Money Creation in Banking System
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Questions and Answers

What happens to the price of a bond when market interest rates rise?

  • The price of the bond increases
  • The price of the bond stays the same
  • The price of the bond decreases (correct)
  • The price of the bond becomes unpredictable

    • 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.

    <p>fall</p> Signup and view all the answers

    Match the following terms with their definitions:

    <p>Market interest rate = The rate that influences the price of bonds Capital loss = Loss suffered due to falling bond prices Speculative demand for money = Desire to hold cash due to expected price changes Bond holder = An individual who owns a bond</p> Signup and view all the answers

    Which of the following scenarios leads to a decrease in bond prices?

    <p>Expectation of rising market interest rates</p> Signup and view all the answers

    If current interest rates are at 5% and expected to rise to 8%, this indicates a potential loss for bondholders.

    <p>True</p> Signup and view all the answers

    What does a decrease in bond price imply for a bondholder?

    <p>It implies a capital loss.</p> Signup and view all the answers

    What happens when the Reserve Bank of India sells a bond?

    <p>It decreases the quantity of reserves.</p> Signup and view all the answers

    Outright open market operations involve an agreement for future resale of securities.

    <p>False</p> Signup and view all the answers

    What is the interest rate called at which the money is lent in a repo agreement?

    <p>repo rate</p> Signup and view all the answers

    The rate at which money is withdrawn during a reverse repo is called the __________.

    <p>reverse repo rate</p> Signup and view all the answers

    Match the following terms with their definitions:

    <p>Outright Operations = Permanent injection/absorption of money Repo = Agreement with a promise to resell securities Reverse Repo = Agreement with a promise to repurchase securities Repo Rate = Interest rate for borrowing in repo agreements</p> Signup and view all the answers

    Which of the following types of open market operations is temporary?

    <p>Repo operations</p> Signup and view all the answers

    The Reserve Bank of India only conducts outright open market operations.

    <p>False</p> Signup and view all the answers

    List one main tool of monetary policy used by the Reserve Bank of India.

    <p>Repo or Reverse Repo operations</p> Signup and view all the answers

    What must a bank ensure regarding its lending activities?

    <p>Sufficient funds to repay depositors on demand</p> Signup and view all the answers

    What is included in M1?

    <p>Currency held by the public and net demand deposits held by commercial banks</p> Signup and view all the answers

    Banks can only lend money if they have all deposits available to them at any given time.

    <p>False</p> Signup and view all the answers

    M3 is considered a narrow money measure.

    <p>False</p> Signup and view all the answers

    What does a bank's balance sheet record?

    <p>Assets and liabilities</p> Signup and view all the answers

    What does CU stand for in the money supply definitions?

    <p>Currency (notes plus coins) held by the public</p> Signup and view all the answers

    When a bank gives out a loan, it becomes a claim on the _______.

    <p>borrower</p> Signup and view all the answers

    M2 is calculated by adding savings deposits with __________ to M1.

    <p>Post Office savings banks</p> Signup and view all the answers

    Match the following terms with their definitions:

    <p>Assets = What a firm owns or can claim from others Liabilities = What a firm owes to others Reserves = Deposits held with the Central bank Loans = Money given to public that the bank expects to be repaid</p> Signup and view all the answers

    Which of the following is considered a liability for a bank?

    <p>Deposits from customers</p> Signup and view all the answers

    Match the following types of money with their definitions:

    <p>M1 = Most liquid and easiest for transactions M2 = Narrow money including savings deposits M3 = Broad money including net time deposits M4 = Least liquid, including total deposits with Post Office savings organizations</p> Signup and view all the answers

    Which of the following is NOT considered part of the money supply?

    <p>Interbank deposits</p> Signup and view all the answers

    Reserves are the assets banks keep with the Reserve Bank of India.

    <p>True</p> Signup and view all the answers

    Demonetisation in India involved making old Rs 500 and Rs 1000 notes illegal tender.

    <p>True</p> Signup and view all the answers

    What is the equation representing assets for a bank?

    <p>Assets = Reserves + Loans</p> Signup and view all the answers

    What is the primary purpose of demonetisation in India?

    <p>To tackle corruption, black money, terrorism, and fake currency circulation.</p> Signup and view all the answers

    What is the formula used to calculate the sum of an infinite geometric series?

    <p>$S = \frac{a}{1 - r}$</p> Signup and view all the answers

    The value of 'a' in the example derived for the money multiplier is equal to 1.

    <p>True</p> Signup and view all the answers

    What does the term 'lender of last resort' refer to in the context of RBI?

    <p>It refers to the RBI's role to provide liquidity to banks in financial distress.</p> Signup and view all the answers

    In the infinite geometric series, the value of 'r' must be between ___ and ___.

    <p>0, 1</p> Signup and view all the answers

    Match the following terms to their definitions:

    <p>Monetary Policy = Regulation of the money supply and interest rates Money Multiplier = Ratio of money supply to the monetary base RBI = Central banking institution in India Commercial Bank = Financial institution that accepts deposits</p> Signup and view all the answers

    What is the value of 'r' used in the money multiplier example?

    <p>0.4</p> Signup and view all the answers

    A commercial bank is considered a creator of money in the economy.

    <p>True</p> Signup and view all the answers

    What determines the value of the money multiplier?

    <p>The value of the money multiplier is determined by the reserve ratio.</p> Signup and view all the answers

    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.

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