Money and Banking – CS Foundation Economics Notes

Money and Banking – CS Foundation Economics Notes

Money is a good that acts as a medium of exchange in transactions. Classically it is said that money acts as a unit of account, a store of value, and a medium of exchange. Money has been ever-changing its form in the past. Its major role was to come over with the difficulties that were faced by the barter system. Economists have adopted 2 approaches to define money

  • Functional approach
  • Liquidity approach

Functional approach – the basis of this approach was the functional aspect of money. The functional approach has further been classified under three heads

  • Primary functions
  • Secondary functions
  • Contingent functions

1. Primary function
The primary function of money is that it acts as a medium of exchange Features of money

  • Money gave more freedom to people in comparison to the barter system.
  • As in the barter system, the evaluation of commodities was difficult as every commodity has its different importance. Thus the introduction of money helped to overcome this difficulty.
  • Moreover, it was easy to manage accounts with the help of money.

2. Secondary function
There are some other functions of money such as

  • it can easily be stored unlike goods used in barter systems which were difficult and cumbersome to be stored, especially in the case of perishable goods.
  • It is the best means in the case of deferred payment. Thus in the case of loans repayment interest can easily be calculated with the help of money.
  • Money can easily be transferred from one place to another unlike goods whose transferability is difficult,

3. Contingent functions
Prof. Kinley has mentioned that money is the basis of credit.

  • Some examples of credit money are cheque, draft, bill of exchange, etc.
  • Money helps in the proper distribution of national income.
  • It is the general form of keeping all the wealth.
  • It gives people maximum pleasure as they can decide about the utility of the product and can distribute their income accordingly.

Liquidity approach – As per the liquidity approach any assets for which no nominal capital gain or loss is possible are perfectly liquid. As per this approach, money has a generalized purchasing power. It can be used for purchasing goods and services.

Some of the features of this approach are:

  • The liquidity approach emphasizes the function of money as a store of money. :
  • It implies that money is not qualitatively different from other assets.
  • Liquidity is the property of all assets; only the degree of liquidity varies.
  • The liquidity of an asset is inversely related to the average time taken to convert it into cash.
  • The higher the cost of the asset less liquid it is.
  • The prevalence of near-money assets greatly increases the overall level of liquidity and hence the level of economic activity.

Certain problems delating to the concept of liquidity creates difficulties in adopting the liquidity approach:

  • It is not easy to quantify the liquidity content of an asset
  • The liquidity contents of an asset may not be constant.

4. Credit
Credit is the trust which allows one party to provide resources (money) to another party where that second party does not reimburse the first party immediately (thereby generating a debt) but instead repay or return those resources at a later date.

It is the amount of money given by the lender to a borrower looking at its worth, his ability to pay back. The money to be paid back by the borrower is more than the money taken by the borrower as he has to pay the interest along with the principal amount. Banks have a major role in providing loans. People are depositing their money in banks and they get paid interest on this amount deposited by them as the bank becomes a borrower in such case.

The commercial banks create multiple expansions of their bank deposits and due to this, these are called the factories of credit. The banks advance a major portion of their, deposits to the borrowers and keep a smaller part with them. The customers have full confidence in the bank. The rate of interest charged by banks is more than the rate of interest paid by the banks. This difference in the rate of interest is the profit of the bank. The banks expand loans by much more than the amount of cash possessed by them. This tendency on the part of the banks to lend more than the amount of cash possessed by them is called the Creation of credit in economics.

Interest charged by the bank is based on the creditworthiness of the borrower. A creditworthy borrower may get loans at a lower rate of interest in comparison to a borrower with less creditworthiness. The whole credit creation process starts with an initial deposit with the bank. Out of these initial deposits, the bank keeps a certain ratio of money as a reserve, and the rest is given in the market as a loan.

The whole process of credit creation is divided into
Case 1 No leakage one bank
Case 2 No cash leakage but multiple banks
Case 3 Some cash leakage one bank
Case 4 Cash leakage multiple banks

Case 1 No leakage
In this case, it is presumed that there is no cash leakage. Let us understand by the below-mentioned example Suppose the Cash Reserve Ratio is 20% and a person deposits Rs. 10,000/- with Bank X. This is the primary deposit. The bank keeps Rs. 2000 as CRR and balance of Rs. 8000 is used for granting credit.

Now suppose Bank X lends Rs. 8000 to Mr. A and Mr. A pays a cheque of Rs. 8000 to Mr. B, who has an account in Bank X. Then Bank X receives Rs. 8000 as a primary deposit. It keeps Rs. 1,600 (20%) as CRR and an excess amount of Rs. 6,400 is used for giving credit. Now if, Mr. C is granted this loan and Mr. C gives a cheque of Rs. 6,400 to another person who may deposit it in Bank X. Bank will again keep Rs. 1,280 as CRR and issue a loan of Rs. 5,120. This process continues until the original excess reserves of Rs. 8000 with the first Bank of India, have been parceled out among various banks and have been required resources. As a result, the aggregate of derivative deposits in the entire banking system approximates 5 times the initial derivative deposit over a period of time.

Let us explain with the help of the table:—

PROCESS OF MULTIPLE EXPANSION OF CREDIT

BANK PRIMARY DEPOSIT CRR 20% Credit Creation or Creation of Derivative Deposits
Bank X 10,000 2000 8000
Bank X 8,000 1,600 6,400
Bank X 6,400 1,280 5,120
Total 50,000 10,000 40,000

In the above Eg., the credit expansion is five times the initial excess reserve of Rs. 8,000 when CRR is 20%.

Case 2 No cash leakage but multiple banks
In this case, although there is no cash leakage multiple banks are involved in credit creation.

Let us under with the help of the below-mentioned example Suppose the Cash Reserve Ratio is 20% and a person deposits Rs. 10,000/- with Bank X. This is the primary deposit. The bank keeps Rs. 2000 as CRR and balance of Rs. 8000 is used for granting credit.

Now suppose Bank X lends Rs. 8000 to Mr. A and Mr. A pays a cheque of Rs. 8000 to Mr. B, who has an account in Bank Y. Then Bank Y receives Rs. 8000 as a primary deposit. It keeps Rs. 1,600 (20%) as CRR and an excess amount of Rs. 6,400 is used for giving credit. Now if, Mr. C is granted this loan and Mr. C gives a cheque of Rs. 6,400 to another person who may deposit it in Bank Z. Bank Z will keep Rs. 1,280 as CRR and issue a loan of Rs. 5,120. This process continues until the original excess reserves of Rs. 8000 with the first Bank X, have been parceled out among various banks and have been required resources. As a result, the aggregate of derivative deposits in the entire banking system approximates 5 times the initial derivative deposit over a period of time.
Let us explain with the help of the table:—

BANK PRIMARY DEPOSIT CRR 20% Credit Creation or Creation of Derivative Deposits
Bank X 10,000 2000 8000
Bank Y 8,000 1,600 6,400
Bank Z 6,400 1,280 5,120
Total 50,000 10,000 40,000

in the above Eg., the credit expansion is five times the initial excess reserve of Rs. 8,000 when CRR is 20%.

Case 3 Some cash leakage one bank Here there is some cash leakage.

Let us understand with the help of an example

As explained in case I the deposit pattern is the same, thus the deposits are being made in the same bank but over here there is some cash leakage thus out of 8000 received by B from A, he only deposits 6000 and keeps 2000 with himself so now bank can create a credit of only 4800 instead of 6400 as done in case I so the process of deposits keeps going on in the fashion shown in the above table. Thus it can be seen that credit expansion is less than 3times in comparison to case 1 where there was no cash leakage.

BANK PRIMARY DEPOSIT CRR 20% Credit Creation or Creation of Derivative Deposits
Bank X 10,000 2000 8000
Bank X 8,000 1,200 4800
Bank X 4600 920 3680
Total 20600 4120 16480

Case 4 Cash leakage multiple banks
In this case, we are presuming cash leakage and multiple banks are involved. Let us understand the procedure of taking all the banks together.
Here also the case is similar to case 2 but the only difference is cash leakage amongst different banks. Keeping the initial deposit as Rs 10,000 and CRR as 20% and the pattern of deposit as shown in case 3 we get credit expansion less than 3X. The only difference is that instead of 1 bank there are 3 banks as in case 2

5. Limitations of credit creation

  • The total amount of cash in the country limits the credit creation
  • The amount of cash that the public wishes to hold affects the total amount of credit creation
  • Banks when creating credit they take into account the cash available with them
  • The minimum percentage of cash to deposits which the banks consider safe.
  • Every bank is required to keep margin reserve money
  • The creditworthiness of borrower so that loan doesn’t turn out to be bad debt.

6. Quantity theory of money
The quantity theory of money states that there is a direct relationship between the quantity of money in an economy and the level of prices of goods and services sold. According to QTM, if the amount of money in an economy doubles, price levels also double, causing inflation.

(a) Fisher’s Transactions Approach
This approach first emerged in Fisher’s book The Purchasing Power of Money (1911). For most economists of that period, money was viewed solely as a means of exchange. As per him the essential function of money is to be used as a medium of exchange. The purchasing power of money depends on the quantity of money relative to the number of goods to be purchased MV= PT where M = Money Supply
V= Transactions Velocity of Circulation of money (the number of times the money stock changes hands per period).
P = Price level.
T = The number of Transactions undertaken per period
Supply of money (MV) -It is the total volume of money that is in supply in the market at a particular time. Thus it is the total expenditure that is being done in the market at a particular time period.
Total expenditure per period or total demand of money (PT) – Money is needed by people for making transactions. Thus equation MV=PT suggests that the price level is determined by the money supply.
This equation implies that the quantity of money determines the price if V and T remain constant.
Here only primary money is taken.
Earlier Fisher took into consideration money that is currency money (notes etc.) but later the definition of money changed. Along with currency money bank money that is credit money also formed a part of the money. As per this money meaning which included currency as well as credit Fisher equation becomes MV+M’V’=PT Where
M’ =Money deposited in the bank (credit money)
V’ = velocity of circulation of credit money
This equation shows that price level is directly related to M, M’, V,V’ but inversely related to T.

(b) Cash Balance Approach.
This theory assumed that money was only held to expedite transactions and had no further purpose. Thus, if the money supply increased, agents holding the increased money stock would seek to get rid of it. However, the emphasis in this approach concentrated on establishing the quantity of money that agents would voluntarily desire to hold, p = kR/M
where p = the purchasing power of money
k = the proportion of income that people like to hold in the form of money;
R = the volume of real income; and
M = the stock of supply of money in the country at a given time.
This equation shows that the purchasing power of money or the value of money (p) varies directly with k or R, and inversely with M.
Since p is the reciprocal of the general price level; that is p = 1/P, the equation, p = kR/M can be expressed alternatively as:
1/P = kR/M or M = Krp (1)
If we multiply the volume of real income (R) by the general price level (P), we have the money national income(Y). Therefore,
M = kY
Where Y is the country’s total money income. We can also write equation (1) in terms of the general price level thus:
P = M/kR
This equation implies that the price level (P) varies inversely with k or R and directly with M.
In the Cash Balance approach, k was more significant than M for explaining changes in the purchasing power (or value) of money. This means that the value of money depends upon the demand of the people to hold money.

7. Central Banks
The central bank is the apex institution that regulates, guides, and helps the financial system. This entity is responsible for overseeing the monetary system for a nation (or group of nations). Central banks have a wide range of responsibilities, from overseeing monetary policy to implementing specific goals such as currency stability, low inflation, and full employment. Central banks also generally issue currency, function as the bank of the government, regulate the credit system, oversee commercial banks, manage exchange reserves and act as a lender of last resort. Central banks came into existence in the 20th century. Central banks perform various functions which are (/) Leading functions

– Issue of notes – Note issue primarily is the main function of a central bank in every country. These days, in all the countries where there is a central bank generally it has got the monopoly of the sole right of note issue. There are many advantages with the monopoly of issue of notes by central banks. These are

• There will be uniformity in the currency system in the country.
• By controlling the amount of currency in circulation, the volume of credit can be controlled to quite a large extent.
• People have more confidence in the currency issued by the control bank
• Central bank earns profit from the issue of paper notes ^
• As central banks operate independently thus there is no political influence on the central bank.

– As bankers to the government, the central bank provides all those services and facilities to the government which the public gets from ordinary banks. It operates the account of the public enterprise. It mangers government departmental undertaking and government funds and where there is a need gives loans to the government. It is collecting all the taxes of the government.

– Central bank is the bank of banks. This signifies that it has the same relationship with the commercial banks in the country that they gave with their customers. It provides security to their cash reserves, gives them loans at the time of need, gives. their advice on the financial and economic matter and work as clearinghouse among various members bank.

– Central bank is the custodian of the foreign currency obtained from various countries. This has become an important function of the central bank.
– Another major work of the central bank is to manage and regulate the exchange rate. It assesses the financial trends and the type of corrective measures that will be required to manage the exchange rate of the currency.

– Central bank works as lender of the last resort for commercial banks because in the time of need it provides them financial assistance and accommodation. Whenever a commercial bank faces a financial crisis, the central bank as lender of the last resort comes to its rescue by advancing loans, and the bank is saved from being failed.

– All commercial bank have their accounts with the central bank. Therefore, the central bank settles the mutual transactions of banks and thus saves all banks

– the most important function of a central bank is to control the volume of credit for bringing about stability in the general price level and accomplishing various other socio-economic objectives

(2) Other Functions

  • It collects statistical data regularly relating to economic aspects of money, credit, foreign exchange, banking, etc.
  • It can play an important role by mobilizing people to make investments and to promote saving.

8. Reserve Bank of India
The Reserve Bank of India is India’s central banking institution, which controls the monetary policy of the Indian rupee. It was nationalized on Jan 1, 1949. Governor is the executive head of the bank.

9. Commercial banks
Commercial Banks are a financial institution that provides services, such as accepting deposits, giving business loans and auto loans, mortgage lending, and basic investment products like savings accounts and certificates of deposit. Commercial banks play an important role in the financial system and the economy. As a key component of the financial system, banks allocate funds from savers to borrowers in an efficient manner.

Major functions of commercial banks are
• Banks operate by borrowing funds-usually by accepting deposits from the public in the form of saving deposits, fixed deposit and current deposits. Saving accounts are such accounts in which bank gives interest on the money deposited by the public while in current deposit you do not get any interest but mostly gets an overdraft facility. Fixed deposits are deposits made by the public for fixed period of time and they get interest on this deposit. The rate of interest for fixed deposits is higher than that of a saving accounts.

• Giving loans to public in the form of loans and advances, overdraft, cash credit, discounting of bill etc. Bank use deposits and borrowed funds (liabilities of the bank) to give loans. Banks make these loans to businesses, other financial institutions, individuals, and governments (that need the funds for investments or other purposes). This is the earning source for banks.

Overdraft is an arrangement where current account holders are allowed to draw in excess of their deposit and pay interest on the amount overdrawn Banks lend without any collateral security is bill of exchange. Cash credit is an arrangement where customers are allowed to borrow money from the bank up to a certain limit against some tangible securities.

• Besides these banks also provide some of the utility services like lockers, traveller’s cheque, transfer of fund from one bank to another, collect dividend and interest on securities, collection and payment of cheques, bills and promissory notes, provides various trade information and statistics, issues personal and commercial letters of credit, maintain customers demat account etc.

10. Monetary policy of India
Monetary policy of any country is made by its central bank. Monetary policy involves influencing the availability and cost of money and credit to promote a healthy economy. Central bank of country drafts many policies so that to cash and credit availability is regulated. In India these policies are being drawn by government with the help of RBI. It helps in the stabilization of money supply, interest etc. In the market, some of the general credit control measures taken are:

Bank rate -This is traditional way of regulation put by central bank. Central bank decides at which rate of interest the bank will give loans to commercial banks. It is also the rate at which central bank discounts the bills and other instruments of commercial banks.

When the rate of interest charged by central bank from commercial bank is high, than commercial bank’s lending rate of interest also rises which ultimately decreases the number of borrowers. This leads to recession in market. On contrary when central bank decreases the rate of interest for commercial banks i.e. the loan can be taken by commercial banks from central bank at lower rate of interest than commercial banks also give loans at lower rate of interest which ultimately increases the borrowers.

Repo rate and Reverse repo rate – Repo rate is the interest rate at which commercial bank borrow money from central bank. Repo rate is also called repurchase rate. When Repo rate falls than commercial banks are more tempted to borrow more money from central bank. This is called repurchase rate because when they borrow money from the RBI, they keep government securities with the central bank as collateral. When they pay the money back to RBI, they take the collateral back.

While Reverse Repo rate is the rate at which when they keep their surplus money with the RBI. Repo rate is always higher than the reverse repo rate. By controlling these rates, the RBI controls the rate of interest in the economy Open market operations – Open market operations are the market operations conducted by the Reserve Bank of India by way of sale/purchase of Government securities to/from the market with an objective to adjust the rupee liquidity conditions in the market on a durable basis. When the RBI feels there is excess liquidity in the market, it resorts to sale of securities thereby sucking out the rupee liquidity. Similarly, when the liquidity conditions are tight, the RBI will buy securities from the market, thereby releasing liquidity into the market.

CRR and SLR – CRR or cash reserve ratio is the minimum proportion/percentage of a bank’s deposits to be held in the form of cash. Banks actually don’t hold these as cash with themselves, but deposit the same with RBI/currency chests, which is considered equivalent to holding cash with themselves. This ratio keeps changing and acts as a controlling measure in the hands of central bank. A lower CRR means banks have more money to lend.

SLR or statutory liquidity ratio is the minimum percentage of deposits that a bank has to maintain in form of gold, cash or other approved securities. It is the ratio of liquid assets (cash and approved securities) to the demand and term liabilities/deposits. An increase in SLR restricts the bank’s leverage position to pump more money into the economy, thereby regulating credit growth.

Regulation, Supervision and Development of Financial Stability Regulation of non banking financial institution. Besides these there are other control measures adopted by Central bank which can be called selective control measures such as rationing of credit, issuing directives to commercial banks, issuing consumer credit regulation etc.

Money and Banking MCQ Questions

Question 1.
Factors responsible for the change in the form of money are
a Political
b. Economic
c. Government
d. All of the above
Answer:
d. All of the above

Question 2.
The reason for giving monopoly to Central Bank is
a. It can have a control on the credit of commercial banks
b. Brings uniformity to the monetary system
c. Management of the paper money becomes easier
d. All of the above
Answer:
d. All of the above

Question 3.
The assets that RBI acquire against the currency printed by it are
a. Non income yielding assets
b. Income yielding assets
c. Bonds
d. All of the above
Answer:
a. Non income yielding assets

Question 4.
For Banks, Central Bank acts as
a. Clearing agent
b. Borrower
c. Lender
d. Both a &c
Answer:
d. Both a &c

Question 5.
Central Bank acts as a custodian of the cash preserves of commercial banks which means
a. Acts as a lender of last resort
b. As clearing agent
c. Maintains the cash reserves of the commercial banks
d. None of the above
Answer:
c. Maintains the cash reserves of the commercial banks

Question 6.
With the help of cash reserve deposited by commercial banks with Central bank commercial banks can
a. Increase their credit in the market
b. A cash reserve ratio can be formed
c. Both a & b
d. None of the above
Answer:
c. Both a & b

Question 7.
Following are considered as money
a. Metallic money
b. Financial investment
c. Both a &b
d. None of the above
Answer:
c. Both a &b

Question 8.
All these characteristics are required for any item to qualify as money except.
a. be countable
b. be made of metal
c. be portable
d. be divisible
Answer:
b. be made of metal

Question 9.
As a measure of value money provides
a. Its holder with perfect liquidity
b. Its fixed return in future
c. A common denominator for determining value of goods
d. A mechanism for allocating resources and distributing output
Answer:
c. A common denominator for determining value of goods

Question 10.
Near money assets are
a. assets for which no nominal capital gain is possible
b. assets for which slight capital gain is possible
c. assets for which high capital gain is possible
d. none of the above
Answer:
b. assets for which slight capital gain is possible

Question 11.
A government bond is being matured after five years in comparison to Rs. 50000 that is lying with Ram. Which is more liquid?
a. Government bond
b. Rs. 50000
c. Both are equally liquid
d. None of the above
Answer:
b. Rs. 50000

Question 12.
The interest rate are different for financial institutions in comparison to general borrower because
a. Financial institutions are more credit worthy
b. Financial institutions are in the market of borrowing and lending
c. Average of term for which loan has been taken by financial institutions is shorter
d. Both a &c
Answer:
d. Both a &c

Question 13.
Out of the following which assets is most liquid?
a. shares of stock
b. government securities
c. land
d. currency
Answer:
c. land

Question 14.
When the liquidity trap occurs the demand for money
a. becomes perfectly interest elastic
b. becomes perfectly interest inelastic
c. means that an increase in money supply leads fall in the interest rate
d. means that an increase in the money supply to an increase in the interest rate
Answer:
a. becomes perfectly interest elastic

Question 15.
The quantity theory of money says an increase in the money supply is most likely to lead to inflation if;
a. the velocity of circulate in decreases
b. the number of transactions decreases
c. there is deflation
d. the velocity of circulation and the number of transaction is constant
Answer:
d. the velocity of circulation and the number of transaction is constant

Question 16.
For reducing the supply of money the government –
a. reduce interest rates
b. buy back government bonds
c. sell government bonds
d. encourage banks to lend
Answer:
c. sell government bonds

Question 17.
The open market operations occur when the government:
a. reduces spending
b. buys and sells bonds and securities
c. increases taxation
d. increases the exchange rate
Answer:
b. buys and sells bonds and securities

Question 18.
Some of the functions that are Not done by Central Bank are
a. banker to Government
b. banker to customer
c. collection of taxes
d. foreign exchange resources
Answer:
b. banker to customer

Question 19.
Central Bank is collecting data related to economic aspects of
a. money
b. credit
c. foreign exchange
d. all of the above
Answer:
d. all of the above

Question 20.
Name of the central Bank of USA is
a. American Central Bank
b. Federal Reserve
c. Federal Reserve Bank
d. Federation Reserve
Answer:
b. Federal Reserve

Question 21.
Executive head of the RBI is called
a. Chairman
b. Governor
c. President
d. None of the above
Answer:
b. Governor

Question 22.
In current account the banks
a. Pay against the deposits of the customer
b. Pay above the deposits of the customer in certain condition
c. Both a &b
d. Pay only up to a certain limit as described by bank
Answer:
c. Both a &b

Question 23.
Collection of dividend for their customers is the _____________ type of function of the commercial banks
a. Primary function
b. Agency service
c. General utility service
d. None of the above
Answer:
b. Agency service

Question 24.
Deposits with the bank are considered ________ of that bank.
a. an assets
b. Credit
c. Share worth
d. a liability
Answer:
d. a liability

Question 25.
The difference between a bank’s actual reserves and its required reserves is its.
a. Capital
b. Share value
c. net worth
d. excess reserves
Answer:
d. excess reserves

Question 26.
Banks decrease the rate of interest for borrowing because the banks are holding excess reserves as business firms and consumers are not willing to borrow money A decrease in the discount rate is likely to
a. not change the money supply because banks already have excess reserves which they cannot lend
b. As borrowing money from banks will become difficult people will start depositing more money with the banks
c. There will be a sharp increase in the deposits made by the business firms as the rates of loans given by banks have fallen sharply.
d. None of the Above
Answer:
a. not change the money supply because banks already have excess reserves which they cannot lend

Question 27.
Because money serves as a medium of exchange, it eliminates
a. the need to write checks.
b. The need for specialization.
c. The use of commodities as money
d. The need for a double coincidence of wants
Answer:
d. The need for a double coincidence of wants

Question 28.
Money’s function as a medium of exchange means that
a. money is a common denominators for expressing the value of goods and services
b. money can be sued to store wealth.
c. money serves as an acceptable means of payment
d. money is a standard f deferred payment on exchange contracts extending into the future
Answer:
c. money serves as an acceptable means of payment

Question 29.
Which of the following is correct? Money is
a. medium of exchange.
b. A store of value
c. A unit of account
d. All of the above
Answer:
d. All of the above

Question 30.
Suppose an increase in the supply of money occurs, while the demand for money is constant, according to the quantity theory of money, the price level will .
a. stay the same because of an offsetting decrease in the demand for money
b. rise because as people try to spend excess money balances, prices are driven up.
c. Fall because real GDP will rise as interest rates fall
d. Raise because of a decrease in the demand for money
Answer:
b. rise because as people try to spend excess money balances, prices are driven up.

Question 31.
The main source of profits to commercial banks is
a. the service charges on bank accounts
b. the interest earned on their loans.
c. The proceeds from home and card foreclosures.
d. The interest re earned on the securities
Answer:
b. the interest earned on their loans.

Question 32.
The Lorenz curve shows the relationship between
a. asset creation and income generation
b. population groups and their respective income shares
c. unemployment and inflation
d. wages, labour hours and leisure
Answer:
b. population groups and their respective income shares

Question 33.
In India Central Bank is
a. Federation Bank of India
b. State bank of India
c. Reserve Bank of India
d. Central Bank Of India
Answer:
c. Reserve Bank of India

Question 34.
The primary function of Central Bank is
a. Issue of notes
b. Collection of data
c. Central banking in developing countries
d. Both a &c
Answer:
a. Issue of notes

Question 35.
Marshall – Lerner condition states that the foreign exchange market would be stable if the sum of the price elasticity of the demand for imports and the demand for exports is:
a. greater than one
b. less than one
c. equal to one
d. equal to zero
Answer:
c. equal to one

Question 36.
You deposit money into your bank account, which of the following entry Bank will pass in its books of account.
a. debit cash account
b. debt your account
c. reverse the entry
d. debit assets account
Answer:
a. debit cash account

Question 37.
Which of the following represents the fisher’s equation?
a. nominal interest rate = real interest rate + inflation
b. nominal interest rate + inflation – real interest rate
c. nominal interest rate – real interest rate – inflation
d. nominal interest rate – real interest rate/inflation
Answer:
d. nominal interest rate – real interest rate/inflation

Question 38.
Credit creation is
a. Process where money is given by banks through loan
b. Process where the money is taken by lenders
c. Process by which the money is taken by depositors
d. All of the above
Answer:
a. Process where money is given by banks through loan

Question 39.
Derived deposits are
a. Deposits created by depositors
b. Deposits created due to the loans extended by banks to borrowers
c. Deposits with the financial institutions
d. Deposits created with the cash of the customers
Answer:
b. Deposits created due to the loans extended by banks to borrowers

Question 40.
In the accounts of banks “loans and advances” are
a. High interest income
b. Loans given to customer
c. Liabilities of bank
d. Both a & b
Answer:
d. Both a & b

Question 41.
Credit creation is done only
a. After primary deposits are made by bank
b. Reserves have been created with RBI
c. Banks have started giving loans
d. All of the above
Answer:
d. All of the above

Question 42.
For deciding the credit of a bank
a. It has to be checked what is the total amounts of deposits bank has
b. Loans granted must earn more interest than its deposits
c. Banks should be able to pay its commitment to deposits
d. Both b & c
Answer:
d. Both b & c

Question 43.
Cash deposit ratio is
a. Total deposits which are kept for encashment by depositors
b. A fraction of cash reserve that a bank is required to keep for encashment
c. Both a &b
d. None of the above
Answer:
b. A fraction of cash reserve that a bank is required to keep for encashment

Question 44.
Which among the following is the full form of FDI in Indian Economics?
a. Foreign Depository investors
b. Foreign departmental investors
c. Foreign direct investment
d. Foreign development investment
Answer:
c. Foreign direct investment

Question 45.
One of the following is not the function of Reserve Bank Of India
a. Issuing currency notes
b. Formulating monetary policies
c. Exercising control over all banks of India
d. Lending money to exporters
Answer:
d. Lending money to exporters

Question 46.
All of the following is function of money except
a. to provide durability
b. to be portable
c. to be divisible
d. None of the above
Answer:
a. to provide durability

Question 47.
The approach used by economics to describe money are
a. Functional approach
b. Purchasing power approach selling
c. Both a & b
d. Purchasing power approach
Answer:
d. Purchasing power approach

Question 48.
Functions of money as per functional approach are
a. Medicine
b. Measure
c. Saving
d. Both a & b
Answer:
d. Both a & b

Question 49.
Unit of account is
a. Monetary unit used in selling
b. Monetary unit used is purchasing
c. Monetary unit used in calculation
d. None of the above
Answer:
c. Monetary unit used in calculation

Question 50.
Difficulty with barter system was
a. Exchange was difficulty due to Lacks of double concordance of wants
b. Persons of credit was difficulty as nature of commodity kept changing
c. Evaluation of the commodity was difficulty as the commodities exchanged were different
d. All of the above
Answer:
d. All of the above

Question 51.
Derived function are
a. Primary function
b. Secondary function
c. Both a & b
d. Neither a nor b
Answer:
b. Secondary function

Question 52.
Limitations for the demand of credit are
a. Demand should exist in the market
b. Amount of loan granted should increase the paying capacity of borrower
c. Bad debts should be avoided
d. All of the above
Answer:
d. All of the above

Question 53.
Which of the following is not included in money?
a. Note
b. Demand deposit of banks
c. Diamond
d. Gold
Answer:
c. Diamond

Question 54.
The contingent function of money are
a. Distribution of national income
b. Distribution from of capital
c. Basis of credit
d. All of the above
Answer:
d. All of the above

Question 55.
Liquidity means
a. A highly acceptable item in the market
b. A credit money
c. A debit money
d. All of the above
Answer:
a. A highly acceptable item in the market

Question 56.
It is uncommon for an item to be liquid if
a. It is not acceptable in the market
b. Can not be sold in the market
c. Not accepted by creditors
d. Both a &b
Answer:
d. Both a &b

Question 57.
Liquidity of an asset is __________ related with the average time taken to convert it into cash in the market
a. Directly
b. Inversely
c. Equally
d. Proportionately
Answer:
b. Inversely

Question 58.
Liquidity is related _________ to price fluctuation
a. Inversely
b. Directly
c. Equally
d. None of the above
Answer:
a. Inversely

Question 59.
As per Fisher transaction approach for inflation
a. If Quantity of money is doubled the price level will also double
b. If quantity of money is doubled price will double and the value of money will half
c. If Quantity of money is doubled price level will double and the value of money will double
d. If quantity of money is doubled price level will be half
Answer:
b. If quantity of money is doubled price will double and the value of money will half

Question 60.
Value of money is dependent on holding power of money. It is
a. Transaction approach
b. Cash balance approach
c. Debit balance approach
d. Asset approach
Answer:
b. Cash balance approach

Question 61.
Central bank came into existence in
a. Early 18th century
b. Early 20th century
c. Late 20th century
d. Late 18th century
Answer:
b. Early 20th century

Question 62.
The role played by Central Bank is
a. Organizing financial system
b. Earning profits
c. Supervising financial system
d. Both a & b
Answer:
d. Both a & b

Question 63.
Some of the policy of Central Bank are
a. High rate of growth in GDP
b. Price stability
c. Reduction in income inequalities
d. All of the above
Answer:
d. All of the above

Question 65.
Primary function of money is that-
a. It serves as a medium of exchange
b. It serves as a standard of deferred payment
c. It serves as a store of value
d. It serves as a general form of capital
Answer:
a. It serves as a medium of exchange
Hint
The primary function of money is that it acts as a medium of exchange

Question 66.
Match the following:

Functions of Money Classification of Money
1. Medium of Exchange (i) Contingent Function
2. Distribution of National Income (ii) Secondary Function
3. Transfer of value (iii) Primary Function

The correct option is
a. 1. (i), 2. (ii), 3. (iii)
b. 1. (ii), 2. (iii), 3. (i)
c. 1. (iii), 2. (i), 3. (ii)
d. 1. (iii), 2. (ii), 3. (i)
Answer:
c. 1. (iii), 2. (i), 3. (ii)
Hint
Primary function
The primary function of money is that it acts as a medium of exchange Secondary function
There are some other functions of money such as
– it can easily be stored unlike goods used in barter system which were difficult and cumbersome to be stored .specially in case of perishable goods.
– It is best means in case of deffered payment. Thus in case of loans repayment interest can easily be calculated with the help of money.
– Money can easily be transferred from one place to another unlike goods whose transferability is difficult.

Contingent functions
Prof. Kinley has mentioned that money is the basis of credit.

  • Some examples of credit money are cheque, draft, bill of exchange etc.
  • Money helps in the proper distribution of national income.
  • It is the general form of keeping all the wealth. ,

It gives people maximum pleasure as they can decide about the utility of the product and can distribute their income accordingly

Question 67.
In a POW Camp during the Second World War, biddies came to perform the function of money although-
a. It did not work as a medium of exchange
b. It did not work as a store of value
c. It did not serve as a standard of deferred payments
d. It was not declared a legal tender.
Answer:
d. It was not declared a legal tender.

Question 68.
____________ is the rate at which the central bank discounts the bill of commercial banks.
a. Bank Rate
b. Interest Rate
c. Growth Rate
d. None of the above
Answer:
a. Bank Rate
Hint
Bank rate -This is traditional way of regulation put by central bank. Central bank decides at which rate of interest the bank will give loans to commercial banks. It is also the rate at which central bank discounts the bills and other instruments of commercial banks.

Question 69.
A Commercial bank cannot—
a. Advance you cash loans
b. Advance you home loans
c. Purchase a house for you
d. Advance educational loan
Answer:
c. Purchase a house for you
Hint
Commercial banks
Commercial Banks are financial institution that provides services, such as accepting deposits, giving business loans and auto loans, mortgage lending, and basic investment products like savings accounts and certificates of deposit. Commercial banks play an important role in the financial system and the economy. Major functions of commercial banks are
• Banks operate by borrowing funds
• Giving loans to public in the form of loans and advances, overdraft, cash credit, discounting of bill etc.

Question 70.
The Central Bank of a country is not empowered to:
a. Change the cash reserve ratio for commercial banks
b. Lend call loans to corporates
c. Extend financial assistance to commercial banks
d. Supervise the functioning of commercial banks.
Answer:
b. Lend call loans to corporates
Hint
Central Banks
Central bank is the apex institution that regulate , guide and help financial system.
Leading functions

  • Issue of notes
    As banker to the government, central bank provides all those service and facilities to the government which public gets from the ordinary banks.
  • Central bank is the bank of banks. It provides security to their cash reserves, give them loan at the time of need, gives them advice on financial and economic matter and work as clearinghouse among various members bank.
  • Central bank is the custodian of the foreign currency obtained from various countries.
  • Another major work of the central bank is to manage and regulate the exchange rate.
  • The central bank works as lender of the last resort for commercial banks
  • All commercial bank have their accounts with the central bank. Therefore, the central bank settles the mutual transactions of banks and thus saves all banks
  • the most important function of a central bank is to control the volume of credit for bringing about stability in the general price level and accomplishing various other socio-economic objectives

Other Functions

  • It collects statistical data regularly relating to economic aspects of money, credit, foreign exchange, banking, etc.
  • It can play an important role by mobilizing people to make investments and to promote saving.

Question 71.
A commercial bank normally, does not pay interest on
a. A fixed deposit with the bank
b. A current deposit with the bank
c. A saving deposit with the bank
d. Long-term deposit with the bank
Answer:
b. A current deposit with the bank
Hint
Banks operate by borrowing funds-usually by accepting deposits from public in the form of saving deposit, fixed deposits and current deposit. Saving accounts are such account in which the bank gives interest on the money deposited by the public while in the current deposit you do not get any interest but mostly gets an overdraft facility.

Question 72.
If a bank has an initial deposit of Rs. 100 crores and cash deposit reserve. maintained by the bank is 10%, then the total amount of credit creation will be?
a. Rs. 1,000 Crares
b. Rs. 500 Crores
c. Rs. 1,250 Crares
d. Rs. 1,500 Crores
Answer;
a. Rs. 1,000 Crares
Hint
Credit creation by the bank = initial deposit/cash deposit reserve = 100/10% = 1000 crores.

Question 73.
In the fisher’s equation of exchange- P = r\frac{r V T V+M^{1} V^{\prime}}{T}
P indicates-
a. The amount of money in circulation
b. The total amount of transaction in the economy
c. The value of money
d. The velocity of money.
Answer:
c. The value of money

Question 74.
Match the following:

Name of the Bank Country
1. Reserve Bank of India (i) Europe
2. Federal Reserve Bank (ii) USA
3. European CentralBank (iii) China
4 People’s Bank of China (iv) India

The given options are:
a. 1. (iv), 2. (ii), 3. (i), 4. (iii)
b. 1. (iii), 2. (iv), 3. (ii), 4. (i)
c. 1. (ii), 2. (iii), 3. (iv), 4. (i)
d. 1. (i), 2. (ii), 3. (iii), 4. (iv)
Answer:
a. 1. (iv), 2. (ii), 3. (i), 4. (iii)
Hint
Reserve Bank of India – India Federal Reserve Bank – USA European Central Bank – Europe People’s Bank of China -China

Question 75.
A primary function of money is to:
a. Serve as a medium of exchange
b. Serve as a standard of deferred payments
c. Serve as a general form of capital
d. Serve as a store of value.
Answer:
a. Serve as a medium of exchange
Hint
The primary function of money is that it acts as a medium of exchange.

Question 76.
Among the following assets the most liquid asset is:
a. Gold
b. Stocks of commodities
c. Equity shares of blue-chip companies
d. Currency notes.
Answer:
d. Currency notes.

Question 77.
An increase in bank rate results in:
a. Banks’ ability to create credit falls
b. Banks can give new loans more easily
c. Demand for bank loans rises
d. Demand for bank loans falls.
Answer:
d. Demand for bank loans falls.
Hint
When the rate of interest charged by central bank from commercial bank is high than commercial banks lending rate of interest also rises which ultimately decreases the number of borrowers. This leads to recession in market.

Question 78.
Depreciation of rupee would normally result in:
a. Increase in India’s imports of luxury goods
b. Increase in India’s exports
c. Fall in India’s external debt burden
d. Domestic deflation.
Answer:
b. Increase in India’s exports
Hint
Currency depreciation is the loss of value of a country’s currency with respect to one or more foreign reference currencies. Thus if the Indian currency will fall then goods of India will become much cheaper in comparison to other countries thus will lead to increase in exports.

Question 79.
An important monetary-policy tool among the following is
a. Better access to Public Distribution System (PDS)
b. Higher expenditure on social services
c. Rationing of credit
d. Increased subsidies on petroleum, food, exports and fertilizers.
Answer:
c. Rationing of credit
Hint
Credit rationing refers to the situation where lenders limit the supply of additional credit to borrowers who demand funds, even if the latter are willing to pay higher interest rates. These are the control measures adopted by Central bank which can be called selective control measures such as rationing of credit, issuing directives to commercial banks, issuing consumer credit regulation etc.

Question 80.
If the target of the Central Bank is to reduce the rate of inflation in the economy, it should not –
a. Reduce the bank rate
b. Raise the Cash Reserve Ratio (CRR)
c. Raise the Statutory Liquidity Ratio (SLR)
d. Raise the Repo rate.
Answer:
a. Reduce the bank rate
Hint
Bank rate -This is traditional way of regulation put by central bank. Central bank decides at which rate of interest the bank will give loans to commercial banks. It is also the rate at which central bank discounts the bills and other instruments of commercial banks.

Question 81.
Central Bank in India is known as-
a. Federal Bank
b. People’s Bank
c. RBI
d. None
Answer:
c. RBI
Hint
RBI – Reserve Bank of India

Question 82.
In which city are the head quarters of R.B.1. situated?
a. New Delhi
b. Bangalore
c. Mumbai
d. Hyderabad
Answer:
c. Mumbai

Question 83.
In which bank interest rate is not changed-
a. RBI
b. SBI
c. Swiss Bank
d. Federal Bank
Answer:
a. RBI

Question 84.
In which city head office of Andhra bank is situated?
a. Hyderabad
b. Kolkata
c. Chennai
d. Coimbatore
Answer:
a. Hyderabad

Question 85.
Who controls CRR & SLR?
a. Central Government
b. RBI
c. Commercial Bank
d. None
Answer:
b. RBI

Question 86.
Which of the following are the functions of money-
a. Medium of exchange
b. Store of value
c. The measure of value
d. All of the above
Answer:
d. All of the above
Hint
Features of money

  • Money gave more freedom to people in comparison to the barter system.
  • As in the barter system, the evaluation of commodities was difficult as every commodity has its different importance. Thus the introduction of money helped to overcome this difficulty.
  • Moreover it was easy to manage accounts with the help of money
  • Acts as a medium of exchange .

Question 87.
People’s bank is an open bank of which country?
a. India
b. China
c. USA
d. UK.
Answer:
b. China

Question 88.
Transaction Approach is given by-
a. Alfred Marshall
b. Irving fisher
c. Adam smith
d. Hicks
Answer:
b. Irving fisher
Hint
The transactions Approach was given by Irving Fisher. This approach first emerged in Fisher’s book The Purchasing Power of Money

Question 89.
Which of the following is not a Quantitative credit control measure
a. Bank Rate
b. Open market operation
c. Variable cash reserve requirement
d. Rationing of credit
Answer:
d. Rationing of credit
Hint
Some of the general credit control measures taken are

  • Bank rate
  • Repo Rate and Reverse Repo Rate
  • Open Market operations
  • CRR and SLR (variable cash reserve requirement)

Question 90.
The rate at which Central Bank borrows money from Commercial Banks is known as-
a. Repo Rate
b. Rate of interest
c. Reverse Repo Rate
d. Loan Rate
Answer:
b. Rate of interest
Hint
Reverse repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) borrows money from commercial banks within the country.

Question 91.
Commercial banks provide the facility of-
a. Providing loans.
b. Accepting deposit
c. Both (a) & (b)
d. None of the above
Answer:
c. Both (a) & (b)
Hint
Major functions of commercial banks are

  • Banks operate by borrowing funds
  • Giving loans to the public in the form of loans and advances, overdraft, cash credit, discounting of bills etc.
  • These banks also provide some of the utility services like lockers, traveller’s cheque, transfer of funds from one bank to another, collect dividend and interest on securities, collection and payment of cheques, bills and promissory notes, provides various trade information and statistics, issues personal and commercial letters of credit, maintain customers Demat account etc.

Question 92.
Which of the following measure is taken by Bank for credit creation?
a. Printing
b. Accepting cheques
c. Lending out a proportion of their deposits
d. Issuing debit cards
Answer:
c. Lending out a proportion of their deposits
Hint
Commercial banks
Commercial Banks are financial institution that provides services, such as accepting deposits, giving business loans and auto loans, mortgage lending, and basic investment products like savings accounts and certificates of deposit. Commercial banks play an important role in the financial system and the economy. As a key component of the financial system, banks allocate funds from savers to borrowers in an efficient manner. Credit creation is one of the important function of commercial banks. It starts with banks lending money out of primary deposits.

Question 93.
Which of the following lists primary function of money?
a. Medium of Exchanqe, inflation hedge, store
b. Medium of Exchange, standard of deferred
c. Standard of deferred payments, inflation hedge, store of value
d. Medium of exchange, measure of value
Answer:
d. Medium of exchange, measure of value
Hint
The primary function of money is

  • It acts as a medium of exchange
  • It is measure of value

Question 94.
Largest Commercial bank in India, in terms of deposits is:
a. Bank of Baroda
b. Reserve Bank of India
c. State Bank of India
d. Canera Bank
Answer:
c. State Bank of India

Question 95.
Head Office of Reserve Bank of India is situated at:
a. Mumbai
b. Delhi
c. Chennai
d. Ahmedabad
Answer:
a. Mumbai

Question 96.
Reduction in statutory liquidity ratio result into:
a. Increased borrowing powers of the banks,
b. Reduced borrowing powers of the banks
c. Increased lending power of banks
d. Reduced lending power of banks
Answer:
c. Increased lending power of banks
Hint
SLR or statutory liquidity ratio is the minimum percentage of deposits that a bank has to maintain in form of gold, cash or other approved securities. It is the ratio of liquid assets (cash and approved securities) to the demand and term liabilities/deposits. An increase in SLR restricts the bank’s leverage position to pump more money into the economy, thereby regulating credit growth. A decrease in SLR gives more liquidity to the banks.

Question 97.
Which of the following things have been used as money in past times?
a. Shells
b. Goats and Cows
c. Gold, Silver and Rice
d. All are applicable.
Answer:
d. All are applicable.

Question 98.
The executive head of Reserve Bank of India is called
a. Executive Director
b. Chairman
c. President
d. Governor
Answer:
d. Governor

Question 99.
Commercial Banks provide:
a. Free Credit
b. Agency services
c. Both loans and agency services
d. Loans.
Answer:
c. Both loans and agency services
Hint
Commercial Banks are financial institution that provides services, such as accepting deposits, giving business loans and auto loans, mortgage lending, and basic investment products like savings accounts and certificates of deposit.

Question 100.
Which of the following measures is taken by Banks for Credit Creation?
a. Printing
b. Issue debit cards
c. Accepting cheques
d. Lending out a proportion of their deposits.
Answer:
d. Lending out a proportion of their deposits.
Hint
The power of commercial banks to expand deposits through loans, advances and investments is known as “credit creation.”

Question 101.
Which of the following is a measure used by Reserve Bank of India to decrease credit in the economy?
a. Decrease ¡n Bank Rate and decrease in Cash Reserve Ratio (CRR)
b. Decrease In Bank Rate and increase in Cash Reserve Ratio (CRR)
c. Increase in Bank Rate and decrease in Cash Reserve Ratio (CRR)
d. Increase in Bank Rate and ¡ncrease in Cash Reserve Ratio (CRR)
Answer:
d. Increase in Bank Rate and ¡ncrease in Cash Reserve Ratio (CRR)
Hint
CRR or cash reserve ratio is the minimum proportion/percentage of a bank’s deposits to be held in the form of cash. Banks actually don’t hold these as cash with themselves, but deposit the same with RBI/currency chests, which is considered equivalent to holding cash with themselves. This ratio keeps changing and acts as a controlling measure in the hands of central bank. A lower CRR means banks have more money to lend. Increased CRR means banks have less money to lend.

CS Foundation Business Economics Notes