CBSE Class–12 economics

Important Questions - Macro Economics 03

Money and Banking

VERY SHORT ANSWER QUESTIONS (1 Mark)

Q1. Central Bank is an

a) Apex bank
b) Rural bank
c) Regional bank
d) Commercial bank
Ans. (a)

Q2. Money is a medium of

a) Communication
b) Barter
c) Exchange
d) Speculation
Ans. (c)

Q3. The functions of money is that it is a

a) Store of currency
b) Store of stocks
c) Store of a value
d) None of the above
Ans. (c)

Q4. Money overcomes the problems of barter system.

a) Can’t say
b) Seldom
c) 0
d) 1
Ans. (d)

Q5. One of the measures of money supply is

a) O1
b) N1
c) M1
d) P1
Ans. (c)

Q6. The process of money creation or credit creation is done by

a) Rural bank
b) World bank
c) Central bank
d) Commercial bank
Ans. (d)

Q7. Money is something that is

a) Universally accepted
b) Locally accepted
c) Accepted by banks
d) Regionally accepted
Ans. (a)

Q8. One drawback of barter exchange is

a) Lack of trust
b) Lack of coincidence of wants
c) Lack of double coincidence of wants
d) Lack of goods
Ans. (c)
Q9. What do you mean by credit creation by commercial banks?
a) It is the process of loan creation
b) It is the process of creation of foreign exchange
c) It is the process of total withdrawal creation
d) It is the process of total deposit creation
Ans. (d)

Q10. Bank rate is for

a) Commercial banks by the government
b) Commercial banks by the central bank
c) Central banks by the central bank
d) Central bank by the commercial banks

Ans. (b)

Q11. Lending rate is for

a) Public by the commercial banks
b) Central bank by the commercial banks
c) Central banks by the central bank
d) Commercial banks by the government
Ans. (a)

Q12. Open market operations is

a) Buying and selling of currency by the central bank
b) Buying and selling of securities by the central banks
c) Buying and selling of securities by the commercial banks
d) Buying and selling of foreign exchange by the central bank
Ans. (b)

Q13. Money supply is equal to

a) Money saved in post office savings bank only.
b) Total stock of money held by government.
c) Total stock of money circulating in an economy.
d) Total flow of money circulating in an economy.
Ans. (c)

Q14. The lender of last resort is a function of

a) Rural bank
b) Post office
c) Central bank
d) Commercial bank
Ans. (c)

Q15. Legal reserve ratio is equal to

a) CRR÷SLR
b) CRR-SLR
c) SLR-CRR
d) CRR+SLR
Ans. (d)

SHORT ANSWER QUESTIONS (3/4 Marks)

Q16. Calculate the value money multiplier and the total deposit created if
initial deposit is Rs. 500 crores and LRR is 10%.

Ans. Value of money multiplier = 1/LRR which is equal to 1/0.1 = 10

Initial deposit was Rs. 500 crores

Hence Total Deposit will be Initial Deposit × Money Multiplier

= 500 ×10

= 5000 Crores
Q17. Calculate LRR, if initial deposit of Rs. 200 crores lead to creation of total
deposits of Rs. 1600 crores.

Ans. Money Multiplier = Total Deposits / Initial Deposits

= 1600 / 200 = 8

Hence Money Multiplier = 1/LRR

8 = 1/LRR

LRR = 1.25 or 12.5

Q18. If total deposits created by commercial banks are Rs. 12,000, LRR is
25%, calculate initial deposit.

Ans. Money Multiplier = 1/LRR = 1/025 = 4

Initial Deposit = Total Deposit / Money Multiplier

= 12000 / 4

= Rs. 3000

Q19. What do you mean by high powered money?

Ans. High powered money or powerful money refers to that currency that has
been issued by the Government and Reserve Bank of India. Some
portion of this currency is kept along with the public while rest is kept
as funds in Reserve Bank.

The equation is:

H=C+R

Where H = High Powered Money

C = Currency with the public (Paper money + coins)

R = Government and bank deposits with RBI

Thus the sum total of money deposited with the public and the funds of
banks is termed as powerful money. It is mainly created by the central
bank.
Q20. Bring out the role of Central Bank as the controller or money supply or
credit.

Ans. If the Central Bank wants to control credit, it will raise the bank rate. As a
result, the market rate and other lending rates in the money-market will
go up. Borrowing will be discouraged. The raising of bank rate will lead
to contraction of credit. Similarly, a fall in bank rate mil lowers the lending
rates in the money market which in turn will stimulate commercial and
industrial activity, for which more credit will be required from the banks.
Thus, there will be expansion of the volume of bank Credit.

LONG ANSWER QUESTIONS (6 Marks)

Q21. Explain the following functions of the Central Bank of India.

1. Bank of Issue
2. Banker’s bank

Ans.

1. Bank of Issue –

A country's main bank whose responsibilities include the issue of

currency, the administration of monetary policy, open market
operations, and engaging in transactions designed to facilitate healthy
business interactions. For e.g. Reserve Bank of India, Bank of England
or the U.S. Federal Reserve banks. In simple words, a bank that has the
official right to produce currency, it can be paper money and coins, etc.
In India, The Reserve Bank has the sole authority to issue banknotes in
India. Reserve Bank, like other central banks the world over, changes
the design of banknotes from time to time. The Reserve Bank has
introduced banknotes in the Mahatma Gandhi Series since 1996 and has
so far issued notes in the denominations of Rs.5, Rs.10, Rs.20, Rs.50,
Rs.100, Rs.200 and Rs.500 in this series.
 2. Banker’s bank –

A bankers' bank is specific type of bank that a group of larger, more

established banks create. Bankers' banks exist for the purpose of
servicing the charter banks that founded them. While their banking
services are not generally open to the public in any fashion, these
institutions are designed to support community banks. The commercial
banks maintain a current account with the central bank and can borrow
money in the very short term. Thus, the banks which have to supply
banknotes for their customers (either over the counter or through
automatic teller machines) obtain them from the central bank which has
an issuing monopoly. In India, RBI as an apex bank acts as the banker's
bank. All the commercial banks in India are supposed to keep a cash
reserve ratio with this bank. Commercial banks create credit. It is the
duty of the RBI to control the credit through the CRR, bank rate and open
market operations.

Q22. Explain the leading functions of commercial banks.

Ans. Commercial banks are the most important components of the whole
banking system. A commercial bank is a profit-based financial institution
that grants loans, accepts deposits, and offers other financial services,
such as overdraft facilities and electronic transfer of funds. According to
Culbertson, “Commercial Banks are the institutions that make short term
bans to business and in the process create money.”
 As per above illustration, commercial banks has divided its functionality
in two divisions, viz, Primary and Secondary functions.

(a) Primary Functions mainly refer to the basic functions of commercial

banks that include the following:
i. Accepting Deposits implies that commercial banks are mainly
dependent on public deposits. There are two types of deposits mainly
demand and time deposits. Demand deposits refer to kind of deposits
that can be easily withdrawn by individuals without any prior notice
to the bank. Time deposits refer to deposits that are for certain period
of time. Banks pay higher interest on this deposits.

ii. Advancing Loans means the public deposits are used by commercial
banks for the purpose of granting loans to individuals and businesses.
Commercial banks grant loans in the form of overdraft, cash credit,
and discounting bills of exchange.

(b) Secondary Functions mainly refer to crucial functions of commercial

banks. The secondary functions can be classified under three heads,
namely, agency functions, general utility functions, and other functions.
i. Agency Functions means commercial banks act as agents of
customers by performing various functions, which includes,
Collecting Checks, Collecting Income, and Paying Expenses.
ii. General Utility Functions which includes Providing Locker Facilities,
Issuing Traveller’s Checks, Dealing in Foreign Exchange,
Transferring Funds.
iii. Other functions include Creating Money by lending money to
individual and opening demand deposit, Electronic Banking which
includes services, such as debit cards, credit cards, and Internet
banking, etc.

Q23. State the functions of money.

Ans. Money is often defined in terms of the three functions or services that it
provides. Money serves as a medium of exchange, as a store of value, and
as a unit of account. It is a current medium of exchange in the form of
 coins and banknotes; coins and banknotes collectively. According to Prof.
Walker, ‘Money is as money does.’

The main functions of money are as follows:-

i. Money as the Medium of Exchange - Medium of exchange is the basic or

primary function of money. People exchange goods and services through
the medium of money. Money acts as a medium of exchange or as a
medium of payments. Money by itself has no utility. It is only an
intermediary.
ii. Money as a Unit of Account or Measure of Value - Money serves as a unit
of account or a measure of value. Money is the measuring rod, i.e., it is
the units in terms of which the values of other goods and services are
measured in money terms and expressed accordingly Different goods
produced in the country are measured in different units like cloth m
metres, milk in litres and sugar in kilograms.
iii. Money as the Standard of Deferred Payments - Deferred payments are
payments which are made some time in the future. Debts are usually
expressed in terms of the money of account. Loans are taken and repaid
in terms of money.
iv. Money as a Store of Value - Wealth can be stored in terms of money for
future. It serves as a store value of goods in liquid form. By spending it,
we can get any commodity in future. Keynes places great emphasis on
this function of money. Holding money is equivalent to keeping a reserve
of liquid assets because it can be easily converted into other things.
v. Liquidity of Money - Money is perfectly liquid. Liquidity means
convertibility into cash. Thus, the ability to convert an asset into money
quickly and without loss of value is called liquidity of asset. Modern
economists are laying stress on liquidity of money.
Q24. How does money overcome the problems of barter system?

Ans. Money can overcome the problems of barter system in following ways:

i. Money as medium of exchange solves the barter’s problem of lack of

double coincidence of wants as money has separated the acts of sale
and purchase.
ii. Money as measure or unit of value or a unit of account solves the
barter’s problem of absence of common measure of value. Money
serves as a unit of value or unit of account and acts as a yardstick to
measures exchange value of all commodities.
iii. Money as store of value solves the barter’s problem of difficulty in
storing wealth. It generalised purchasing power.
iv. Money as standard of deferred payments helps to solve the barter
problem of lack of standard of deferred payment. Again, it helps to
make contracts which involve future payments.
v. The use of money meant that people could sell their surplus of goods
in exchange for money and use the money earned to buy their needs.
During ancient wartime, currency was created as it was just too
difficult for soldiers to carry around chickens and beans around to swap
for what they needed.
vi. Indivisibility of goods was a major problem. Under barter, a serious
problem of indivisibility of certain articles was arisen. Some articles
were impossible to divide into small parts. So, that one of the trading
party was compelled to give his indivisible item in full in exchange for
the other's product.
vii. Difficulty in transfer of wealth was also main problem during that time.
Under barter, the difficulty of transferring of a person's wealth arises.
When he intend to shift his wealth like house, property, car from one
place to another, because it is almost impossible to find a person in
another place, who can exchange his property or wealth.

Q25. Why only a fraction of deposits is kept as Cash Reserves?

Ans. Banks operate by taking in deposits and making loans to lenders. Thus,
banks can lend out some of their depositors' money, while keeping some
on hand to satisfy daily withdrawals by depositors. This is called the
fractional-reserve banking system. Banks keep a fraction of deposits as
Cash Reserves. Any experienced banker from his or her experience,
knows two things. Firstly, all the depositors do not approach the banks
for withdrawal of money at the same time and also they do not withdraw
the entire amount in one go. And secondly, there will be constant flow of
new deposits into the banks every day. So, to meet the daily demand for
withdrawal of cash, it is sufficient for banks to keep only a fraction of
deposits as cash reserve. It means, if experience of the banks show that
withdrawals are generally around 20% of the deposits, then it needs to
keep only 20% of deposits as cash reserves (LRR).