MONEY AND BANKING Flashcards
barter exchanges
double coincidence of wants i.e., there should be diametrically opposite demand
of the two parties doing the exchange.
On what basis does RBI increase money supply?
Based on Nominal GDP ie. growth of economy and inflation
is money usually backed by physical assets?
yes, but not necessarily. In modern economies, based on trust i.e. fiat.
Seigniorage meaning
Seigniorage refers to the profit from money creation and, thus, is a way for governments to generate revenue without levying conventional taxes
1) RBI maintains reserves of currency that it invests and gets interest
2) commercial banks have to keep money w RBI that it invests and gets interest
(iii) The inflation tax concept- currency w public undergoes dvelauation due to inflation and thus reduces liability
If money supply is increased while output decreases or remains constant
then prices may go up
If money supply is decreased while output increases or remains constant
then prices may come down
If money supply remains constant and output decreases
then prices may go up
If money supply remains constant and output increases
then prices may come down
Functions of Money
- Money acts as a medium of exchange
- Money also acts as a convenient unit of account
- Money acts as a store of value.
Exchange Rate Systems
- Fixed and adjustable
- Floating exchange rate- Free Float, Managed Float
Fixed and adjustable excahnge rate system
Fix exchange rate with respect to dollar and other major currencies and depending on economic situation. Eg India before 1992
Free Float
Under this system, the Central bank of the country never intervenes in the foreign exchange market and the currency price is totally left to the demand and supply forces i.e. market forces. For example, US, Japan and some European countries.
Managed Float
Managed Float: Under this system, the Central bank sometimes intervenes in the market to buy and sell foreign currencies in case the domestic currency becomes very volatile. For example, Indian Rupee is managed float. In case of India, RBI intervenes in the foreign exchange market generally indirectly through select public sector banks
Securities
Securities are financial instruments (receipts/slips) which promises return (payment) in future and which are tradable
Securities categories and define
- Equity security (stock/ shares) represents ownership held by shareholders (owners) in a company/ corporation. Holders of equity security receive profit/ dividend and capital gains (share price appreciation).
- Debt security represents money that is borrowed and must be repaid with terms that define the amount borrowed, interest rate and maturity date. Holders of debt security receive interest and repayment of the principal.
Bonds
Debt securities
Government Securities characteristics
1.G-Secs a tradable instrument issued by the Central Government or the State Governments
2.G-Secs carry practically no risk of default and, hence, are called risk-free gilt-edged instruments.
3.Govt. issues only debt securities.
How are GSecs issued? who can deal in them?
1.G-Secs are issued through auctions conducted by RBI on E-Kuber (primary market). Commercial banks, scheduled UCBs, Primary Dealers, insurance companies and provident funds, who maintain funds account (current account) and securities accounts with RBI, are members of this electronic platform.
2. There is an active secondary market in G-Secs and Negotiated Dealing System-Order Matching (NDS-OM) is such a market/platform. Stock exchanges are also a secondary market for government securities.
kinds of government securities
Treasury bills or T-bills
Cash Management Bills (CMB)
Dated Securities
State Development Loans (SDL)
Treasury bills or T-bills
- These are short term debt instruments issued by the Government of India for a maturity of less than one year
- Treasury bills are zero coupon securities and pay no interest. Instead, they are issued at a discount and redeemed at the face value at maturity.
- are traded in money market
Cash Management Bills (CMB):
- To meet the temporary mismatches in the cash flow of the Government of India
- Same as T-bills
- issued for maturities less than
91 days
Dated Securities and name types
These are basically long-term securities issued by the Central Govt. and generally have a tenor of 5 years to 40 years. 6 types- Fixed rate bonds, Floating rate bonds, Inflation indexed bonds,
Special Securities, Bank recapitalization bonds, Sovereign gold bonds (SGB)
State Development Loans (SDL):
When States want money, they issue long term bonds or dated securities of more than one year maturity which are called SDLs.
Fixed rate bonds
Interest rate is fixed till maturity
Floating rate bonds
The interest/coupon rate is not fixed and can be linked to the yield of Treasury bills
Inflation indexed bonds
Interest and principal both are protected against inflation and can be linked with any inflation index like CPI or WPI. Every year principal is increased by the inflation index and the interest is offered on the increased principle.
both principal and index are protected. Note change in principal amount.
Special Securities:
Government of India also issues special securities to entities like Oil Marketing Companies, Fertilizer Companies, the Food Corporation of India, etc. (popularly called oil bonds, fertiliser bonds and food bonds respectively) as compensation to these companies in lieu of cash subsidies.
Bank recapitalization bonds
Government of India has also issued Bank Recapitalisation Bonds to specific Public Sector Banks in 2018.
Sovereign gold bonds (SGB)
SGBs are unique instruments, prices of which are linked to commodity price viz Gold. Investors receive the equivalent of the face value of gold in rupees at the time of redemption, based on the gold price prevailing then.
who manages the Govt. Securities Market and how?
This market is regulated and managed by RBI. When Govt. (Central or State) wants money,
RBI raises money for them by issuing securities/bonds in the Govt. Securities Market.
Which securities are traded in the Govt. Securities Market
All the four types of Govt. securities i.e., “Cash Management Bills”, “Treasury Bills”, “Dated Securities” and “State Development Loans” are traded in the Govt. Securities Market.
Which securities are traded in the Capital Market
“Treasury Bills”, “Dated Securities” and “State Development Loans” are also traded in Capital Market like BSE/NSE.
Tbills usuallly money market but here also
Retail Direct Scheme (of RBI)
1.Retail individual investors will be able to open a Retail Direct Gilt (RDG) Account with the RBI.
2.Retail individual investors will be able to purchase Govt. securities in the primary market directly as well as in the secondary market. [But still, they cannot participate in the competitive bidding process].
3.Retail investors can purchase Government Securities except CMBs
Pros of Retail Direct Scheme (of RBI)
1.This scheme will expand investment opportunities in the country and ensure easier access to capital markets with simple and secure mechanism.
2.The scheme will give strength to the inclusion of everyone in the economy as it will bring in the middle class, employees, small businessmen and senior citizens with their small savings directly and securely in government securities.
3.Govt. securities have the provision of guaranteed settlement; this gives assurance of safety to the small investors.
global bond index, platform
includes bonds of different entities like different corporations and Governments, on the international platform “Euroclear”.
Indian Govt. securities will very soon join Global Bond Index. Explain.
1.Once Govt. of India bonds/securities are included in the ‘Global Bond Index’ then Govt. of India will be able to access foreign capital easily.
2.When foreign investors will purchase Govt. of India bonds then Govt. of India will get funds in dollars/foreign currency and then it will convert in Rupee (for its spending in India) and after maturity of the bonds, Govt. of India will have to first convert rupees (which it will get through tax and other receipts) into dollars/foreign currency to repay to the investors. This investment by foreigners will be treated as Govt. of India’s external Debt.
3.So, RBI removed this cap for investments by non-residents (NRIs, FPIs) in Govt. securities under ‘Fully Accessible Route’.
Pros of Global Bond Index
- As the interest rates in foreign markets are less, it will be a cheaper source of finance for the Govt. of India.
- More investment by foreigners in the Govt. of India bonds will lead to a lesser interest
rate on Govt. bonds and hence lesser yield and this will also increase liquidity (more
trade and easy conversion into cash) in Indian Govt. securities. - This will also ease pressure on Govt. borrowing from the domestic market and hence domestic interest rate and yield will also come down.
Cons of Global Bond Index
1.could expose the country to a greater degree of exchange rate risk and potentially lead to volatility in the rupee if external conditions were to turn adverse.
2. Needs SEBI approval
Corporate Bond Market in India current status and why
1.There are only a few corporate entities which are capable of meeting investor requirements in terms of transparency and governance standards
2.Public offering of bonds (the process) being expensive, time consuming and procedure oriented
3.Non availability of bankruptcy laws to ensure investor protection has also contributed towards slow development of the corporate bond market (with the coming of IBC 2016 this challenge has now been resolved).
Pros of Corporate Bond Market in India and govt steps
1.has the capability to make India less vulnerable, especially to volatile capital flows.
2.could supplement the banking system in meeting the requirements of the corporate sector for long term capital investment and asset creation.
1.Government, in consultation with RBI, has raised the Foreign Portfolio Investors (FPI) ceiling limit to 15% from the present 9% in corporate bonds.
2.Government is framing an investor charter that would focus on the rights and responsibilities of investors and a grievance redressal mechanism.
3.Govt. has announced in the budget 2021-22 regarding creation of a ‘backstop facility’. [A backstop is a financial arrangement that creates a secondary source of funds in case the primary source is not enough to meet current needs. It can also be thought of as an insurance policy that covers the inadequacy of a source of funds]. ‘Backstop facility’ would purchase the bond/debt papers (of investors) which are of investment grade.
financial market and types
is a market that brings buyers and sellers together to trade in financial securities. Capital Market and Money Market
Capital Market and types
Financial markets for buying and selling debt and equity securities. In this market (generally) securities of medium and long term of more than one year are bought and sold. Primary and Secondary.
Primary Capital Market
1.It refers to the capital market where securities are created.
2.It is in this market that companies sell new shares and bonds for the first time (Initial Public Offering, IPO).
3.In this market transaction is between the issuer (company) of security and the investor
Secondary Capital Market
Once the securities have been issued by the issuer in the primary market, it gets traded in the secondary market among the investors. In this market, investors trade the previously issued securities among themselves without the involvement of the issuer of security (company). Example, Bombay Stock Exchange.
Money Market
Money market instruments are basically debt instruments and include Call/Notice money, Repos, Treasury Bills, Cash Management Bills, Commercial Paper, Certificate of Deposits and Collateralized Borrowing and Lending Obligations (CBLO).
high liquidity and very short maturities (less than one year) are traded.
Call/Notice Money
funds are transacted for overnight basis and under notice money; funds are transacted for the period between 2 days and 14 days. These are unsecured instruments. Participants include Commercial and Cooperative Banks, Primary Dealers (PDs), development finance institutions, insurance companies and select mutual funds.
Certificate of Deposits (CD)
- for a maturity period up to one year against funds deposited at the bank are negotiable/tradable,
- unsecured money market instruments issued
- mostly by Scheduled Commercial Banks
Commercial Paper (CP):
- The maturity of a CP shall be between seven days to one year
- CP is an unsecured money market instrument issued in the form of a promissory note (promise to pay in future)..
- NBFCs, development financial institutions (like NABARD, SIDBI etc.) cooperative societies, Govt. entities (PSUs) and other companies can issue CP to raise money in the money market.
Government company
means any company in which not less than 51% shares are held by any state government and includes subsidiary company of a government company.
Non-government companies
those which are not government companies and defined as those companies where government ownership is less than 49% and majority of the ownership lies with private individuals/companies.
private company or close corporation
is a company where the number of members is limited to 200 and there is restriction on the transfer of shares. The shares are not available to the general public but rather, owned and exchanged privately. (The private word here does not refer to private ownership rather it tells about whether the shares of the company can be bought/sold publicly or not).
Public Company
is a company which is not private.
Unlisted Public Company
means a public company whose securities are not traded on any stock exchange.
Listed Public company
means a company which has any of its securities (shares/bonds) are listed on any recognized stock exchange.
Types of Deposits Name
Demand Deposit, Time Deposit
Demand Deposit
1.can be withdrawn at any time on demand without any advance notice to the depository institution, no fixed term of maturity for demand deposits.
2.cheque-able deposits.
Time Deposit
1.can be withdrawn only by giving an advance notice to the depository institution. The deposits are held for a specified time period or maturity.
2.Banks do not issue cheques on this kind of deposits and are hence non cheque-able deposits.
Types of Accounts
1.Current Account
2.savings account
3.recurring deposit account
4.Fixed deposit account
Current Account
1.It is always a demand deposit A/c
2.There is no limit on number of transactions and value of transactions and these are the most liquid deposits.
3.Current account is used mainly for business purpose/ companies and never used for saving purpose. No interest is paid by banks on these accounts and the banks charge certain service charge on these accounts.
Savings Account
1.Demand
2.restrictions on the number of transactions and the value of transactions during a specified period.
3.This account is mainly for individuals. Banks generally prescribe minimum balances in the accounts in order to offset the cost of maintaining and servicing such deposits. The deposits in these accounts earn interest.
Recurring Deposit Account:
1.These are term deposits. Maturity is generally between 6 months to 10 years.
2.suitable for people who do not have lump sum amount of savings but are ready to save small amount every month or quarterly or half yearly. Such deposits earn interest on the amount already deposited as applicable to fixed deposits.
Fixed Deposit Account
1.These are term deposits with tenure varying from 7 days to 10 years.
2.These deposits are for fixed term but can be withdrawn prematurely by giving an advance notice to the bank and some penalty.
NRI/PIO Accounts
FCNR
NRE
NRO
Foreign Currency Non-Resident (FCNR) Account
1.Term deposits
2.in any freely convertible foreign currency
3.The interest and principal are non-taxable and freely repatriable.
Non-Resident External (NRE) Account
1.Can be demand or term deposits
2.This account can be maintained in Rupee
3.The interest and principal are non-taxable and freely repatriable.
Non-Resident Ordinary (NRO) Account:
1.Can be demand or term deposits
2.Income earned from Indian sources like rent, dividend, pension can be deposited only in this account
3.Principal and Interest are taxable and has restricted repatriability.
Money supply constituents?
So, money supply is money of the public either in cash form or in deposit form
RBI measures for money supply? Most liquid? Most commonly used?
M1 = Currency with the Public + Demand deposits of public with banks
M2 = M1 + Savings Deposits with Post Office Savings Bank
M3 = M1 + Time deposits of public with banks
M4 = M3 + Total deposits with Post Office Savings Bank
M1 and M2 are called narrow money and are most liquid and M3 and M4 are called broad money and are least liquid.
M3 is the most commonly used measure of money supply and is also called “aggregate monetary resources”.
M1
Currency with the Public + Demand deposits of public with banks
M2
= M1 + Savings Deposits with Post Office Savings Bank
M3
= M1 + Time deposits of public with banks
M4
= M3 + Total deposits with Post Office Savings Bank
Aggregate monetary resources?
M3 = M1 + Time deposits of public with banks
Monetary Base?
M0=Equal to the Currency held by public + currency held by banks + deposits of bank with RBI
In India all coins and currency notes are issued for circulation by?
the Reserve Bank of India (RBI)
Who prints/mints One-rupee note and all coins and subsidiary coins?
Government of India
Who prints currency notes for circulation?
RBI
Why is the Re. 1 note signed by the finance secretary and printed by govt?
Testimony to the fact that it is the base unit of the currency system.
Are all banknotes (except one rupee note) issued by RBI are backed by assets? What kind?
Yes. Like Gold, Government Securities and Foreign Currency Assets, as defined in the RBI Act, 1934.
What are liabilities and assets of the govt and RBI wrt coins and currency?
1 rupee note and coins Liability for govt and asset for RBI since it buys it. All other notes- liability for RBI, guaranteed by Government of India as per the RBI Act, 1934.
What is fiat money?
Currency notes and coins do not have intrinsic value, but derive value from the promise of RBI.
What is legal tender?
as they cannot be refused by any citizen of the country for payment/discharge of debt
Monetary Base
all the money RBI is responsible for. Currency held by public + currency held by banks + deposits of bank with RBI. Liability for RBI. Also called ‘Monetary Base’ is also called ‘High Powered Money’ or ‘Reserve Money’ or ‘Base Money’ or ‘Central Bank Money’ or ‘M0’. Has direct bearings on Money Multiplier.
How does increase in FDI cause inflation?
Commercial banks use vault money to give INR to investors. Then they exchange this Foreign money for INR with RBI, which they can now lend causing an increase in money supply due to money multiplier
Unsecured and secured market instruments
without/with specific collateral backing. Commercial Papers, Certificates of Deposits are unsecured while T-bills and Repos are secured
