44- Money and Banking

Question 1

Money

Answer 1

Money is an item generally accpetable as a means of payment

Question 2

Explain in detail

4 Functions of Money

Answer 2

• Medium of Exchange - overcome the problem of double coincidence of wants
• Store of Value - enables people to save
• Unit of Account - measure of value, prices of diffrent items compared in monetary terms
• Standarad for deferred payments - borrow and lend. Buy now and pay later

Question 3

Double coincidence of wants

Answer 3

a situtaion where two people each ahve something the other person wants

Question 4

With example explain

most imporatnt characteristics of Money

Answer 4

generally acceptable - people are willing to accpet in exchange of goods.

people in Zimbabwe lost confidence in the Zimbabwean dollar and they had to use $

Question 5

7 other charcteristics apart from acceptibility

Answer 5

• Portable: can be carried around easily
• Divisible: can be divided into differnt units of values. ₹10, ₹20, ₹50, ₹100
• Homogenous/uniform
• Limited in supply
• Durable
• Stable value
• Not easy to counterfiet

Question 6

Why is having limited supply important

Answer 6

So that money doesn’t lose its value.
Zimbabwe printed a lot of money making it abundant and lose itps value

Question 7

Money Supply

Answer 7

The total amount of money in an economy

Currency in circulation + relevant deposits

Question 8

Why does the government calculate the money supply

Answer 8

Gain information on
- Aggregate demand (AD)
- state of financial market
- and determine the direction of the monetary policy

Question 9

Limitations of calculating money supply

Answer 9

Difficult to decide what to include in the money supply

Question 10

Two main measures of money supply

Answer 10

• Narrow money –> high liquidity
• Broad money –> low liquidity

Question 11

narrow money

Answer 11

money that can be spent directly
notes and coins in circulation
medium of exchange

Question 12

broad money

Answer 12

narrow money + other store of value

cash+saving

Question 13

Quantity theory of money

Answer 13

The theory that links inflation in an economy to changes in the money supply.

change in money supply causes euqal percentage change in the price levels, inflataion.

Question 14

velocity of circulation

Answer 14

the number of times money changes hands

Question 15

Fisher Equation

Answer 15

MV=PT

both sides show nominal income

m = money supply
v = velocity of circulation
p = price level
t or y = output/transcation/real GDP

Question 16

assumptions of the quantity theory of money

Answer 16

V and Y are constant and unaffected by the money supply

keynesians appose this belief

An exmaple, when people anticipate that the inflation rates are going to rise they most likely would want to spend their money. Therefore, the velocity of circuation would increase.

Question 17

Volume of transaction

Answer 17

nominal GDP,
PY
price* output

Question 18

Differences between Keynesian and Monetaraist theory approach

Answer 18

1. K - Believe in government intervention budget deficit (spending) to incraese AD
2. M - Gs will only lead to inflation in LR, more stable with a stable money supply
3. K- employement, M - Inflation key priority
   3.

Question 19

2 primary function of commercial bank

Answer 19

• Accept deposists
• Give loans

Question 20

Explain the function of a commercial bank

Answer 20

Loans :
-Overdraft and loans
Deposits :
- Savings and current/demand deposit account
Government Bonds and equities

Question 21

Demand deposit account

Answer 21

• Where money can be easily withdrawn for purchsaes by the holder

Also known as a current account

Question 22

Savings deposits account

Answer 22

• Interest is received on the savings
  -A notice may be required before withdrawal

Question 23

Overdraft

Answer 23

• A consumer can withdraw more than what they have in their demand deposit accounts
• Higher interest rates are charged

Question 24

Loans

Answer 24

money lent at an agreed rate of interest for a given period of time

Question 25

government securities

Answer 25

Bills and bonds issued by the government to raise money

Question 26

3 objectives of a commercial bank

Answer 26

- Profitability - Security - Liquidity

Question 27

# Explain in detail the objective of a commercial bank Profitability

Answer 27

The interest rates they charge on money lent to the customers

Question 28

# Explain in detail the objective of a commercial bank Liquidity | Also explain what is liquidity

Answer 28

- Assets in liquid form are not profitable - However banks have to have enough money to meet expected withdrawals requests by holders - ## Footnote The ability to turn an asset into cash without loss

Question 29

Security

Answer 29

Firms have to keep some of thier profits for - Some lenders do not repay - Invested businesses go out of business This is important to ensure credibility

Question 30

Reserve Ratio

Answer 30

the proportion of liquid assets to total liabilities legal minimum fraction of deposits which the banks are mandate to keep as cash with themselves.

Question 31

Capital ratio

Answer 31

Bank's available financial assets as a percentage of it's riskier assets financial assets/ riskier assets ## Footnote The higher the capital ratio the more unexpected losses can be covered by the bank. Less risk taking and allows survivals during hard times.

Question 32

5 main causes of changes in the Money Supply

Answer 32

- Increase in lending by commercial banks - Increse in G finaced by financial central/commercial banks - quantitative easing --- Selling of givernment bonds to financial institutes - More money entering than leaving the eocnomy

Question 33

Money Multiplier

Answer 33

1/cash reserve ratio 100/liquidity ratio value of new assets created/change in liquid assets

Question 34

potential increase in liabilities of a bank

Answer 34

credit multiplier * Intial deposits

Question 35

Potential increase in bank lending

Answer 35

liabilities - intial amount

Question 36

Assumptions of the credit creation process

Answer 36

- All transaction happen through bank - During any given period of time only a few of the customers will need to withdraw cash - All customers would not withdraw cash at the same time

Question 37

Why may banks not choose to lend as much as the credit multiplier implies?

Answer 37

- Lack of households/firms who want to borrow - Lack of credit worthy borrowers --> will affect their liquidity as the people do not pay back on time

Question 38

commercial bank and credit creation

Question 39

Functions of Central Bank