Questions and Answers
What happens to the price of a bond when market interest rates rise?
A capital loss occurs when the price of a bond increases.
False
If you expect the market interest rate to rise, what might happen to the bond prices?
Bond prices will fall.
When interest rates are very high, investors expect them to ______ in the future.
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Match the following terms with their definitions:
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Which of the following scenarios leads to a decrease in bond prices?
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If current interest rates are at 5% and expected to rise to 8%, this indicates a potential loss for bondholders.
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What does a decrease in bond price imply for a bondholder?
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What happens when the Reserve Bank of India sells a bond?
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Outright open market operations involve an agreement for future resale of securities.
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What is the interest rate called at which the money is lent in a repo agreement?
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The rate at which money is withdrawn during a reverse repo is called the __________.
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Match the following terms with their definitions:
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Which of the following types of open market operations is temporary?
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The Reserve Bank of India only conducts outright open market operations.
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List one main tool of monetary policy used by the Reserve Bank of India.
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What must a bank ensure regarding its lending activities?
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What is included in M1?
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Banks can only lend money if they have all deposits available to them at any given time.
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M3 is considered a narrow money measure.
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What does a bank's balance sheet record?
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What does CU stand for in the money supply definitions?
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When a bank gives out a loan, it becomes a claim on the _______.
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M2 is calculated by adding savings deposits with __________ to M1.
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Match the following terms with their definitions:
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Which of the following is considered a liability for a bank?
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Match the following types of money with their definitions:
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Which of the following is NOT considered part of the money supply?
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Reserves are the assets banks keep with the Reserve Bank of India.
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Demonetisation in India involved making old Rs 500 and Rs 1000 notes illegal tender.
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What is the equation representing assets for a bank?
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What is the primary purpose of demonetisation in India?
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What is the formula used to calculate the sum of an infinite geometric series?
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The value of 'a' in the example derived for the money multiplier is equal to 1.
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What does the term 'lender of last resort' refer to in the context of RBI?
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In the infinite geometric series, the value of 'r' must be between ___ and ___.
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Match the following terms to their definitions:
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What is the value of 'r' used in the money multiplier example?
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A commercial bank is considered a creator of money in the economy.
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What determines the value of the money multiplier?
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Study Notes
Banking and Money Creation
- Banks must maintain a balance in lending to ensure they can repay depositors on demand.
- Money creation occurs as banks lend, resulting in new deposits while existing deposits remain intact.
- Total money supply equals old deposits plus new deposits plus currency.
Bank Balance Sheets
- A bank's balance sheet records assets on the left and liabilities on the right, ensuring both sides are equal.
- Assets include loans issued to public and reserves kept with the central bank (e.g., Reserve Bank of India).
- Reserves consist of cash and financial instruments such as bonds and treasury bills.
- Bank assets can be summarized as: Assets = Reserves + Loans.
Liabilities in Banking
- Liabilities comprise debts or obligations that banks owe to others, including customer deposits.
Open Market Operations
- Open market operations are actions taken by the central bank to manage money supply through buying or selling securities.
- Two types of operations:
- Outright: Permanent changes to money supply (buying/selling securities without a future promise).
- Repo: Temporary agreements with specifications for resale date/price.
- The interest rate for repo transactions is termed the repo rate, while reverse repos have a reverse repo rate.
Interest Rates and Bond Prices
- Bond prices are inversely related to market interest rates.
- Expectations of future interest rate movements influence demand for bonds and money.
- Anticipation of falling interest rates may drive capital gains from bond-holding, causing speculative demand for money.
Measures of Money Supply
- M1 = Currency in circulation (CU) + Demand Deposits (DD)
- M2 = M1 + Savings deposits with Post Office savings banks
- M3 = M1 + Net time deposits of commercial banks
- M4 = M3 + Total deposits with Post Office savings organizations (excluding specific savings certificates)
- M1 and M2 are considered narrow money; M3 and M4 are broad money, ordered by liquidity.
Demonetisation in India
- Demonetisation was initiated in November 2016 to combat corruption, black money, terrorism, and fake currency.
- Old currency notes of Rs 500 and Rs 1000 ceased to be legal tender.
Monetary Policy Instruments
- Key tools of the Reserve Bank of India include repo and reverse repo operations to manage liquidity and stimulate or dampen economic activity.
The Money Multiplier
- The money multiplier effect arises as banks lend more than they hold in physical cash based on reserve ratios.
Infinite Geometric Series
- The sum of an infinite geometric series can be calculated using the formula: S = a / (1 - r), where 0 < r < 1.
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Description
This quiz explores the principles of money creation by banks and their responsibility to balance lending activities. Understand how banks manage deposits and loans to ensure liquidity for depositors while expanding the money supply.