The Monetary System

Question 1

What is the monetary system?

Answer 1

It is a set of laws regarding the nation’s currency and the mechanisms and institutions by which the government provides money in the economy.

It consists of a Mint (who is coining the money), Central Bank and Commercial banks.

Question 2

What are the elements of a monetary system?

Answer 2

• monetary standard
• monetary unit
• types of money
• money convertibility

Question 3

What is the monetary standard?

Answer 3

It is the value behind the money in the monetary system.

Question 4

What are the types of monetary standard?

Answer 4

Metallic standard system (silver, gold, or both)
Mixed system (reserve currency standard+gold standard)
Paper currency standard system

Question 5

What is the gold exchange standard?

Answer 5

It was set up in Bretton Woods (1944)

It helps convert currencies into gold.

The USD was the last currency to be convertible to gold until 1971.

The price of gold remained at $35 after 1971

Question 6

Why was the gold standard created?

Answer 6

It should:

• reintroduce the convertibility of currency
• eliminate exchange controls
• establish an international monetary system with stable exchange rates

Question 7

What are the rules of the gold exchange standard?

Answer 7

A reserve currency was chosen
The reserve currency agreed to fjx its value to a weight in gold
The reserve country agreed to exchange gold for its currency with other CB’s in the system.

Question 8

What is the paper currency standard system?

Answer 8

It is a fiat system which does not allow the free convertibility into a metallic standard and the money is given value by the government.

Today, all countries use it.

Question 9

What are the paper currency system’s characteristics?

Answer 9

• currencies are made of paper
• the value of the money is set by supply and demand
• value of the money depends on its purchasing power

Question 10

What are the advantages of the paper currency system?

Answer 10

Paper money is economical
Its cost of production is insignificant
It is convenient to handle
It is standardized
Its supply can be made elastic
Its value can be kept stable
It is perfect for internal trade

Question 11

What are the disadvantages of the paper currency system?

Answer 11

It can be over-issued by the managing authorities thus leading to inflation.
It may only be accepted in the country it is issued.

Question 12

What is Par Value?

Answer 12

It is the official value of a currency unit, fixed by monetary authorities by law.

Question 13

What is monetary parity?

Answer 13

It is the ratio between 2 par values (official exchange rate).

Question 14

What is the exchange rate?

Answer 14

It is the price of one currency expressed in another currency.

The base currency (1 unit) can be bought with x units of the term currency.

Question 15

What are the direct and indirecr quotations?

Answer 15

Direct quotation uses the country’s home currency as the term currency.

Indirect quotation uses the country’s home currency as the base currency.

Direct quotation is more frequently used.

Question 16

Types of exchange rates based on how they are set

Answer 16

Official exchange rates: fixed, free-floating and pegged.

Market exchange rate (price recorded on the market based on demand and supply).

Question 17

What are the official exchange rates?

Answer 17

Fixed ER=set by considering the par values of currencies
Free-Floating ER=varies among other currencies and is determined by demand and supply.
Pegged ER=varies according to the currency it is pegged with.

Question 18

Types of exchange rates based on economic implications

Answer 18

Single ER: applied by developed countries for internarional transactions
Multiple ER’s: used by developing countries to stimulate or discourage some transactions.

Question 19

Types of exchange rates based on the bank’s position

Answer 19

• selling ER

- buying ER

Question 20

Types of exchange rates based on the settlement date of transaction

Answer 20

Spot ER-current ER

Forward ER-ER that is traded today for delivery and payment occurs on a future date.

Question 21

What are the types of money?

Answer 21

Cash money: banknotes and metallic money
Scriptural money: deposits in a credit institution
Money with intrinsic value: given by the precious metal they are made out of
Fiat money: fiat value higher that its intrinsic value
Convertible money: in precious metal or other currency
Nonconvertible money: recognized only in the domestic currency.

Question 22

What is money convertibility?

Answer 22

It is the ability to exchange money for some other kind of value (gold or other currencies).

It represents the legal feature of a currency to be exchanged freely on the market in othet currencies without restrictions.

Question 23

What types of convertible currencies are there?

Answer 23

Convertible currencies
Inconvertible currencies: currencies of the countries which maintian restrictions on payments for current international transactions
Freely usable currencies: USD, Euro, Japanese yen, british pound.