Money and Banking Class 12 Economics Exam Questions

Exam Questions Class 12

Please refer to Money and Banking Class 12 Economics Exam Questions provided below. These questions and answers for Class 12 Economics have been designed based on the past trend of questions and important topics in your class 12 Economics books. You should go through all Class 12 Economics Important Questions provided by our teachers which will help you to get more marks in upcoming exams.

Class 12 Economics Exam Questions Money and Banking

Class 12 Economics students should read and understand the important questions and answers provided below for Money and Banking which will help them to understand all important and difficult topics.

Question. Do you consider a commercial bank ‘creator of money’ in the economy?
Ans. Credit Creation. Credit creation is one of the most significant function performed by commercial banks. Credit is defined as finance made available by one party to another party on a certain rate of interest. Credit plays a crucial role in the monetary and business system. Credit creation process. Depositors have current account in commercial banks and can meettheir obligations through cheques. These banks have the power to expand or contract demand deposits. This power is known as credit creation or credit contraction. Whenever a bank gives  a loan, it creates a deposit. Commercial banks are able to multiply loans and investment and, thus, multiply deposits. A small volume of cash is the basis of multiplication of deposits, through multiplication of loans and advances. This is how commercial banks creates credit.

Question. What role of RBI is known as ‘lender oflast resort’?
Ans. Lender of the last resort. The central bank acts as a lender of the last resort for commercial banks. When commercial banks fail to meet obligations of their depositors, the central bank comes to their rescue. The central bank advances necessary credit against eligible securities subject to certain terms and conditions. This saves banks from a possible breakdown. Central bank never refuses to accommodate any eligible bank and help them in need. This function of the central bank is regarded as the basic important function of Central Banking System.

Question. Explain M1 
Ans. From April 1977, following the recommendations of its Second Working Group on Money Supply, the Reserve Bank of India (RBI) has presented four measures of money supply namely M1, M2, M3 and M4 These are defined below in decreasing order of their liquidity:
M1 Measurement. M1 is narrow definition of money. M1 is most liquid and easiest for doing transactions.
M1 = C + DD + OD
where,
  C = Currency held by public.
DD = Net demand deposits of the bank (Net demand deposits do not include interbanking claims)
OD = Other deposits held with the RBI. These are deposits of quasi-government institutions like Industrial Development Bank of India, International Monetary Fund, World Bank etc., with the RBI.

Question- Explain money multiplier.
Ans. This process of a deposit becoming a loan or an investment, which in turn becomes a new deposit goes on, till the original deposit of f 1,000 is completely exhausted. The original deposit of   1,000 becomes additional deposits of   900,   729, etc. If we add up all these deposits, the total will be   10,000 or 10 times the original deposits of 1,000. That is, the deposit multiplier is 10. It is a self-sustaining, continuous and complete process where on one hand deposits are multiplying and on the other hand commercial banks are increasing their assets.
The formula for calculating deposit or money multiplier is:
Money Multiplier = Lim
where,
                      k = deposit multiplier
                  LRR = legal reserve ratio.

Question. lflegal reserve ratio is 0.5 and initial deposit by people is f 100 crores then calculate total money created by commercial banks?
Ans. Money multiplier = Lk = is = 2
         Money creation = Initial deposit x Lk
                                = 100 x 2 = f 200 crores.

Question. What is High Powered Money?
Ans. It is money created or produced by the RBI.

Question. Give the formula of Money Multiplier?
Ans. Money Multiplier = Lk
Lower the value of LRR, higher is the value of money mulitiplier.

Question. How does bank rate p olicy help in expanding or contracting credit in an economy?
Ans. The bank rate is the rate at which the central bank lends funds as a ‘lender of last resort to banks, against approved securities or eligible bills of  xchange. The effect of a change in the bank rate is to change the cost of securing funds from the central bank. An increase in the bank rate increases the costs of borrowing from the central bank. This will reduce the ability of banks to create credit. A rise in the bank rate will then cause the banks to increase
the rates at which they lend. This will then discourage businessmen and others from taking loans, thus reducing the volume of credit. A decrease in the bank rate will have the opposite effect.

Question. Explain “bankers bank and supervisor” function of central bank.
Ans. As the banker to banks, the Central Bank holds a part of the cash reserves of banks, lends them short-term funds and provides them with centralised clearing and remittance facilities. The banks are required to deposit a stipulated ratio of their net total liabilities (the CRR) with the Central Bank. The purpose of this stipulation is to use these reserves as an instrument of monetary and credit control. In addition to this the bank holds excess reserves with the Central Bank to meet any clearing drains due to settlement with other banks or net withdrawals by their account holders. The pool of funds with the Central Bank serves as a source from which it can make advances to banks temporarily in need of funds, acting in its capacity as lender of last resort.
The Central Bank supervises, regulates and controls the commercial banks. The regulation of banks may be related to their licensing, branch expansion, liquidity of assets, management, amalgamation (merging of banks) and liquidation (the winding up of banks). The control is exercised by periodic inspection of banks and the returns filled by them.

Question. What is a ‘legal tender’? What is ‘fiat money’?
Ans. Fiat money. It refers to money by order/authority of the government. It includes notes and coms. Legal tender. Money may be classified as limited legal tender and unlimited legal tender.

(i) Limited legal tender. Limited legal tender is that money which no person can be forced to accept beyond a particular limit fixed by law. In India, coins of the denominations of one paise to twenty five paise are legal tender only upto f 25.

(ii) Unlimited legal tender. Unlimited legal tender is that money which a person has to accept without any legal limit. In India, one-rupee coin, 50 paise coin and paper notes of all denominations are unlimited legal tender.

Question. What is transaction demand for money? (a) How is it related to the value of transactions over a specified (b) Period of time?
Ans. This question is out of syllabus.

Question,. Why is speculative demand for money inversely related to the rate of interest?
Ans. This question is out of syllabus.

Question. What is ‘liq uidity trap’?
Ans. This question is out of syllabus.

Question. What are the main functions of money? How does money overcome the shortcomings of a barter system?
Ans. Main functions of money are:
(a) Money acts as a medium of exchange. Money serves as a medium of exchange or medium of payments. Money helps in buying and selling of goods. Goods are exchanged for money and this money can be used for buying any other good that we need. Thus, money acts as an intermediary and facilitates trade. Money has removed the difficulty of double coincidence of wants. Now, a person A can sell his goods to another person B for money and then he can use that money to buy the goods he wants. Money has made the exchange of goods easy.

(b) Unit of value. Money serves as a unit of value or common measure of value in terms of which the value of all goods and services are measured. This helps in measuring the exchange values of commodities. The prices of all the goods and services can be fixed in terms of money and the problem of expressing of the value of each commodity in terms of quantities of other goods can be avoided. This function of money makes it possible to keep business accounts. It would not be possible to keep business account unless all business transactions are expressed in terms of money.

(c) Standard of deferred payments. Money also serves as a standard of deferred payments. Deferred payments refer to those payments which are made in future. When we borrow money from somebody in the present, we have to return both the principal as well as interest amount at some future date. It is easy to make such payments in terms of money because its price remains relatively stable as compared to other commodities.

(d) Store of value. Money serves as a store of value. It means that money is an asset and can be stored in future. Under barter system, storing of value (savings) is very difficult in terms of goods. But money has completely solved this problem. Now, savings are done in terms of money. Whereas the value of goods are frequently changing, value of money is more or less stable. Moreover, goods are perishable, money is not perishable in the same sense. Money occupies less space for storage in comparison with goods. Hence, money is the best form of ‘store of value’.

Question. What are the alternative definitions of money supply in India?
Ans. Measures of Money Supply From April 1977, following are the recommendations of its Second Working Group on Money Supply the Reserve Bank of India (RBI) has presented four measures of money supply namely Mi, M2, M3 and M4• These are defined below in decreasing order of their liquidity:
where,
M1 Measurement: M1 is narrow definition of money. M1 is most liquid and easiest for transactions.
M1 = C + DD + OD
M2 = M1 + Savings of the people with post offices.
M3 = M1 + Net time deposits with the commercial banks.
M4 = M3 + Savings with the Post Offices (other than in the form of National Saving Certificate

Question. Give some importance of money.
Ans. Importance of money can be seen from the following:
1. Money may not produce anything, but without it, nothing can be produced.
2. With the help of money, consumers make payment for goods and services.
3. With the help of money, producers can buy raw material, plant and machinery. They can settle their debts and pay corporate taxes.
4. Money has contributed to economic growth all over the world because it has removed trade barriers.
5. With the help of money, government realises all taxes, fees, fines, penalties and other sources of public revenue.
Thus, money can serve mankind if it is controlled and regulated. But if it goes out of control, it can lead to disastrous consequences.

Question . What is a barter system? What are its drawbacks?
Ans. The direct exchange of goods for goods without the use of money is called barter system.
The major drawbacks of the barter system are:

(a) Lack of double coincidence of wants. The lack of double coincidence of wants is the major drawback of the barter system. It is very rare when the owner of some good or service could find someone who wanted his goods or services and possessed that good or service that the first person wanted. No exchange is possible if the double coincidence of wants is not there.

(b) Lack of common measure of value. The second main drawback of barter is the absence of a common unit of measurement in which the value of goods and services can be measured. In the absence of common unit, proper accounting is not possible.

(c) Lack of standard for deferred payments. The third drawback of the barter system is that it lacks any satisfactory unit to engage in contracts involving future payments. In a barter economy, future payments would have to be stated in specific goods or services which may involve disagreement over the quality of goods or even on the commodity used for repayment.

(d) Lack of store of value. The barter system does not provide for any method of storing purchasing power for future use. It can be stored only in terms of commodities which is subject to storage cost, durability, increase or decrease in the value of good and the difficulty in disposing of the commodity without loss.

Question. Explain the following functions of Central Bank:
(a) Custodian of foreign exchange reserves
(b) Lender oflast resort
Ans. (a) Custodian of foreign exchange reserves. The central bank is the custodian of a country’s stock of gold and international currencies. The central bank maintains the stability of exchange rate fixed by the government. All earnings, in foreign exchange transactions are to be deposited with the central bank and are routed through it. By the sale and purchase currencies at par with their internal values, and help the government to pursue a coordinated policy towards balance of payment situation in a country.

(b) Lender of last resort. The central bank is under the obligation to provide funds to commercial banks as and when they need financial help. The aim is that no sound and genuine business transaction should be restricted or abandoned due to shortage of funds. Commercial banks approach the central bank as a last resort in distress. The central bank advances necessary credit against eligible securities, subject to certain terms and conditions. Central bank never refuses to accommodate any eligible bank and help them to meet emergencies.

Question,. What is a ‘legal tender’? What is ‘fiat money’?
Ans. Fiat money. It refers to money by order/authority of the government. It includes notes and coms.
Legal tender. Money may be classified as limited legal tender and unlimited legal tender.
(i) Limited legal tender. Limited legal tender is that money in which no person can be forced to accept beyond a particular limit fixed by law. In India, coins of the denominations of one paise to twenty five paise are legal tender only upto f 25.
(ii) Unlimited legal tender. Unlimited legal tender is that money which a person has to accept without any legal limit. In India, one-rupee coin, 50 paise coin and paper notes of all denominations are unlimited legal tender.

Question. What do you mean by money supply? Explain the main components of money supply.
Ans. The stock of money held by the public at a point of time in an economy is referred to as the money supply.
There are two main components of money supply, i.e., currency component and deposit component.
1. Currency Component. It consists of coins and paper currency.
(a) Coins. Coins are made up of metal. The metallic coins are issued by the monetary authority of the country i.e., central bank with the central government of the country. Today, in India coins of 50 paise, f 1, f 2 and f 5 are in use.
(b) Paper Currency. Paper currency or currency notes are the most important part of the money supply. The central bank in every country has monopoly right of issuing currency notes. In India, one rupee note is issued by the Ministry of Finance, Government of India, while the remaining notes of higher denominations or coins are issued by the central bank, i.e., Reserve Bank of India.

2. Deposit Component or Demand Deposits Demand deposits are also the most important component of the money supply. These are the money deposits made by the depositor or owner of the deposit to the bank Now bank is agreed to honour such demands or pay money on demand at any time and to  homsoever the owner of the deposit may wish. For this purpose the people use cheques to meet financial obligations.

Question. What is money multiplier? How will you determine its value? What ratios play an important role in the determination of the value of the money multiplier?
Ans. Money Multiplier = Lk.
Lower the LRR, higher is the value of money multiplier and vice versa.

Question. What are the instruments of monetary p olicy of RBI ? How does RBI stabilise money sup ply against exogenous shocks?
Ans. The main instruments of monetary policy of RBI are:
Qyantitative Methods
1. Bank Rate Policy
2. Open Market Operations
3. Varying Reserve Requirements
(a) Cash Reserve Ratio
(b) Statutory Liquidity Ratio.
Qyalitative Methods
1. Margin Requirement
2. Moral Suasion
3. Selective Credit Controls
Stabilisation by RBI. RBI often uses its instruments of money creation for stabilising the stock of money in the economy from external shocks.

Question. What is credit money?
Ans. Credit money is money whose value as money is more than the commodity value of the material form in which the money is made. Credit money is of four kinds:

Question. What is High Powered Money?
Ans. It is money created or produced by the RBI.

Question. Explain the functions of a commercial bank.
Ans. A commercial bank is a financial institution which accepts deposits from the public and advances loans to others. The main functions that commercial banks perform are:
(i) Accepting of deposits.
(ii) Agency functions.
(iii) Investment of funds.
(iv) Agency functions.
( v) General utility services.

Money and Banking Class 12 Economics Exam Questions

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