Sure Shot Questions: Money and Banking

Very Short Answer Type Question

Q1: What is barter?
Ans: Barter is a system of exchange in which goods and services are traded directly for other goods and services without the use of money. It requires direct swapping between parties and is limited by the need to find matching wants and by difficulties in dividing or storing value.
Q2: Define bank money.
Ans: Bank money refers to money created by banks in the form of deposits that can be used for making payments. It includes cheques, drafts and other transferable deposit instruments that allow holders to make payments without using currency notes and coins.
Q3: Write the secondary function of money.
Ans: Secondary functions of money include:

• Store of value - Money can be saved and retrieved in the future without losing much of its value, making it a convenient means to preserve wealth.
• Standard of deferred payments - Money provides a standard measure for settling future payments and debt obligations, making credit transactions possible.

Q4: Define money supply?
Ans: Money supply is the total stock of money of different types (currency in circulation and various deposits) existing in an economy at a specific point of time. It is a stock variable measured at an instant, not a flow over time.
Q5: State the components of money supply.
Ans: The constituents of money supply in the narrow sense are coins, currency notes and demand deposits (bank deposits that are payable on demand). These together form the most liquid part of the money supply.
Q6: What are the functions of commercial banks?
Ans: The main functions of commercial banks are accepting deposits and advancing loans. In addition, they perform important services such as funds transfer and remittance, agency services (like collection and payment of cheques, bills and dividends), and providing safe custody for valuables.
Q7: What are time deposits?
Ans: Time deposits are bank deposits made for a fixed period of time. They cannot be withdrawn by the depositor before maturity without notice or penalty. Examples include fixed deposits and recurring deposits; these typically earn higher interest than demand deposits.
Q8: Define 'money multiplier'. 
Ans: The money multiplier measures how much additional deposit money the banking system can create with every unit of high-powered money (or every initial deposit). It indicates the ratio of change in total deposits to a change in reserves and depends on reserve ratios and public cash holdings.

Short Answer Type Questions

Q9: Give meaning of money. Explain the 'store of value' function of money.
Ans:

• Meaning: Money can be defined as a generally acceptable medium of exchange that can be used to buy goods and services, and which also serves as a measure and store of value.
• Money as a store of value: Money is durable, portable and easy to store compared with most commodities. It does not perish and its storage cost is low. Because it is widely accepted, people can hold wealth in the form of money and use it when required. Under barter, wealth in the form of goods (for example, grain or livestock) may spoil or require costly storage; money avoids these problems by preserving purchasing power over time.

Q10: Explain the evolution of money.
Ans: Money is a generally acceptable medium that can be exchanged for goods and services, and can be used as a measure and store of value. Its form has changed over time through a historical process. Initially, barter-direct exchange of goods-was used. Later, commodity money emerged: items of intrinsic value such as hides, shells, cattle, rice or other agricultural products served as mediums of exchange. Over time metallic money (coins) became common because metals were durable and portable. Paper notes followed, issued by authorities as a convenient medium. In modern times, bank money (deposits and electronic balances) and central bank issued currency are the main forms used as a medium of exchange.

Q11: Explain the problem of double coincidence of wants faced under barter system. How has money solved it?
Ans: Double coincidence of wants means that for a barter exchange to occur, each trader must want exactly what the other offers. This requirement makes barter exchanges difficult and inefficient because matching such needs is hard. Money eliminates this problem by acting as a common medium of exchange. For example, if a vegetable seller needs a cart but the cart maker wants clothes rather than vegetables, the vegetable seller can sell vegetables for money, use the money to buy a cart, and the cart maker can use the money to buy clothes. Thus money allows each person to obtain what they want without finding a direct barter match.

Q12: Explain the concept of money supply.
Ans: Money supply is a stock variable. It is the total stock of different types of money (currency in circulation and deposits) available in an economy at a specific point of time. In India, M₁, M₂, M₃, and M₄ are the four commonly used measures of money supply. They are defined as follows:
M₁ = CU + DD
M₂ = M₁ + Savings deposits with post office saving banks
M₃ = M₁ + Time deposits of commercial banks
M₄ = M₃ + Total deposits with post office savings organisations (excluding National Savings Certificates)
where, CU = Currency (notes and coins held by public)
DD = Net demand deposits held by commercial banks
These measures move from the narrowest (M₁) to broader definitions (M₄) by including progressively less liquid assets.
Q13: State any two components of Ml measure of money supply.
Ans: The two components of M₁ measure of money supply:

• Currency: Currency is the main component of money supply. Currency consists of coins and currency notes held by the public.
• Demand Deposits: Demand deposits are bank deposits payable on demand by the account holder, for example current account and savings account deposits. These deposits can be used for transactions through cheques and other instruments.

Long Answer Type Questions

Q14: What is meant by the supply of money? Discuss the factors which determine the supply of money.
Ans: Money supply refers to the amount of money that is in circulation in an economy at any given point of time.
The following factors determine the money supply:

• Monetary Standard: The monetary standard (for example, gold standard or fiat paper standard) affects how easily money can be issued. Under a gold standard money supply is constrained by gold reserves, whereas a paper currency system allows more flexibility to expand money supply.
• Production Volume: The level of production and economic activity influences money demand and therefore the effective money supply needed for transactions. Higher production generally requires a larger money supply to facilitate exchanges.
• Monetary Policy: The central bank's policies - such as changes in the Cash Reserve Ratio (CRR), bank rate and open market operations - directly affect the ability of banks to create deposits and hence the money supply. For example, raising CRR reduces banks' lending capacity and contracts money supply.
• Fiscal Policy: Government budgetary actions affect money supply. A fiscal deficit financed by borrowing from the central bank increases high-powered money and thus expands money supply; conversely, government surplus or borrowing from the market can have opposite effects.
• Other Factors: Public banking habits (preference for cash versus deposits), the velocity of money (frequency of transactions per unit of money), liquidity preference, and the magnitude of the money multiplier also influence the overall money supply.

Q15: Explain any two methods of credit control used by Central Bank.
Ans: Methods of credit control used by the central bank include:

• Bank Rate: The bank rate is the rate at which the central bank lends to commercial banks against approved securities. When the central bank raises the bank rate, borrowing from it becomes costlier for commercial banks. This reduces their lending capacity, contracts credit in the economy and helps check inflation. Conversely, reducing the bank rate makes funds cheaper for commercial banks, encouraging more lending and expanding money supply to address deficient demand.
• Open Market Operations (OMO): Open market operations are purchases and sales of government securities by the central bank in the open market. To reduce excess liquidity and control inflation, the central bank sells government securities; this withdraws high-powered money from circulation. To inject liquidity and counteract deficient demand, the central bank buys government securities, which increases the stock of high-powered money in the economy.

Q16: Explain any two methods of credit control used by Central Bank.
Ans: Methods of credit control used by the central bank are as follows:

• Bank Rate: The bank rate is the minimum rate at which the central bank discounts first-class bills of exchange and advances credit to commercial banks. Increasing the bank rate raises the cost of funds for commercial banks, which discourages lending and helps reduce money supply. Decreasing the bank rate lowers borrowing costs for banks, encourages lending and expands money supply to stimulate economic activity.
• Open Market Operations: These are the central bank's transactions in the government securities market. Selling government securities to banks and the public absorbs liquidity and reduces the stock of high-powered money, helping to control inflation. Buying government securities injects liquidity into the banking system, increases high-powered money and supports expansion of credit when demand is weak.

Q17: Define money. Explain its main functions.
Ans: Money can be defined as a generally acceptable medium that can be exchanged for goods and services, and can be used as a measure and store of value.
The following are the important functions of money:

• Medium of Exchange: Money acts as an intermediary in exchange transactions of goods and services. It removes the need for a double coincidence of wants and facilitates smooth trading.
• Unit of Value: Money acts as a convenient unit of account. Prices and values of goods and services are expressed in monetary terms, which simplifies comparison and record-keeping.
• Store of Value: Money preserves purchasing power over time and can be held for future use. It is less perishable than many goods and usually involves lower storage costs.
• Standard of Deferred Payments: Money provides a standard measure for settling debts and contracts that are payable in the future, enabling credit transactions and lending.