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  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 1

    Q#1: WHAT IS BARTER SYSTEM? WHAT ARE

    INCONVENIENCES OF BARTER SYSTEM?

    Barter system

    Barter is a system in which goods or services are directly exchanged with the goods or

    services without the use of money.

    Barter system is suitable only when people have few needs and money system does not exist

    in the economy.

    Inconveniences / difficulties/ hindrances /barriers / of barter system

    Followings are the difficulties that were faced in barter system.

    1. Lack of coincidence of wants

    2. Lack of common measure of value

    3. Lack of subdivision

    4. Lack of store of value

    5. Difficulty in future payments (credit)

    6. Difficulty in transfer of wealth

    7. Difficulty in tax collection

    8. Lack of specialization

    9. Difficulty in budgeting

    1. Lack of coincidence of wants

    Barter is possible only when there is double coincidence of wants. The main defect of barter

    is that there is lack of coincidence of wants.

    Example

    If a person has surplus rice and he wants to exchange it with wheat. He will have to

    find a person who has surplus wheat as well as he needs rice.

    2. Lack of common measure of value

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 2

    In barter system it is very difficult to measure the value of goods because there is no

    standard measure for the valuation of goods

    Example

    A man who has rice may assign the value to his 1kg rice as equal to 2 kg wheat. But the other

    person may assign a value to his 1 kg wheat as equal to 3 kg rice.

    3. Lack of subdivision

    In barter system another problem arises when the goods that are exchanged cannot be

    subdivided into small parts (units)

    Example

    If a person has a cow and he wants to exchange it with a goat. It is clear that a cow has more

    value than a goat. The problem is what a part of cow is to be given in exchange of goat. The

    transaction is impossible because cow cannot be sub-divided.

    4. Lack of store of value

    In barter system it is very difficult to store the commodities like fruit, vegetables and animal

    skins. It means that one cannot secure his future by storing commodities.

    5. Difficulty in future payments (credit)

    In barter system it is very difficult to lend ( ) goods to other people because at the

    time of repayment commodities may loss their value so credit transitions are impossible.

    Example

    A person borrowed ( ) a goat for one month but at the time of return the goat may

    fall sick and lose her value, so the payments in future under barter are difficult.

    6. Difficulty in transfer of wealth

    Under barter system it is very difficult to transfer moveable and immovable from property

    from one place to another place

    Example

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 3

    If a person has to transfer 100 goats from Faisalabad to Lahore, It would be very difficult for

    him to transfer them.

    7. Difficulty in tax collection

    Another difficulty which arises under barter is that the tax cannot be collected in form of

    goods. If the tax is collected they will lose their value with the passage of time.

    8. Lack of specialization

    Under the barter it is very difficult to attain specialization in their fields, because the people

    remain busy in meeting their own needs and they do not focus on effective ( )

    utilization ( ) of resources.

    9. Difficulty in budgeting

    Budgeting is an art of estimating of estimating ( ) future expenses and revenues.

    Under the barter system it is very difficult to estimate future expenses and incomes

    Imperial learning institute

    (Near Madina college for boys, sheikhupura road Faisalabad)

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 4

    Q#2: WHAT IS BARTER SYSTEM? HOW MONEY REMOVED

    BARRIERS OF BARTER SYSTEM?

    Barter system

    Barter is a system in which goods or services are directly exchanged with the goods or

    services without the use of money.

    Barter system is suitable only when people have few needs and money system does not exist

    in the economy.

    Removal of Inconveniences / difficulties/ hindrances /barriers / of barter

    system

    Followings are the difficulties that were faced in barter system.

    10. Lack of coincidence of wants

    11. Lack of common measure of value

    12. Lack of subdivision

    13. Lack of store of value

    14. Difficulty in future payments (credit)

    15. Difficulty in transfer of wealth

    16. Difficulty in tax collection

    17. Lack of specialization

    18. Difficulty in budgeting

    10. Lack of coincidence of wants

    Money has removed this difficulty by serving as a medium of exchange. Anyone can sell his

    goods for money and can buy goods against money.

    Example

    11. Lack of common measure of value

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 5

    In barter system it was very difficult to measure the value of goods because there was

    no standard measure for the valuation of goods but money has provided a standard

    measure. The value of goods can be measured in terms of money.

    12. Lack of subdivision

    Money has removed the difficulty of subdivision of goods into small parts because money

    has made easy to buy goods of both high and low value without wasting. In barter system goo

    often lose their value after indivisibility.

    13. Lack of store of value

    Money has removed the difficulty of storing wealth. Money can be stored easily and is a best

    medium to store savings.

    14. Difficulty in future payments (credit)

    In barter system it was very difficult to lend ( ) goods to other people because at the

    time of repayment commodities may loss their value. But in money economy debts can be

    returned in monetary units so there is no possibility of lose of value

    15. Difficulty in transfer of wealth

    Under barter system it was very difficult to transfer moveable and immovable from property

    from one place to another place but now with the help of money a person can sale his

    property from one place can buy similar property at some other place

    16. Difficulty in tax collection

    In money economy there is no difficulty in collection of taxes because they are collected in

    money form but in barter system it was very difficult to collect and store the tax collections.

    17. Lack of specialization

    Under the barter it is very difficult to attain specialization in their fields, because the people

    remain busy in meeting their own needs and they do not focus on effective ( )

    utilization ( ) of resources.

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 6

    18. Difficulty in budgeting

    Budgeting is an art of estimating of estimating ( ) future expenses and revenues.

    Money has made easy to estimate the future incomes and expenses in terms of money

    Imperial learning institute

    (Near Madina college for boys, sheikhupura road Faisalabad)

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 7

    Q#3

    DEFINE MONEY. WHAT ARE THE FUNCTIONS OF MONEY?

    OR

    DEFINE MONEY. HOW MONEY HAS FACILITATED ECONOMY?

    OR

    DEFINE MONEY. WHAT ARE THE ADVANTAGES OF MONEY?

    Money has facilitated economy by providing the following functions

    1. Medium of exchange

    2. Measure of value

    3. Future payments

    4. Budgeting

    5. Economic activities

    6. Transfer of wealth

    7. Store of wealth

    8. Determination of national income

    9. Liquidity of wealth

    10. Promote to foreign exchange

    11. Market mechanism

    12. Basis of credit creation

    1. Medium of exchange

    Money acts as a medium of exchange between the buyer and seller. Money is used to make

    payments for goods and services. Goods can sold for money and that money can be used to

    purchase goods.

    2. Measure of value

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 8

    Value of different goods and services can be measured in Monterey terms, in the same as we

    can measure weight in kg and distance in KM.

    3. Future payments

    Future payments can be easily determined with the help of money. One can borrow loans

    from banks and other financial institutions in form of money and repayment can be made as

    well in form of money.

    4. Budgeting

    Money helps government and companies in preparation of budgeting. Incomes and expenses

    are estimated and recorded in terms of money

    5. Economic activities

    All type of economic activities such as investments, savings, credit are made in terms of

    money. Money has played a vital role in economic growth of a society.

    6. Transfer of wealth

    With the help of money wealth can be transferred easily form one place to another place. One

    can sold his property at one place against money and he can buy similar at some other place

    7. Store of wealth

    Wealth can be stored easily in form of money. One can save his wealth by converting it in

    money.

    8. Determination of national income

    With the help of money, it becomes easy to determine the income generated by a nation. It

    also helps in determination of Gross Domestic Product of a country.

    9. Liquidity of wealth.

    Liquidity means conversion of property in form of cash. Wealth or property can be converted

    in liquid from with the help of money.

    10. Promote to foreign trade

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 9

    Money has played a vital role in the growth of foreign trade. Foreign investments are made in

    terms of money. Payments and receipts of other countries are made in terms of money.

    11. Market mechanism

    Market mechanism is based on the demand, supply and price of the goods. Demand

    and supply are the two major factors of market which work only because of money.

    Money is the only factor which determines the price, demand and supply of goods.

    12. Basis of credit creation

    Banks create credit on the basis of cash deposits in banks. So it is not possible for

    banks to create credit without the help of money.

    Imperial learning institute

    (Near Madina college for boys, sheikhupura road Faisalabad)

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 10

    Q#4 what are the different kinds of money? Or what are the different stages in the

    evolution of money? Or what is the origin and growth of money?

    Different forms of money

    On the basis of evolution the money is classified in five main types

    1. Commodity money

    2. Metallic money

    3. Paper money

    4. Credit money

    5. Electronic money

    1. Commodity money

    In commodity money, different commodities have been used as money like cattle ( ),

    Goats, Horses, animal skins, arrows. Commodity money was used in barter system in which

    goods were exchanged with other goods and services

    Problems of commodity money

    It was found that commodity money was not best to make payments due to the following

    problems.

    19. Lack of coincidence of wants

    20. Lack of common measure of value

    21. Lack of subdivision

    22. Lack of store of value

    23. Lack of divisibility

    24. Lack of transferability

    2. Metallic money

    Metallic money consists of gold coins, silver coins, nickel coins. In our country coins of Rs

    five, two and one are the metallic money. Metallic money cannot be eliminated from

    economy. It is playing vital role in the economy. Metallic money is of three kinds.

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 11

    i. Full bodied money

    ii. Token money

    iii. Tender money

    i. Full bodied money

    In full bodied money, the metallic value of coin is equal to their face value. Full bodied

    money is also called standard money or natural money. The gold silver and nickel are

    considered as full bodied money. Now such money is not used anywhere in the world.

    ii. Token money

    In token money the face value of coin is higher than the metallic value. They are usually

    made of silver, copper or nickel. In Pakistan full bodied money does not exist only token is

    used.

    iii. Tender money

    Any currency which is generally acceptable in discharge of debts is called tender money it

    can be made of paper or metal. If someone offers tender money against debts, nobody can

    refuse to take it. Tender money has two types

    a. Limited tender money

    b. Unlimited tender money

    a. Limited tender money

    Coins of small denominations are called limited tender money. Such as coins of RS 1, 2 and

    5.

    b. Unlimited tender money

    Coins of large denominations are called unlimited tender money. Notes of Rs 5, 10, 50, 100,

    500, 1000, 5000 are called unlimited tender money.

    3. Paper money

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 12

    Paper money consists of notes issued by the state bank of Pakistan. The paper money is of

    different denominations, colors and sizes. Paper money is more convenient than any other

    form of currency.

    4. Bank money

    Bank money includes cheques, bills of exchange, and drafts. Bank money is playing a vital

    role in the economic development. Because varies transactions are settled without the use of

    paper money. Bank money is safer than any other form of money. but bank money also have

    some defects.

    Dishonor of cheque may delay payments

    Uneducated may not know the best use of cheque

    Cheque is not a legal tender; one can refuse to take it against the settlements of debts.

    5. Electronic money

    With the development of computers and its application, the business and business

    transactions are changing very fast. Now a days most of the transactions take place through

    electronic money. People prefer to use debit cards and credit cards instead of paper money or

    bank money. With the passage of time electronic money may diminish the use of paper

    money.

    Imperial learning institute

    (Near Madina college for boys, sheikhupura road Faisalabad)

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 13

    Q#5 what are the qualities of good money?

    Good money should have the following qualities.

    1. Acceptability

    2. Transferability

    3. Stability

    4. Storability

    5. Recognizable

    6. Malleability

    7. Divisibility

    8. Durability

    9. Economy

    10. Elasticity

    11. Homogeneity

    1. Acceptability

    Good money should have the quality of general acceptability. General acceptability means

    every person must accept it for the settlement of payments. It should be accepted for purchase

    and sale of goods.

    2. Transferability

    Good money is easily transferable from one place to another for doing business and making

    payments. Paper money is easy to transfer from one place to another place because it has

    minimum possible weight.

    3. Stability

    Value of money should remain stable. If value of money is changing or fluctuating day by

    day than it would not be considered reliable.

    4. Storability

    The money should be storable. Value of money should not depreciate with time. If money

    material is perishable it will lose its value in few days. Paper money has quality of storability.

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 14

    5. Recognizable

    The money should be easily recognizable so that the holder of money may not confuse about

    the value of money. For example if every note has the same color it will not be easily

    recognizable. Paper money is easily recognizable because notes of different value have

    different color.

    6. Malleability

    The material which is used for making money should be malleable. The material which

    cannot be melted is not fit for making coins. The gold, silver, copper and nickel coins are

    malleable

    7. Divisibility

    Divisibly means ability to divide into small units without losing its value. Good money

    should be divisible. In barter system, commodity money was not divisible into small units.

    Thats why it was replaced by the paper money.

    8. Durability

    The material used in making money should be durable and long lasting. Coins do not wear

    quickly, so the quality of money remains stable.

    9. Economical

    Good money should be economical. Economical means low cost of printing and more value.

    If there is heavy cost on issuing money that is not good money.

    10. Elasticity

    Supply of money should be elastic. Elastic means whenever it is needed, supply of money

    can be increased or decreased. Paper money has the quality of elasticity

    11. Homogeneity

    Homogeneity means the money should be identical. So that there is no ambiguity to the

    holder of money

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 15

    Q #6 what are the merits and demerits of paper money?

    Or

    What are the advantages and disadvantages of paper money?

    Paper money

    Money made up of paper is called paper money. It consists of the notes issued by the central

    bank. In Pakistan notes of Rs 5 to 5000 are the examples of paper money

    Advantages of paper money

    Following are the advantages of paper money

    1. Economical

    2. Easy handling

    3. Easy counting

    4. Emergency needs

    5. Metal savings

    6. Easy transfer

    7. Easy payment

    8. Uniform quality

    9. High value in small bulk

    10. Stability

    11. Recognizable

    12. Storability

    13. Advantage for banks

    1. Economical

    Printing cost of paper money is less than the minting charges of metallic money. Paper

    money is cheaper than the metallic money. A large quantity of paper money can be issued at

    very low cost

    2. Easy handling

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 16

    Paper money has lesser weight than metallic money. It is easy to handle paper money than

    coins.

    3. Easy counting

    Paper money is easy to count than the metallic money. The counting of coins in larger sum in

    coins takes more time. Paper money takes lesser time than the metallic money.

    4. Emergency needs

    Paper money is friend in peace and war. Central bank can increase the supply of paper money

    for meeting the economic needs.

    5. Metal saving

    Metal saving is possible when paper money is used rather than metallic money. Metals like

    gold and silver can be used for other productive purpose.

    6. Easy transfer

    Transfer of paper money is easy and cheaper than metallic money because it is light weight

    and takes less space

    7. Easy payment

    Payments of larger sums are easy and cheaper than the metallic money because paper money

    is easy to count and easy to transfer.

    8. Uniform quality

    Paper money has a also a uniform quality and holder of the paper money does not suffer lose

    because old and new notes have the same value

    9. High value in small bulk

    Paper money contains high value in small quantity as compared to the metallic money.

    10. Stability

    Paper money is more stable in value but the value of coins do not remain stable due to wear

    and tear. The value of coins changes with the passage of time.

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 17

    11. Recognizable

    Paper money of every denomination is easily recognizable because of its different size, color

    and design.

    12. Storability

    Paper money is easy to store because of more value in light weight. It takes less space so that

    a large sum can be stored in small space even in pockets.

    13. Advantage for banks

    Banks have the great advantage of paper money they can easily count paper money buy using

    counting machines.

    Disadvantages of paper money

    1. Inflation

    2. Limited acceptability

    3. Danger of cancellation

    4. Short life

    5. Instability of exchange rate

    6. Less confidence

    1. Inflation

    Printing of paper money is easy. In time of need government may over issue currency

    notes. This over issue may cause inflation which increases the prices of goods and

    decreases the value of money.

    2. Limited acceptability

    Paper money has limited acceptability. It is acceptable only in the domestic country

    and in other countries of the world it is not acceptable.

    3. Danger of cancellation

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 18

    There is always a danger of cancellation. If government canceled the paper money

    then holder of money just has the worthless piece of paper.

    4. Short life

    Paper money is less durable than the metallic money. Paper money can be easily

    destroyed by fire, water or heat. So life of paper money is less than coins.

    5. Instability of exchange rate

    Exchange rate means the rate at which the domestic money is exchanged with the

    foreign money. Value of paper money depends upon the fluctuations. The instability

    of exchange rate directly affects the foreign trade.

    6. Less confidence

    As value of paper money is less stable and it has no real value in it. So people have

    less confidence in paper money.

    Imperial learning institute

    (Near Madina college for boys, sheikhupura road Faisalabad)

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 19

    Q #7

    What are the methods of note issue?

    There are the following methods of note issue

    1. Fixed fiduciary system

    2. Proportional reserve system

    3. Modified proportional reserve system / exchange management

    4. Minimum reserve system

    1. Fixed fiduciary system

    According to this principle, central bank can issue notes up to a certain limit by keeping

    government securities. If any time central bank wants to issue more notes, then the notes

    must be issued by keeping 100% gold reserve.

    Advantages

    i. No danger of over issue

    Under this system there is no danger of over issue of notes because 100% gold reserves are

    kept

    ii. No danger of inflation

    There are no chances of inflation because money can be converted into gold at any time

    Disadvantages

    i. Inelastic

    In emergency, if there is gold is not available government cannot issue notes.

    ii. Unnecessary lock up of gold

    Large amount of gold is locked that can be used for other productive purposes.

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 20

    2. Proportional reserve system

    Under this system central bank keeps certain percentage of note issue in form of gold reserve.

    This ratio may be different in every country. In Pakistan this ratio is 30%.

    Advantages

    i. Elastic

    Under this system central bank can increase the supply of money easily whenever needed

    ii. No lock of Gold

    Under this system, a large amount of gold is not locked. Gold can be used for other

    productive purposes.

    iii. Emergency needs

    This system is very helpful in emergency needs of currency.

    Disadvantages

    i. Danger of over issue

    There is always danger of over issue of notes

    ii. Danger of inflation

    There is always danger of inflation due to over issue of notes

    3. Modified proportional reserve system / exchange management

    Under this system, central bank keeps certain percentage of note issue in form of gold,

    foreign bills of exchange, foreign currency at some other country where gold system is used.

    This system is used in many countries.

    Advantages

    i. Elastic system

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 21

    Central bank can increase supply of money easily.

    ii. No lock of Gold

    Under this system, a large amount of gold is not locked. Gold can be used for other

    productive purposes.

    Disadvantages

    i. Lock up of foreign exchange

    Under this system a large amount of foreign currency is locked up in unproductive sector.

    ii. Over issue

    There is always danger of over issue of currency notes

    4. Fixed minimum reserve system

    Under this system central bank keeps only a fixed amount of gold or silver reserves against

    whatever amount of note issue.

    Advantages

    i. Elastic

    This system is highly elastic because central bank can issue a large amount of notes by

    keeping small reserve

    ii. No lock up of gold

    A large amount of gold is not locked up that can be used for productive purpose

    Disadvantages

    i. Over issue

    In this system, there is a great danger of over issue.

    ii. Currency value

    Under this system, central bank may fail to stable the price level.

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 22

    Q #8

    What is inflation? What are the measures to control inflation?

    Inflation

    Inflation is a process in which there is continuous increase in general price level and there is

    continuous decrease in money value. Inflation is a situation where demand of goods and

    services exceeds available supply of goods.

    The main measures used to control the inflation are;

    1. Monetary measures

    2. Fiscal measures

    3. Other measures

    1. Monetary measures

    Monetary measures are adopted by the central bank to control the supply of money.

    i. Bank rate policy

    Bank rate or discount rate is the rate at which central bank lend loans to commercial banks.

    Whenever central bank wants to control the inflation it increases the bank rate which help in

    reducing borrowings from commercial banks and inflation may be controlled.

    ii. Open market operation

    In open market operation central bank sales or purchases the securities in open market. If

    there is inflation in the country the central bank sells the securities which reduce the supply of

    money. So that inflation may be controlled.

    iii. Variable reserve ratio

    In order to control inflation, the central bank increases the reserve ratio due to which more

    funds of commercial banks are kept with the central bank. So the borrowings from

    commercial bank deceases and inflation may be decreased.

    iv. Credit rationing

  • MONEY BANKING & FINANCE

    Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND BANKING

    0334 5040190, 0313 5040191 Page # 23

    Under this policy central bank advices commercial banks to stop issuing loans for some time.

    In this way inflation may be controlled.

    v. Monetary reforms

    The government can order commercial banks to exchange old notes by new one. In this way a

    large amount of money can be blocked for some time. Repayment should be made after

    achieving the objective.

    2. Fiscal measures

    Fiscal measures are based on the demand management. Central bank may raise or lower

    down the demand by controlling expenditures.

    i. Decrease in tax rate

    In order to control inflation, central bank may decrease the tax rate. Resultantly industrialists

    increase the level of production which reduces the price level.

    ii. Decrease in government expenditures

    In government decreases expenditures on unproductive purposes the inflation is automatically

    controlled

    iii. Deficit financing

    In order to control inflation the government should avoid from deficit financing

    3. Other methods

    i. Increase the supply of goods

    If the supply of goods is equal to the demand in the market, Inflation will be automatically

    controlled

    ii. Population planning

    Control on population by adopting different measures of family planning. It will reduce the

    demand of goods which will help in controlling price level.

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    iii. Political stability

    If there is political stability in country, it will encourage investment and increase in

    production which may help in controlling prices

    iv. Smuggling of goods.

    Shortage of supply is normally due to the smuggling of goods. If govt take actions to control

    smuggling it will help in controlling price level.

    v. Price control policy

    The government should adopt strict price control policy against the profiteers and hoarders.

    So that inflation can be controlled

    Imperial learning institute

    (Near Madina college for boys, sheikhupura road Faisalabad)

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    Q #9

    What is deflation? What are the measures to control deflation?

    Deflation

    Deflation is a situation in which prices, output and employment are falling down. Inflation

    and deflation both are harmful for the economy but the deflation is more harmful. It creates

    hurdle on path of economic growth.

    According to the Philips deflation is a period during which level of prices declines and the

    value of money increases

    Causes of deflation

    1. Decrease in money supply

    The main reason of deflation is decrease in money supply. Sufficient money supply is

    necessary to meet the economic need.

    2. Strict banking policy

    Sometimes, restriction on lending is imposed by the central bank to decrease the money

    supply. This policy may decrease the investments.

    3. High taxes

    Sometimes government levied high taxes due to which the purchasing power of the people is

    also decreased and the result is deflation in economy

    4. Excess production

    If goods are produced more than the demand, then it also becomes the cause of deflation and

    prices are decreased

    5. No storage facility

    If businessmen have no storage facility than they are bound to sell goods even at low prices,

    which may cause deflation

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    6. Excess saving

    In case of inflation, commercial banks promote savings but unnecessary promotion of saving

    May leads towards the deflation.

    7. Heavy imports

    Imports in large scale quantity are also the cause of deflation. Due to increase in imports the

    supply is also increased which is the cause of deflation

    8. Decrease in exports

    If exports are decreased, the goods and services will be increased in the market, hence price

    will be decreased.

    9. Decrease in demand

    Decrease in demand of goods and services is another cause of deflation. Demand may be

    decreased due to the fall in income.

    10. Decrease in government expenditures

    Sometimes the government decreases expenditures due to which demand for goods is also

    decreased.

    11. Increasing cost

    Increasing cost of production also becomes the reason for deflation. People may not have

    buying power to purchase costly goods.

    12. Lower profits

    The lower profit rate is also the cause of deflation. Businessmen cut their profits to retain in

    the market a stage becomes when the profit becomes zero. Business at this stage may decide

    to stop production

    13. High bank rate

    An increase bank rate may also cause deflation. Increase in bank rate decreases the

    borrowings which decreases the money supply. Decreases in money supply cause deflation.

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    14. Sale of securities

    Sale of securities (shares and bonds) is also the cause of deflation. The people may like to

    invest their savings in shares due to this their purchasing power is decreased and they can buy

    fewer goods

    Measure / methods to control deflation

    1. Increase in supply of money

    To control deflation, supply of money in the country can be increased. Central bank should

    issue currency notes to meet the economic needs. when the supply is increased the demand

    for goods and services is also increased

    2. Increase in wages

    Increase in wages also helps decreasing deflation. The purchasing power of the people will be

    increased which will increase the demand of goods.

    3. Decrease in reserve ratio

    Decrease in reserve ratio also helps in controlling deflation. It increases the borrowings from

    commercial bank. Increase in borrowings increases the demand and price level.

    4. Control on production

    Production of different commodities should be controlled and there should be equilibrium in

    demand and supply. Control on production helps controlling production

    5. Decrease in interest rate

    The rate of interest on loans should be decreased. Loans should be provided to the producers

    to increase the production and investment level. This will increase the incomes of people.

    Demand for goods will be increased and deflation will be decreased.

    6. Increase in private investments

    The government should provide facilities to the industrialists to increase investment in

    country. By setting up new industries, the employment opportunities will be increased,

    incomes of people will also be increased which help to control inflation

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    7. Tax reduction

    Government should reduce the taxes which will increase the incomes of people. Increase in

    incomes increases the demand for goods and services which helps controlling inflation

    8. Increase in exports

    The excess supply of goods can be exported to control deflation. Increase in exports

    encourages producers for more production which helps in decreasing deflationary pressure.

    9. Increase in investments

    Deflation can be controlled through new investments. The production and employment

    increases due to new investments. The use of idle money decreases the deflation

    10. Fixed prices

    Deflation can also be controlled by fixing the price of goods and services. Government may

    appoint a price commission who supervises the price level so that the producer is not

    discouraged.

    11. Public works

    Government may start public works to eliminate the deflation. The amount is transferred

    from government to public. The demand for the goods and services is increased and there is

    increase in production.

    Imperial learning institute

    (Near Madina college for boys, sheikhupura road Faisalabad)

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    Q# 10

    Critically examine the fishers quantity theory of

    money (Or)

    Explain and criticize the fishers equation of

    exchange.

    Statement of theory

    This theory was introduced by the Irving Fisher. According Irving fisher, other things

    remaining the same as the quantity of money in circulation increases, the price level also

    increases in direct proportion and the value of money decreases and vice versa.

    Fisher equation of exchange

    P =

    P = general price level

    M = Quantity of money

    V= Velocity of circulation of M

    M = Quantity of credit money

    V= Velocity of circulation of M

    T = Total value of goods bought and sold

    Explanation

    Quantity theory of money can be explained with the help of following example

    M = 100 Rs

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    M = 200 Rs

    V = 3

    T = 90 goods

    P = ( ) ( )

    = 10 Rs per good

    If the supply of money is doubled

    P =

    P = ( ) ( )

    = 20 Rs per good

    If the supply of money is halved

    P =

    P = ( ) ( )

    = 05 Rs per good

    Conclusion

    Thus it is clear that if the supply of money is doubled, the price level will also be doubled and

    the value of money is one halved. Similarly if the supply of money is halved, the price level

    of money is doubled.

    Assumptions of theory

    1. Full employment

    Theory assumes that there is full employment in the economy. It states that all the factors of

    production are fully utilized no resource are idle

    2. Velocity of money is constant

    It is assumed that the velocity of circulation of money remains unchanged in short run

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    3. Volume of trade

    It is also assumed that the volume of trade remains constant in the short period because

    method of production and habits of consumer remain unchanged

    4. Constant relationship between M and M

    There must be constant relationship between M and credit money M

    5. Price level is passive factor

    P should be affected by the other factors but should not affect other factors

    6. Short period

    This theory applied to the changes in price level only in short period

    Criticism on theory

    1. Other things may not remain same

    The drawback of this theory is that other things are assumed to be unchanged. But in reality it

    is not possible that the factors in an economy remain unchanged

    2. Variables are not independent

    The various variables in the equation are not independent. The factors have great influence on

    each other. In this equation p is assumed to be passive factors which do not affect other

    factors but in reality when price level is increased, it increases the profit rate and promotes

    trade

    3. No proportionate change

    This theory assumes that if quantity of money is doubled, the prices are also doubled, this

    assumption is wrong. There is no proportionate change in the money and prices

    4. Ignores the rate of interest

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    This theory ignores the influence of rate of interest on the quantity of money. An

    increase in the quantity of money is due to the decrease in interest rates.

    5. Fails to explain trade cycle

    This theory is failed to explain the trade cycle. According to this theory, if the

    quantity of money is doubled the price level will also be doubled. During 1929

    1933 the quantity of money was increased but it fails to increase price level.

    The depression was not eliminated. So theory has failed to explain the causes of

    trade cycle

    6. Full employment

    This theory assumes full employment in an economy which is not possible at all

    7. Static theory

    The quantity theory of money is a static theory. The world is dynamic and things are

    changing at fast speed. The ups and down in an economy cannot be explained with the help

    of this theory.

    (650 words)

    Imperial learning institute

    (Near Madina college for boys, sheikhupura road Faisalabad)

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    Q #11

    What is trade cycle? What phases of trade cycle?

    Trade cycle

    Fluctuations (ups and down) in economic activities of a country is called trade cycle. These

    changes or ups and down may be positive or negative. The duration of trade cycle may vary

    from 5 years to ten years or above.

    Phases of trade cycle

    Trade cycle is composed of four phases which are given below

    1. Depression / slum / trough

    2. Recovery

    3. Boom / peak

    4. Recession

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    1. Depression

    Depression is the most fearful stage of trade cycle. In the period of depression there is fall in

    national income, employment, prices, and production. Cost of production is higher than the

    sale price. During this phase of trade cycle factories are closed and workers become jobless.

    Features of depression

    o low production

    o low prices

    o low employment

    o low profit margin

    o decrease in demand

    o low interest rate

    o low borrowings

    2. Recovery

    Recovery is a stage of economy where demand of goods starts increasing. Profit margin start

    rising because cost of production fall below the general price level. New investments are

    made in different productive activities or businesses. At this stage unemployment level start

    decreasing.

    Features of recovery

    There is increase in level of production

    Increase in demand

    There is decrease in cost of production

    Increase in public borrowings

    Improvement in level of employment

    Rise in Investment opportunities

    Improvement in business profit

    3. Boom / peak

    It is a stage of economy where business activities attain maximum best level. After some time

    economy moves from recovery to boom, At this stage national income, demand of goods,

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    level of production and employment level is growing rapidly. This is an ideal stage of an

    economy

    Features of boom

    High level of profit

    Ideal level of national income

    Maximum production

    Low cost of production

    Rapid increase in demand of goods

    Growth in public borrowings

    Low rate of unemployment

    Ideal investment opportunities

    4. Recession

    This is the level of economy where economic activities starts falling down. At this stage

    economy moves from boom to recession and investments, employment, production starts

    reducing. There is shrinkage in profit margin because cost of production exceeds the sale

    price, due to this poor firms close their business while other reduce their production.

    Features of recession

    Decrease in production

    Fall in employment level

    Shrinkage in profit margin

    Decrease in public borrowings

    Decrease in demand

    Decrease in price of product

    Cut down in national income

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    Q #12What are the causes/ reasons of trade cycle also explain

    remedies of trade cycle?

    Causes of trade cycle

    Trade cycle is affected by the two factors that are;

    A. Internal factors

    1. Under consumption

    There is to much saving in the boom period. This reduces the price level. The price start

    increasing but wages do not increase proportionately. The income of rich start increasing at

    higher rate but incomes of poor do not increase as compared to the price level; the result is

    that the demand for consumption goods decreases.

    2. Unsold stock

    Trade cycle is the result of inventories ( closing stock). There is excess of goods and services

    but people are unable to buy goods of their own choices due to their low incomes. Unsold

    stock results in depression

    3. Imports

    Imports are also the reason for depression. When the goods are imported, it increases the

    supply of goods. Increase in supply of goods decreases the price level

    4. Liquid assets

    Liquid assets are includes coins, paper money, bonds and shares. Increase in liquid assets

    leads economy toward boom. The increase in liquid assets increases the investments, in this

    way the stock exchange activities will flourish and economy leads towards prosperity

    5. Unfilled orders

    Unfilled orders means the demand of goods is higher and the supply is low the manufacturers

    are unable to meet the demand of customers. Increase in demand encourages the

    manufacturers to produce more which leads toward boom.

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    6. Reserves / excessive profits

    The retained profits are the source of capital but excessive reserves or profits are kept idle

    that is the wastage of funds. During the boom period, this policy is bad because it leads

    towards the depression.

    7. Over capitalization

    The capitalization of profits is desirable for meeting emergency needs. if all the profit of the

    company is capitalized and company do not pay dividend on shares. It may discourage

    investment which causes the depression.

    8. Trade union

    Trade union also becomes the cause of depression. They demand more wages which

    increases cost and resultantly price level rise. The increase in price level decreases the

    demand of product.

    9. Investments

    The changes in investment rates affects the trade cycle. High investment rate increase brings

    boom in economy. If investment rate is low it will cause depression.

    External factors

    10. War

    War is a major factor which affects trade cycle. The war brings damages to the country; fall

    in investments and incomes, employment and price level. War becomes the reason of

    depression.

    11. Population

    Population increases the aggregate demand of products which raises the price level higher.

    High price brings the inflation. Investment and income level falls. There will be depression in

    the economy

    12. Migration

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    The increase and decrease in migration affects the demand. Decreases in population due to

    migration, deceases the demand of products. The supply of goods exceeds the demand which

    brings depression

    On the other hand if there is increases in population due to migration. The demand of goods

    is high and the supply is low. More demand encourage investors to produce more which

    brings boom in the economy

    13. Innovations

    Innovations brings boom in the economy. When a new business is started or a new product is

    introduced, it increases the demand for that product. This may encourage the investments in

    new business which brings boom in the economy.

    14. Invention

    Invention means discovery of new methods of productions, new machinery or material.

    Inventions reduce the cost of production which increases the competition and investment.

    This result in boom

    15. Weather

    The weather also affects the produce of agriculture sector. In bad weather conditions there is

    low yield of crops. The demand is the same but the output is low so the price level goes up.

    16. Government purchases

    When government purchases goods from supplier it increases the demand which leads

    towards the boom and if government do not purchases goods, it reduces the demand of goods

    which result in depression.

    17. Export surplus

    Exports surplus is then, when exports are more than the imports. Exports surplus brings the

    prosperity in economy

    What are the remedies to control trade cycle?

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    Trade cycle can be controlled by applying following methods

    A. Monitory policy

    B. Fiscal policy

    C. International measures

    A. Monitory policy

    1. Bank rate

    Bank rate means, rate at which central bank discounts the bill of commercial bank. The

    central bank can increase bank rate when there is boom and can decreases when there is

    depression in economy. Increase and decreases in bank rate control the borrowings.

    2. Market operation

    The central bank can increase or decrease the money supply by open market operation. If

    central bank wants to increase the money supply, it buys bonds, treasury bills and other

    securities. If central bank wants to decrease the supply of money, it starts selling bonds,

    treasury bills and other securities. The purpose of open market operation is to control the

    supply of money.

    3. Reserve ratio

    The central bank can increase or decrease the reserve ratio. Central bank keeps reserve with

    central bank. During depression this ratio can be decreased and in boom period reserve ratio

    is increased.

    4. Selective control

    The central bank can provide credit to one sector at low rate and other sector at high rate. The

    commercial can refuse to grant loans for non productive purposes. The main purpose is to

    regulate the supply of money and to ensure the effective use of money.

    B. Fiscal policy

    5. Public work

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    Government may start the public work program during depression. Government may start

    construction and development of various projects. Public development projects helps to

    control trade cycle.

    6. Taxes

    The government can increases the tax rate to control supply of money. The tax rate can be

    increased to reduce the supply of money and if there is shortage of money supply. Then tax

    rates can be decreased.

    7. Budget

    Surplus budget can be prepared in boom period and deficit budget is prepared in depression.

    Government can use the budgetary measures to control trade cycle

    8. Public debt

    Government should borrow loans in depression to meet the various needs. In case of boom

    the debt should be repaid. The government can overcome crises by public debts.

    9. Imports

    Government should promote imports during the boom period but when there is depression;

    imports should be restricted or reduced.

    10. Government purchase

    Government should purchase goods during the depression. Government purchases plays an

    important role to control the depression.

    C. International measures

    11. Production control

    The production of goods can be controlled at international level because goods produced in

    excess of demand can create problem. Producers can fix the quota at international level. In

    this way trade cycle can be controlled

    12. Buffer stock

    Buffer stock can be kept in warehouses. When production is low the suppliers can met the

    demand from surplus stock.

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    13. Investment control

    The government may increase investment in less developed areas. Excess In any sector may

    lead toward depression. There is a great need for the equal investment in all the sectors of

    economy

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    Q #13

    What are the features of trade cycle?

    1. Phases

    Trade cycle has four phases

    i. Boom

    It is a period of good trade

    ii. Recession

    It is period in which there is a downward trend in business activities

    iii. Depression

    It is a period of bad trade

    iv. Recovery

    It is a period in which economic activities start rising up

    2. Cyclic effect (following nature)

    Phases of trade cycle follow each other. Boom follows depression and depression follows

    boom. The factors which generate boom automatically generate recession and depression and

    so on. The trade cycle is completed in this way.

    3. Time period

    Time period for the completion of trade cycle is not fixed. It may last for 5, 10, 15, 20 even it

    can be of fifty years.

    4. International in nature

    Trade does not affect economy only at national level, but it also effect the other countries

    through foreign exchange.

    5. Rhythm change

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    It means that all the sectors of economy moves in the same direction. If there is boom in one

    sector the other would also move upward. It is no possible to have boom in one economy and

    depression in other sector

    6. Difference in intensity

    Difference in intensity means that the effect of every phase is different on different sectors

    7. Not of equal length

    All the phases of trade cycle are not of equal length for example boom may last for ten years

    and depression may last for 4 years. Length of every phase of trade cycle depends on the

    economic conditions of economy.

    8. Slow recovery

    The recovery phase of economy is slow and the fall in economic activities is sharp.

    9. Important phases

    Out of four phases boom and depression are very important phases.

    10. widespread

    When trade cycle takes place in any economy their effect spread to all other sectors of

    economy.

    11. Social effects

    Phases of trade cycle have their effect on society. Facilities are available in boom period and

    hoarding, smuggling is found in depression period.

    Imperial learning institute

    (Near Madina college for boys, sheikhupura road Faisalabad)

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    Q #14 What is bank? What are the types of banks? (Or) what are the

    classifications of bank?

    Bank

    Bank is a financial institution which borrows savings from general public at lower rate and

    lends it to the other people at higher rate of interest.

    Kinds of bank

    Following are the types of bank;

    1. Central bank

    A bank which supervises the activities of banking in Pakistan is called central bank. In

    Pakistan state bank of Pakistan is the central bank. Main purpose of the central bank is not to

    earn profit but it work for the welfare of the society. Central bank has the right to issue notes.

    Central bank is also called bank of banks.

    2. Commercial bank

    A bank which accepts deposits from general public and lends them to the other people to earn

    profit is called commercial bank. The main aim of commercial bank is to earn profit. it also

    provides the services of agency to his clients. Examples of commercial banks are; national

    bank of Pakistan, Habib bank limited, Allied bank limited, united bank limited etc.

    3. Industrial bank

    The main purpose of industrial bank is to provide credit facility for setting up and running

    industries in country. In Pakistan, Industrial development bank and other financial institutions

    are providing loans to the different industries.

    4. Agricultural bank

    These banks provide short term and long term loans to the farmers so that they can purchase

    seeds, fertilizers, tractor and other agricultural equipments.

    5. Exchange bank

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    A bank which buys and sells foreign currency to facilitate imports and exports is called

    exchange bank. In Pakistan commercial bank deals in foreign exchange.

    6. Savings bank

    A bank which collects the savings of the people having low income and pay interest on it is

    called saving bank. Such bank is formed to encourage saving habits of people. In Pakistan no

    such bank exists but saving account can be opened in post office

    7. Investment banks

    Bank which buys and sells shares, debentures and bonds is called investment bank.

    Investment banks also grant loan for the purchase of shares and other securities. Investment

    Corporation of Pakistan are national investment trust are the examples of investment banks.

    8. Consumers bank

    The main purpose of these banks is to provide credit facility to the consumers to purchase

    goods. City bank is performing services of consumer bank in Pakistan.

    9. Mortgage bank

    This provides loan against land and building for short and long period. House building

    Finance Corporation is working as mortgage bank in Pakistan.

    10. School banks

    These banks provided the banking facility to the schools students. No bank in Pakistan is

    providing facility to the students of school. However in European countries these banks are

    providing banking facility to the students.

    11. Co operative bank

    These banks are formed to work for the welfare of society. Their aim is not to earn profit.

    These banks provide credit facility to the farmers of small income.

    12. Consortium bank

    A bank which is formed and run by some other banks is called consortium bank. These banks

    provide long term loan loans to large scale companies. In Pakistan no such bank exists.

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    13. Labor bank

    These banks are opened by trade unions of laborers. The main purpose of this bank is to

    manage workers fund, like pension fund, provident fund etc in a better way.

    14. Islamic bank

    It is an interest free bank which is working under the principles of Islam. Islamic banks are

    working under the profit &loss sharing principle. Meezan bank is the example of the Islamic

    bank in Pakistan.

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    Q#15

    What is a commercial bank? What are the functions

    of commercial bank?

    Commercial bank

    Commercial bank is the most popular form of bank. They are established for the purpose of

    earning profit. Commercial bank receives deposits from the individuals, firms and companies

    at lower rate and lends it to those people who have need it at higher rate of interest. The

    difference of rate is the profit of bank.

    FUNCTIONS OF COMMERCIAL BANK

    A commercial bank performs various functions that are classified into;

    A) Primary functions

    B) Secondary functions

    C) General utility functions

    A) Primary functions

    Primary or main function of commercial bank is of accepting deposits and making loans to

    needy people

    1. Accepting deposits

    This is the main function of commercial bank to collect surplus money from the people and

    businessman. For this purpose commercial bank has introduced following types of accounts

    i. Saving account

    Commercial banks offer saving account for the people who have small savings. Interest is

    paid on saving deposits from 6% to 11%. Account holder is not allowed to made frequent

    withdrawals.

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    ii. Current account

    Current account is usually offered to the businessmen because they can withdraw and deposit

    money several times a day. Inertest is not allowed by bank on this account. Traders and

    businessmen maintain such type of account.

    iii. Fixed deposit account / term deposit account

    In term deposit account the amount cannot be withdrawn before the expiry of specified

    (fixed) time. High rate of interest is paid on fixed deposit account. Such type of account is

    usually maintained by the people who have surplus money.

    iv. Foreign currency account

    This account is opened in foreign currency. Account holder cannot deposit local currency in

    this account. Foreign currency account can be opened in form of saving account, current

    account or fixed deposit account

    v. Profit and loss account

    Those people who do not want to earn interest on their deposit, they can deposit their money

    in profit and loss account. Bank pays profit or loss on the amount of deposit that may be

    different from one period to other period

    2. Advancing loans

    Advancing loans is the main function of the commercial bank. The amount of deposits is used

    to advance loans to other people. Bank charges high rate of interest on the amount of loan.

    These loans can be of short, medium and long period

    Bank provide loan in the following ways

    i. Loan

    Commercial bank offer short medium and long term loans against the securities.

    ii. Cash credit

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    Cash credit is an agreement between bank and its client to borrow money up to a specified

    limit. The period of cash credit may consist of days and months. Interest is charged only on

    the amount withdrawn

    iii. Overdraft

    Overdraft is a very short term credit facility. Bank allows his trustworthy customers to draw

    more than the deposit. Bank charges higher interest rate on the amount of overdraft.

    iv. Discounting of bill

    Bank provides money to the holder of bill of exchange after deducting charges of discounting

    of bill. Amount of discount is the income for bank.

    B) Secondary functions

    These functions can be divided in agency function and general utility function

    1. Agency function

    Bank works for his customer as his agent. As a agent bank provide following customers to his

    customers.

    i. Collection and payment of cheque

    This is important function of commercial bank to collect and make payment of cheques

    ii. Purchase and sale of public securities

    Commercial bank also buys and sells securities (shares and debenture) on the behalf of his

    customer. Bank charge his commission for providing such services.

    iii. Financial advisor

    Bank gives on demand valuable advices to his customer on various financial matters

    iv. Execution of standing orders

    Bank also executes the instructions and settles those transactions that are of regular nature.

    For example payment of rent, insurance and utility bills etc.

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    v. Transfer of funds

    Bank also transfers money from one place to another place by means of bank draft,

    telephonic transfer and cheques. Bank performs this function on the orders of his customer.

    vi. Deduction of zakat

    Bank deducts amounts of zakat from customers account on the behalf of government

    Such amount is transferred to the general zakat fund.

    2. General utility function

    Bank also provide general utility function to his customers some of them are given below

    i. Locker facility

    Bank also provides locker facility to his customer for the safe custody of valuable goods like

    jewelry, shares, securities etc. bank charges his services charges.

    ii. Foreign exchange

    Bank also deals in foreign exchange. It converts local currency in to foreign currency and

    vice versa on customer demand.

    iii. Relief fund

    Bank performs the function of collecting money as a charity from general for the relief of

    victims of earthquake and war effected people

    iv. 24 hour cash services

    In this modern money economy commercial banks provide the facility of 24 hour cash

    services. Customer can withdraw money from ATM machines at any time

    (834 words)

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    Q#16

    Explain the role of commercial bank in economic

    development of country

    Or

    Explain the importance of commercial bank.

    Commercial bank

    Commercial bank is the most popular form of bank. They are established for the purpose of

    earning profit. Commercial bank receives deposits from the individuals, firms and companies

    at lower rate and lends it to those people who need it at higher rate of interest. The difference

    of rate is the profit of bank.

    Role of bank in economic development

    Commercial banks are playing vital role in the economic development of country. Few of

    them are given below

    1. Promoting savings

    Commercial bank are playing vital role in the promotion savings. They are offering different

    types of deposit accounts with attractive interest rates to increase savings.

    2. Promoting investments

    Commercial banks do not keep the collected money idle with them; they lend it to the

    businessmen for investment purpose which increases the production and employment level

    3. Transfer of funds

    Commercial bank also provides the facility to transfer money from one place to another place

    which makes the transactions safer and leads to the growth of trade

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    4. Industrial development

    Commercial bank provides short and long term loans to the industrialist. Bank also gives

    valuable advices to them.

    5. Increase in employment

    Commercial bank grants loans to different sectors of business, such as Trade, commerce,

    agriculture and transport to expand the business activities which increases the level of

    employment in country.

    6. Construction of houses

    Bank provides credit facility to their customer for the construction or purchases of house.

    Bank provide short term loan for repairing and long term loans for the purchase of land and

    constriction of houses.

    7. Credit creation

    Commercial banks are called the factories of credit. They create credit from the deposits.

    Through the credit creation process commercial bank provides funds to the various sectors of

    economy

    8. Capital formation

    Capital formation means increase in number of production units. Capital formation depends

    upon the amount of investment and savings. Commercial bank can increase the capital

    formation by granting loans to the productive sectors

    9. Export promotion cell

    Commercial banks are also playing an important role in the growth of export. It has

    established exports promotion cells for the guidance and information to the exporters

    10. Agricultural development

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    Economic development is not only based on the development of industry but it also depends

    on the agricultural. Commercial banks are advancing loans to the farmers on small medium

    and long terms to purchase seeds, machinery, and other equipments.

    11. Development of transport

    The commercial bank financed the transport scheme through Punjab ministers scheme. It has

    reduced the unemployment on one hand and increased the transportation facility on the other

    hand.

    12. Financial advices

    Commercial bank also gives financial advices to their customers to promote their business,

    besides credit facility

    13. Construction of houses

    Commercial bank provides loans for the construction projects. It grants short term loans for

    repairing and long term loans for the construction of houses.

    14. Assistance to government

    It also grants loans to the government for the development projects. The commercial bank

    share the government for the economic stability

    15. Economic prosperity

    Economic growth depends upon the development of banking system. A sound banking

    system promotes economic status of people by providing loans on the lenient terms and

    conditions.

    16. Development of foreign trade

    Commercial bank help the importers and exporters by providing them foreign exchange, it

    also issues letter of credit to ensure the payment.

    17. More production

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    A good banking system increases the production capabilities of the country by growing

    capital formation and proper labour division

    18. Modern technology

    The use of modern technology Is possible only when the banking system is developed as it is

    the main source of their funds

    19. Collection of zakat

    Commercial deducts amount of zakat from depositor account on the behalf of government

    and distribute the same among the deserving people

    20. Use of idle funds

    The idle funds of individuals and firms are get utilized through the commercial bank. This

    helps in expansion of production capacity of a country

    Imperial learning institute

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    Q#17 What is the process of credit creation? What are the limitations

    on the powers of bank to create credit? (Or) Commercial banks are the

    factories of credit, explain. (Or) How does the commercial bank create

    credit what are its limitations? (Or) Loans are the children of deposits and

    deposits are the children of loans. Discuss

    Credit creation

    Commercial banks are the factories of credit. It is the most important function of the

    commercial bank. Commercial banks create credit by providing loans. The amount of loan is

    not paid directly to the customer. The amount is deposited in the borrower account. The

    borrower can withdraw amount by issuing cheque. Thus loans create deposit and deposit

    create loan.

    Assumptions

    1. Many banks

    It is assumed that there are many banks that are working in the country and they are

    cooperating with each other for the purpose of credit creation.

    2. Same cash ratio

    It is assumed that the cash reserve ratio is the same for every bank that may be 20%.

    3. Bank transaction

    It is also assumed that the money taken as loan must be deposited in the same or other bank.

    The loan given by the second bank must be deposited into the third bank and so on

    4. Initial deposit

    There must be initial deposit in every bank by the customer. This initial deposit is the basis of

    credit creation.

    5. Many borrowers

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    It is assumed that there are many borrowers and the bank gives them loan against the

    securities

    Process of credit creation

    The process of credit creation can be explained with the help of examples

    Suppose, Bank A receives RS 1000 as a deposit from customer, the bank keeps 20% of

    deposit and lends 80% of deposit to Mr. X.

    The position of Bank A after credit creation is as follows

    Balance sheet of Bank A

    Liabilities Amount Assets Amount

    Deposits 1000 Cash reserve 200

    Loan to Mr. X 800

    Total 1000 Total 1000

    We now assume that the Mr. X makes Payment of Rs 800 to Mr. Y by cheque. Mr. Y

    deposited his cheque in his account in Bank B. Bank B receives Rs. 800 as deposit and after

    keeping 20% reserve he lends the remaining 80% as loan to Mr. Z. The balance sheet of Bank

    B after giving loan is as follows.

    Balance sheet of Bank B

    Liabilities Amount Assets Amount

    Deposits 800 Cash reserve 160

    Loan to Mr. z 640

    Total 800 Total 800

    The process is not yet completed, it will continue further. The whole process can be

    explained as follows.

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    Bank Primary deposit Reserves 20% Credit creation

    A 1000 200 800

    B 800 160 640

    C 640 L28 512

    D 512 102 409

    E ---- ---- ----

    F ----- ---- ----

    G ------ ---- ----

    H ------ ---- ----

    n ------- ---- ----

    Total 5000 1000 4000

    This table shows that if the bank have initial deposit of 1000 and reserve ratio is 20% then

    bank create credit of Rs 4000 and the total demand deposit is Rs 5000 which is equal to the

    initial deposit of Rs 1000 and credit creation of Rs 4000

    Formula of credit creation

    The amount of credit creation can also be calculated with the help of formula

    = 5000

    Limitation of credit creation

    The capacity of bank to create credit depends upon the following factors

    1. Withdrawals

    Credit creation depends on the deposits. If a borrower withdraws a part or entire amount

    loaned to him the bank will not be able to create credit.

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    2. Cash reserve

    The commercial bank keeps a large portion of cash as reserve for making the payment of

    cheque. If the reserve ratio is high the bank cannot crate much credit.

    3. Proper securities

    Bank grants loan against a proper security, if the proper security is not available the

    commercial bank cannot create credit

    4. Business conditions

    People only borrow loans when there are good business conditions. In worst business

    condition people hesitate to take loan, thus it becomes the hurdle in credit creation.

    5. Willingness to borrow

    Commercial bank can create credit only if customers are willing to borrow but if they are not

    willing to borrow commercial bank cannot create credit.

    6. Policy of lending

    Commercial banks are not independent in connection with lending. They have to follow the

    policies of central bank. The central bank impose restriction on the commercial bank to create

    credit

    7. Primary deposit

    Credit creation depends upon the primary deposit. If people are not in habit to deposit their

    savings in bank, then the central bank cannot create credit

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    Q#18

    Explain the relationship between banker and customer. (Or) What are the

    types of relationship between banker and customer? (Or) explain the

    nature of relationship between the banker and customer

    Banker

    J.W Gilbert says that A banker is a dealer in capital or, more properly, a dealer in money.

    He is an intermediate party between the borrower and the lender. He borrows from one party

    and lends to another.

    In simple words banker can be defined as a person who receives money and accepts the

    cheque drawn upon him by customer. A banker also collects and pays drafts, dividend and

    bill of exchange.

    Customer

    Justice Lindley says customer is a person who has some sort of account either deposit or

    current account or some sort of similar relation with a banker

    Relationship

    The relationship of banker and customer is primarily of debtor and creditor with a super-

    added obligation on the part of banker to accept the customers cheque, if the account is in

    credit.

    Relationship of debtor and creditor

    1. Debtor and creditor

    The relationship of banker and customer is of debtor and creditor. When an account is

    opened, banker becomes the debtor of is customer. And customer becomes the creditor of his

    banker. When the account of customer is out of credit the relationship ends.

    2. Principal and agent

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    The relationship between banker and customer is of principal and agent. The customer is

    principal and banker is agent at the time of collection of cheque and bill of exchange.

    Moreover banker also purchases and sale shares as an agent.

    3. Financer and financee

    The banker is called financer and customer is known as financee. Banker grants loans to his

    customer to meet the cash requirements

    4. Bailor and Bailee

    The customer becomes Bailor at the time of delivery of valuable goods for the safe custody.

    The banker acts as Bailee when he receives goods from customer

    5. Pledger and pledgee

    The customer can become Pledger at that time of providing security of moveable property for

    obtaining loan. And banker becomes pledgee when he grants loans against security.

    6. Mortgager and mortgagee

    The customer becomes mortgager at that time when he obtains loan against immovable

    property and banker becomes mortgagee when he grants loan against immovable property.

    7. Author and trustee

    Banker acts as trustee for a customer who keeps valuable & documents for the safe custody.

    The customer becomes the author.

    8. Reference and referee

    The customer becomes reference and banker becomes referee when banker is asked to

    comment on financial position of customer. The banker as referee can submit favorable and

    unfavorable reports to other bank.

    9. Lessor and lessee

    When the bank pr