bank
during inflation central bank sells government securities to commercial banks with loose amounts of cash reserves thereby affecting their capacity to lend loans

Question 30

legal reserve ratio is the ratio of deposits which are legally bound to be kept in the form of cash with themselves and with the central bank. true or false

Answer 30

true

Question 31

components of LRR

Answer 31

cash reserve ratio: banks’ total deposits that the commercial banks keep in cash with the central bank
statutory liquidity ratio: banks’ total demand and time deposits which every bank is required to keep with itself in liquid assets such as cash and government securities

Question 32

what is primary deposit and secondary deposits

Answer 32

primary deposit: initial deposit by the people in cash. (reflect savings of people in the banks )
secondary deposit: demand deposit. loans given by the bank r

Question 33

reverse repo rate is reduced to help correct ________ in the economy

Answer 33

deflation

Question 34

under deflation is it advisable to sell government defend or refute

Answer 34

under deflation, the money supply is generally low therefore it is advisable to buy government securities to pump more currency into the system

Question 35

define money multiplier

Answer 35

the number of times cash reserves of the commercial multiply to be equal to demand deposits

1/LRR

Question 36

State the two components of M1 measure of money supply.

Answer 36

currency held by the public in the form of notes and coins
other deposits by the RBI

Question 37

components of money supply

Answer 37

Currency (notes and coins) held by the public.
Net demand deposits and time deposits held by commercial banks.
Other deposits held by the Central Bank.
Total deposits with post office (excluding National Saving Certificates).

Question 38

What can RBI do, if it wants to increase credit in the economy?

Answer 38

decrease CRR and repo rate

Question 39

credit creation formula

Answer 39

initial deposit * 1/LRR

Question 40

If LRR is 20% and initial deposit is Rs 10,000 in a commercial bank, find the total money creation amount.

Answer 40

Rs 50,000

Question 41

Supply of money is concept of

Answer 41

stock

Question 42

The ratio of total deposits that a commercial bank has to keep with Reserve Bank of India is called

Answer 42

cash reserve ratio

Question 43

The Central Bank can increase availability of credit by

Answer 43

buying government securities

Question 44

Explain the following functions of the Central Bank. (All India 2011)
(i) Bank of issue
(ii) Banker’s bank

Answer 44

(i) The Central Bank of the country has the sole authority of currency issues in the country, which gives it a monopoly in issuing currency. As in India RBI issues the currency, while currency notes are printed by the subsidiaries of RBI and coins are minted by the Central Government of the country. However, both currency notes and coins are circulated by RBI, which gives RBI the power to control, supervise and enhance the money supply in the economy.

(ii) The Central Bank keeps the cash balances of Commercial Banks and issues loans to them on requirements in the same manner as the Commercial Bank does for its customers. A Central Bank has almost the same relation with the other Commercial Banks of the country that the Commercial Banks have with the common public. That is why the Central Bank is also called a banker’s bank.