Money and Banking

Question 1

definition of money

Answer 1

anything accepted by the majority of people in the exchange for goods and services or in repayment of debt

Question 2

definition of barter

Answer 2

the direct exchange of goods/services for other goods/services

Question 3

double coincidence of wants

Answer 3

If i want to exchange one good for another, not only must I find the person with that good I am looking for, but they also must want the good I have

Question 4

functions of money

Answer 4

• acts as a means of exchange (overcomes double c)
• acts as a measure of value (relative value of a product is shown by the amount of money they are worth)
• acts as a means of deferred payment (enables the operation of an efficient credit system)
• acts as a store of wealth (facilitates saving)

Question 5

token money

Answer 5

money that has an exchange value rather than an intrinsic value

Question 6

why is credit important

Answer 6

industry cannot develop without it

most customers couldn’t buy expensive durables with it

Question 7

characteristics of a good money form

Answer 7

• instantly recognisable as genuine money
• generally acceptable ie people should have confidence in it as a medium of exchange
• portable ie should be able to carry around large amounts safely and inconspicuously
• reasonably durable, not costly to replace
• divisible into units of small value ie enables the purchase of small goods, facilitates giving change
• scarce in relation to demand, this is a characteristic of an economic good

Question 8

bank deposit

Answer 8

a claim on the bank/a form of money
a person may lodge money into the bank
or a bank a/c is created when a person takes out a loan
money can them be withdrawn

Question 9

legal tender

Answer 9

any money form which must be accepted in settlements of debt
eg notes/coins
a cheque is NOT legal tender

Question 10

the money supply

Answer 10

three categories:
M1
M2
M3

Question 11

m1

Answer 11

narrow money supply
currency outstanding and overnight deposits and current accounts
less than 1 year

Question 12

m2

Answer 12

intermediate money supply
m1 +:
post office savings
bank deposits
up to 2 years

Question 13

m3

Answer 13

broad money supply
m2 +:
debt securities over 2 years maturity ie bonds
repurchase agreements

Question 14

liquidity

Answer 14

how readily an asset can be converted to cash

Question 15

primary liquidity reserve ratio

Answer 15

cash: claims

the ratio of cash, which banks must hold to claims on the bank

Question 16

commercial banks create money by

Answer 16

giving loans

people deposit cash with them, they give out loans to a multiple of the cash deposited

Question 17

example of creating credit

Answer 17

• A lodges €100. assuming a reserve ratio of 10%, the bank must keep €10 for any cash claim by A
• the €90 left represents 10% of the maximum that could be loaned to B
• to satisfy the reserve ratio, to give B a €900 loan, they must have €90 ie 10%, and they do
• thus the bank has created a €900 claim on the bank

Question 18

formula for the increase in money supply

Answer 18

increase in cash x (1 ÷ reserve ratio) - initial increase in cash

Question 19

limitations of credit creation by banks

Answer 19

• the value of its cash deposits
• can only lend to customers that are capable of repaying the loans
• any changing of PLR and capital adequacy ratio
• credit guidelines set by ECB and CB
• economic recession (less demand for loans)

Question 20

effect of plastic money on banks ability to create credit

Answer 20

-positive effect-
allows banks to create more credit
people use cards instead of coins, they demand less cash from bank
therefore, banks keep less money on reserve and can reduce the reserve ratio and give out more credit

Question 21

how can the supply of credit affect the economy

Answer 21

• inflation, more credit is created= more money to lend out
• industry, certain industries are heavily dependent on credit
• imports and exports, businesses can use credit to invest in selling abroad
• banking vulnerability, excessive lending= vulnerable if borrowers cannot repay

Question 22

effect of reduction in availability of credit

Answer 22

• decrease in industries which require credit ie motor industry (less people buying new cars)
• deflation due to fall in demand for goods
• imports decrease, exports decrease

Question 23

banks twin objectives

Answer 23

profitability
liquidity
must have a balance between them, as per the diagram

Question 24

profitability

Answer 24

refers to a banks need to make as much profit as possible from its assets to satisfy shareholders
the more profitable an asset is, the less liquid it is

Question 25

liquidity (long answer)

Answer 25

refers to banks need to have liquid assets in order to meet the demand for cash by its customers
the more liquid an asset is, the less profitable it is

Question 26

by focusing on profitability at the expense of liquidity…

Answer 26

banks may give loans to high risk borrowers eg commercial property developers, as they are very profitable but highly illiquid
may run the risk of :
increasing bad debts
falling share prices
bank failure

Question 27

by ignoring liquidity requirements..

Answer 27

banks may not have enough cash to meet the demand of their depositors
could result in a run on the banks ie bank failure