mbf all in one

MONEY BANKING & FINANCE

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

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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


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.




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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.


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.


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.


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.


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

from one place to another place

Example



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

him to transfer them.


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.


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.


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)



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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.











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




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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.


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.


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

medium to store savings.


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


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


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.


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.



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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





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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



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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



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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.





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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.





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.



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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



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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 day’s 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.





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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.



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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.

That’s 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



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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



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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.



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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



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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.





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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.



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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



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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.



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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



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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





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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.





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Q# 10

Critically examine the fisher’s quantity theory of

money (Or)

Explain and criticize the fisher’s 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)





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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.





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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. Consumer’s 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 school’s 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 worker’s 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 customer’s 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 minister’s 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





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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 customer’s 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 provides finance to his customer on the basis of lease, the relationship

becomes of Lessor and lessee. The bank is Lessor and customer is lessee



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10. Adviser and advisee

The banker becomes advisor and customer becomes advisee. Bank gives valuable advices to

his customer about the financial matters of business.

11. Licenser and licensee / banker as a trustee

Banker works as licensor / trustee when he keeps the valuable or document of customer for

the safe custody.

12. Banker as beneficiary

When banker receives money from customer and uses it in various sectors for his benefit he

becomes beneficiary.

13. Modarab and Amal

When banker provides finance to his customer on the agreement of Modaraba, the

relationship becomes that of Modarab and Amal. The banker is Modarab and customer is

Amal.

14. Hirer and owner

When goods are delivered to the customer on hire purchase agreement, the banker becomes

the owner and customer becomes the hirer of the same.

15. Pawnor and Pawnee

When a customer keeps his goods or documents with banker as security for the payment of

debt or the performance of promise, the relationship becomes of Pawnor and Pawnee. The

customer becomes Pawnor and banker becomes Pawnee.

16. Correspondent and respondent

Bank issues traveler cheque, letter of credit and credit cards to customer that can be used in

international market for making payments. Banker becomes correspondent and customer

becomes respondent.

17. Indemnifier and indemnity holder



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When the banker promises his customer to compensate for the loss suffered by him, the

banker becomes indemnifier and customer becomes indemnity holder.

18. Testator and executor

When a banker is asked to execute the will of his customer after his death, the banker

becomes executor and banker becomes executor.





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Q#19

What are the circumstances under which the relationship

between banker and customer comes to an end?

Or

What are the reasons of termination of relationship between

banker and customer?

1. Insanity of customer

When a customer loss his senses permanently or in other words when a person becomes of

unsound mind the banker closes his account and the relationship comes to an end

2. Insolvency of customer

When a customer is declared insolvent and he is unable to pay his debts. The relationship

comes to an end and banker stops withdrawals from account.

3. Death of customer

The relationship is atomically terminated on the death of customer. Credit in account is paid

to the heir of customer

4. Unsatisfactory working of bank

The customer may close his account, if he is not satisfied with the working of bank.

5. Order of court

A court may order to stop withdrawals from account. Due to breach of contract, other part is

compensated by court.

6. Notice by banker



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A banker can terminate the relationship by sending a notice to customer, if he finds that his

customer is involved in illegal activities.

7. Notice by customer

A customer can send notice to the banker about the termination of relationship, when he is

not satisfied with the performance of banker

8. Unsatisfactory operation

A banker may close the account, if the customer is not obeying the rules of operating account.

9. Assignment of account

A customer may assign the whole amount in the account to the other party by giving notice to

the banker. When the amount is transferred the relationship between banker and customer

comes to an end

10. Loss of confidence

If a customer is not satisfied with the financial position of bank he may close his bank

account to avoid any type of loss

11. Low profit

If banker pays low profit or interest and charges more interest than a customer may chose to

close his account

12. Change of residence

A customer may terminate his relationship due to change of residence. Customer may shift

his account to the nearest branch of his destination

13. Insufficient balance

When a customer used to draw cheque and does not have credit in his account, banker may

close his account after giving notice

14. Banking hours not observed



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When a customer used to present his cheque after banking hours, banker may close his

account after giving notice

15. Winding up of company

When a company is wounded up by the order of court, no payment of cheque is made. Thus

relationship between banker and company comes to an end





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Q#20

What are the rights and duties of banker and customer

explain them in detail.

Rights of customer

1. Right to draw cheque

A customer has right to issue cheque for taking money if he has sufficient balance in his

account. Customer can also withdraw cheque against debit balance if agreement of overdraft

is made

2. Right to receive bank statement

Every customer has a right to receive bank statement containing details about the withdrawals

and deposits.

3. Right to receive cheque book

A customer has right to receive cheque book at the time of opening bank account so that he

can withdraw cash from account

4. Right to Claim for damages

Customer has right to claim for the damages from bank when he dishonors cheque without

any reason

5. Right to Claim for damages for not maintaining privacy

Privacy of customer account must be maintained, if banker do not maintain the privacy the

customer has right to claim for the damages.

6. Right of correction

A customer has right of rectification of errors made by the banker while debiting and

crediting his account.



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Duties of customer

1. Banking hours

A customer should present cheque during the banking hours. If he present cheque after

banking hours, banker is not responsible for making payment

2. Presentation of cheque

It is the duty of customer to submit his cheque within the time. The life of cheque is six

months from the date of issue

3. Protection of cheque book

It is the duty of customer to keep the cheque book in safe custody so that no one can misuse

it.

4. Report about theft

It is the duty of customer to inform banker, when cheque book or a cheque is lost to avoid

misuse.

5. Filling of cheque book

It is the duty of customer to fill the cheque with care. If any error or mistake is made the

banker may refuse to make the payment

Rights of banker

1. Right to claim charges

Banker has right to claim charges and commission for the services provided to the customer.

2. Right to Charge compound interest

It is the right of bank to charge compound interest on the amount of overdraft according to

the terms and conditions agreed between the parties.

3. Right to retain securities



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It is the right of bank to retain the securities until the customer pays amount of debt. If

customer fails to pay the amount of debt, the banker has right to sell the securities.

4. Right to adjust debit balance

It is the right of banker to adjust the amount of overdraft as soon as the customer deposit

some cash in his account

Duties of banker

1. Payment of cheque

It is the duty of banker to make the payment of cheque drawn on him. The cheque must be

drawn properly and presented within the time

2. Secrecy

It is the duty to banker to maintain the privacy of customer’s account.

3. Standing orders

It is the duty of banker to obey the standing orders in making payments. Such as rent rate and

taxes that are paid after the regular intervals

4. Safe custody

It is the duty of banker to take reasonable care of goods that are deposited for the safe custody

5. Trustee

While acting as trustee, a banker must work according to the terms and conditions of

agreement.





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Q#21

Define central bank. Explain the function of central

bank

Introduction

Central bank has the central position in the banking system. It controls the activities and

system of other banks. Main purpose of central bank is not to earn profit. It works for the

welfare of society. Central bank has sole authority to issue notes. It works as banker of banks

and banker to government. In Pakistan, state bank of Pakistan is acting as central bank

Definition

An institution which is charged with the responsibility of managing the expansion and

contraction of the volume of money in the interest of welfare of economy

Functions of commercial bank

1. Monopoly of note issue

Central bank has the sole authority to issue currency notes. No other bank has authority to

issue notes. In Pakistan, state bank of Pakistan issues currency notes.

The purpose of sole authority is;

i. To bring uniformity in currency notes

ii. To control over printing of notes

iii. To regulate currency according to the demand

2. Banker to the government

Central bank performs several functions on the behalf of government. It gives all those

facilities to government that commercial gives to the public

Following are the functions that are performed by the central bank to facilitate government



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i. Keeping deposits

Central bank keeps deposits of federal and provincial government. It makes payments on the

behalf of government. Central bank does not pay interest on government deposits

ii. Fiscal agent

As a fiscal agent the central bank grants loans to the government and makes investments in

the treasury bills and other long term securities

iii. Foreign loans

Central bank also makes arrangement to get foreign loans on the behalf of government

iv. Financial advisor

It advices government on all financial matters such as controlling the inflation or deflation

and valuation of currency

v. Transfer of capital

Central bank is also responsible for transferring the funds of government form one place to

another place.

3. Banker’s bank

Central bank is the banker of commercial banks and performs the followings functions to

facilitate commercial banks.

i. Custodian of cash reserve

Central bank keeps a certain percentage of deposits of commercial bank as cash reserve; the

amount is kept in safe custody

ii. Clearing house

Central bank acts as the clearing house for commercial banks. All scheduled banks have their

accounts with central bank so the mutual obligation of banks are settled simple by passing

debit and credit entries in their accounts.

iii. Lender of last resort



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Central bank is the supreme bank of a country if a commercial bank is suffering from crises,

central bank grants loans to the commercial banks.

iv. Opening of new bank

New bank or branch cannot be opened without the permission of central bank.

v. Growth of bank

Central bank is responsible for the growth of banking system in country.

4. Control of foreign exchange

Central bank is responsible for the management of foreign exchange. Central bank maintains

the silver, gold and foreign currency reserves in country.

5. Controlling of credit

It is the duty of central bank to maintain and regulate the supply of money according to the

economic needs. If there is depression in economy, central bank expands the supply of

money. If there is inflation in country, central bank aims at contracting the supply of money.

6. Exchange rate stability

Central bank fixes the exchange rate of domestic currency in terms of foreign currency. It

tries to bring stability in exchange rates

7. Development role

Sometimes the central bank takes the responsibility to enhance economic growth. Central

bank develops money markets and capital markets. It introduces the export promotion

schemes to increase the volume of exports. Facilities are provided to promote investment in

various sectors of economy

8. Miscellaneous functions

i. Staff training



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The central bank establishes training institutes and also provides modern training of banking

to the staff.

ii. Saving habits

Central bank makes and plans and adopts the various methods to promote the habits of

savings among the people of country.

iii. Representative of government

Central bank acts as the representative of government for international institutions, like IMF

and World Bank.

iv. Membership fee

If the government wants to be the member of international institutions, central banks pays

membership fee on the behalf of government.

v. Financial reports

Central bank publishes various reports which give the real picture of economy

(729)





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Q#22 Differentiate central bank and commercial bank.

Difference between central bank and commercial bank

Central bank Commercial bank

1. Formation

Commercial bank is formed under companies

ordinance 1984

Central bank is formed under an act of

parliament or ordinance

2. Ownership

The share capital of the commercial bank is owned

by the people

share capital of central bank may be owned by

the commercial bank and central bank

3. Management

Employees of commercial bank are appointed by the

board of the directors

The management and employees of central

bank is appointed by the government

4. Object

The main object of commercial bank is to earn profit

The main object of the central bank is welfare

of society and economic development

5. Issuance of notes Commercial bank cannot issue currency notes

Commercial bank has sole authority to issue

notes.

It can issue plastic money like debit cards, credit

cards and cherubs

6. Branches

Commercial bank has both foreign and national

branches

Central bank only has inland branches it

cannot form its branches in other countries

7. Number of bank

There is only one central bank in every country There are many commercial banks in every bank

8. Account General public, companies and firms can opens



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Government and commercial bank can open

their account in central bank

account in commercial bank

9. Winding up

The commercial bank can be closed if it is

continuously suffering losses

Central bank cannot closed up even if it is

working on loss

10. Transfer of funds

Commercial bank transfer funds of their customers

Central bank transfer funds of commercial

banks and government

11. Discounting of bill

It discounts the bill of commercial bank

It discounts the bills of the customer

12. Advisor

Financial advices the commercial bank and

government on financial matters

The commercial bank give advices to their

customers on financial matters

13. Nature of account

Central opens account of government under

the various heads of accounts

Commercial bank opens account of their customer

under heads of saving, current , PLS, and fixed

deposit account

14. money market

Central bank is the leader of money market It is the member of money market

15. credit controller

It controls credit by using various methods

The commercial bank creates credit according to

money available

16. Foreign payments

It makes the foreign payment on the behalf of

government

It makes foreign payments on the behalf of his

customer

17. Discount of bill

It discounts the bill of commercial banks It discounts the bill of customers.

18. Evening Banking

Central bank does not provide evening banking

The commercial banks provide evening banking

services to customers.



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Q#23

What are the objectives of monetary policy? Also

explain the tolls of monetary policy

Monetary policy

The primary function of central bank is to control money and credit supply. Central bank can

increase and decrease the money supply according to the economic needs of country. In

Pakistan the state bank of Pakistan is controlling the supply of money. The management of

the flow of money is called monetary policy or credit policy.

Definition

According to the prof. Spencer: monitory policy is the purposeful exercise of the monetary

authority’s power to make expansion or contraction in the money supply

Objectives of monetary policy

Objectives of monetary policy may vary from one country to other country depending upon

the economic needs.

Following are the main objectives of monetary policy.

1. Employment

The main objective of monetary policy is to raise the level of employment in country. It

create more opportunities of employment in less developed countries

2. Price stability

The main objective of monetary policy is to maintain the price level at reasonable level.

Inflation and deflation can be avoided by controlling price level. Central bank can control

inflation by decreasing the supply of money and deflation can be controlled by increasing

supply of money

3. Increase in investment



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Investment level can be increased with the help of monetary policy. Central bank can aim to

promote both foreign and domestic investments.

4. Increase in production

Central bank can increase level of production by granting loans to manufacturers at low

interest rates.

5. Exchange stability

Monetary policy aims to maintain the exchange rate at stable level. Exchange rate stability

is essential for the smooth flow of international trade.

6. Control on inflation

The main objective of monetary policy is to control inflation. Excess money supply is one of

the reasons of inflation. Central bank can control inflation by controlling the supply of

money.

7. Control on deflation

Deflation can be controlled by expanding the supply of money. Unnecessary contraction of

supply of money is one of reasons of deflation. Central bank can increase money supply with

the help of monetary policy.

8. Stability in capital market

The development of country depends upon the development of capital market. Central bank

can create stability in capital market with the help of monetary policy.

9. Foreign value of currency

Foreign value of currency can be maintained at stable level with the help of monetary policy

which leads towards growth in international trade.

10. Control on trade cycle

Trade cycle exists when there are fluctuations in the production, employment and price level.

Trade cycle can be controlled by controlling credit in economy with the help of monetary

policy.



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11. Economic growth

Monetary policy aims to promote rapid growth in national income and per capita income. It

requires the best utilization of resources.

12. Control on speculation

The commodity and stock markets are the speculation places. An artificial demand is cratered

due to which small investor suffers lose. Speculation increases the price level that can be

controlled with the help of monetary policy. Central bank imposes restriction on giving loans

to the speculators

13. Living standard

Living standard of people can be improved with the help of monetary policy by increasing

the purchasing power of money.





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Tools of monetary policy or instruments of monetary policy

Or how central bank control credit Or what are the methods to

control credit?

Tools of monetary policy

Tools of monetary policy can be divided in to two main parts.

A. Quantitative methods

B. Qualitative methods

A. Quantitative methods

1. Bank rate policy

The bank rate or the discount rate is the rate of interest at which central bank lends loan to the

commercial bank. When central wants contraction in supply of money it may increase the

interest rate due to which the borrowings from the commercial bank decrease. When the

central bank wants to increase the supply of money it decreases the interest rate which

encourage the borrowings

2. Open market operation

The buying and selling of government securities by central bank in market is called open

market operation when central bank wants the contraction in supply of money, it sells

securities. When central bank wants expansion in supply of money it buys government

securities.

3. Reserve ratio

The portion of the reserves that is to be kept with the central bank is called reserve ratio.

When the reserve ratio is increases the supply of money is decreased. When the reserve ratio

is decreased the supply of money is increased.

4. Credit limit



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Under this scheme, central bank limits the maximum amount of landings of commercial

bank. Commercial banks are not allowed to grant loan more than the fixed limit

5. Credit rationing

The method of credit control is applied by the central bank in times of financial crises. The

central bank rations the credit of every commercial bank. It fixes the amount that each

member bank can draw by rediscounting the bills of exchange.

B. Qualitative methods

1. Margin requirement

Central bank can control credit by changing margin. if the margin requirement is increased,

then people cannot take more loans. But if margin requirement is decreased people can take

more loans.

2. Direct action

Central can take direct action if the commercial banks are not following the monetary policy.

It may refuse to grant loans or impose penalty on them.

3. Control on consumer credit

According to this technique, the central bank may apply some strict restrictions on

consumer’s credit. It may increase the interest rate or may shorten the period of repayment.

4. Publicity

The central bank may convince the borrowers and lenders through publication of annual

reports and weekly statements about the specific policy.





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Q#24

What is the difference between cheque, bills of exchange

and promissory note?

Basis Bills of

exchange

Promissory

note

Cheque

1 Definition Bills of exchange is an

instrument in writing

which contains order of

payment by creditor to

debtor

Promissory note is an

instrument in which

debtor promises to pay a

certain amount to

creditor

Cheque is an instrument

which is used to withdraw

money from bank

2 parties In case of bill of

exchange there are three

parties, drawer drawee

and payee.

In case of promissory

note there are two parties

maker and payee

In case of cheque there

are three parties

depositor, bank and payee

3 Acceptance Acceptance by drawee is

necessary.

There is no need of

acceptance

In case of cheque there is

no need of acceptance, as

it is order by the

customer.

4 Discounting Bills of exchange can be

discounted from bank

Promissory note cannot

be discounted

Cheque cannot be

discounted

5 Grace days Three grace days are

allowed to make payment

Three grace days are

allowed to make payment

In case of cheque no

grace days are allowed

for making payment

6 Area Promissory note can be

inland or foreign

Promissory note is

generally inland

Cheque is drawn on only

depositor’s bank

7 stamp Pasting of Stamp on bills

of exchange is legally

required

Pasting of Stamp on

promissory note is

legally required

No stamp is required to

paste on cheque

8 Nature It is an unconditional It is an unconditional Cheque is an



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order for making

payment

promise for payment unconditional order for

making payment

9 liability In case of Bills of

exchange it is the liability

of drawee to make the

payment


note it is the liability of

drawer to make the

payment

In case of cheque it is the

liability of bank to make

payment

10 Noting

charges

Noting charges are paid

in case of dishonor of

bills of exchange

Noting charges are not

paid in case of dishonor

of promissory note

Noting charges are not

paid in case of dishonor

of cheque

11 Printed

form

A bills of exchange can

be drawn on simple or

printed paper

A promissory note can be

drawn on simple or

printed paper

A cheque is always drawn

on printed paper that is

provided by the bank

12 Crossing Bills of exchange cannot

be crossed

Promissory note cannot

be crossed

Cheque can be crossed

13 Payee In case of bills of

exhnage the drawer and

the payee may be same

person


note the drawee and the

payee may be same

person

In case of cheque the

drawer and the payee may

be same person

14 Default In case of bills of

exchange the drawee is

responsible to make the

payment

In case of bills of

exchange the drawer is

responsible to make the

payment


bank is responsible to

make payment than the

drawer is responsible

15 Trust In case of bills of

exchange the people

shows less confidence as

compared to the cheque


note people shows less

confidence as compared

to the cheque and bills of

exchange


people shows more

confidence as compared

to the bills of exchange

and promissory note

16 Stop

payment

Payment of bills of

exchange cannot be

stopped

Payment of promissory

note cannot be stopped

Payment of cheque can be

stopped on the orders of

depositor



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17 Period Period for making

payment of bills of

exchange is written on it

Payment period is written

on the note

Cheque can be cashed

within the period of six

months from the date of

issue

18 Use Bills of exchange is less

used than cheque and

more used than the note

Promissory note is less

used than the bills of

exchange and cheque

Cheque is more popular

than the bill and note

19 Drawer Drawer of bill is always a

seller

Drawer of the note is

always buyer

Drawer of the cheque is

always an account holder

20 drawee Drawee of bills is always

a buyer

Drawee of note is always

a seller

Drawee of cheque is

always a bank





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Q#25

Describe the parties of letter of credit; also explain the

procedure for opening letter of credit.

Letter of credit

According to the Mr. Frank henius letter of credit is a written document issued by the buyer’s

bank authorizing the seller to draw in accordance with the certain terms and conditions.

Parties of letter of credit

1. Importer / Applicant

Applicant is the importer of goods. He requests his bank to issue letter of credit in the favour

of exporter.

2. Issuing bank

The bank which issues letter of credit in favour of exporter is called issuing bank. It is also

called importer’s bank.

3. Exporter

The person who exports goods to the importer is called exporter. In other words the person in

whose favour the letter of credit is opened is called exporter.

4. Paying bank

It is bank which makes the payment to the exporter after receiving the letter of credit

Procedure of opening letter of credit

1. Sales contract

Importer of one country makes an agreement with exporter of other country to purchase

goods. When the terms and conditions about the price, quantity and quality are decided the

contract between the parties takes place. The importer then informs his bank to open letter of

credit.



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2. Performa invoice

The banker may ask importer to provide the Performa invoice which contains the details

about the goods that are to be imported.

3. Import license

The banker may ask applicant to provide import license. Import license is issued by the

government.

4. Application form

Application form is also known as “application and agreement for L.C”. It contains all

necessary details about the terms and conditions of sale. It is signed by the applicant.

5. Margin requirement

Margin requirement is generally fixed by the state bank of Pakistan. It is from 10% to 40% of

the total amount for which the L.C is opened. Importer will have to deposit this amount to the

issuing bank. It is refundable amount

6. Issuance of L.C

The issuing bank informs paying bank that the letter of credit has been issued. Three copies

are prepared one copy is kept buy the issuing bank for its own record. The remaining two

copies are sent to the paying bank. The paying bank keeps the second copy and sends the

third copy to the exporter.

7. Information to the seller

The paying bank informs the seller that the letter of credit has been issued. The seller than

sends goods to the importer and provide the shipping documents to the paying bank. The

bank checks the documents and sends them to the issuing bank.

8. Payment to the seller

When the paying bank is satisfied with the documents provided by the exporter he makes the

payment to the exporter.

9. Collection of documents



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The issuing bank collects shipping documents from paying bank. The issuing bank examines

the documents before giving it to the importer

10. Collection of money

The issuing bank collects money from the importer before giving him shipping documents.

11. Receipt of goods

After making the payment the importer collects documents from issuing bank. He submits

these documents to the shipping company to receive goods. Then he can receive goods from

the shipping company, in this way the transaction of import is completed.





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Q#26

What are the types of letter of credit?

1. Revocable letter of credit

A letter of credit that can be cancelled by importer or bank at any time due to any reason is

called revocable letter of credit. This type of letter of credit is not usually acceptable by the

businessmen.

2. Irrevocable L.C

A letter of credit that cannot be cancelled before payment is called irrevocable letter of credit.

This types of letter of credit gives full protection to both the parties. Irrevocable L.C is more

popular than the revocable L.C.

3. Confirmed L.C

If the exporter’s bank confirms the L.C and takes the liability to make payment to the

exporter in case of nonpayment by importer’s bank, it is called confirmed L.C

4. Unconfirmed L.C

If the exporter’s bank does not takes the liability of payment in case of nonpayment by the

importer’s bank. It is called unconfirmed L.C. it is suitable when the financial position of

importer is poor and exporter do not know the issuing bank.

5. Documentary L.C

The L.C in which there is condition that the exporter will submit shipping documents for

receiving money, is called documentary L.C

6. Clean L.C

The L.C in which there is no condition that the exporter will submit shipping documents for

receiving money, is called clean L.C

7. Fixed L.C



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A fixed L.C is that which is issued for a particular transaction. This L.C is automatically

cancelled after the completion of transaction.

8. Revolving L.C

Revolving L.C is issued for the payment of fixed amount but after the completion of

transaction it is automatically cancelled.

9. Transferable L.C

The L.C, in which the exporter (beneficiary) has the right to transfer it to the third party, is

called transferable L.C.

10. Nontransferable L.C

The L.C which cannot be transferred by the exporter to any other person is called

nontransferable L.C

11. Red clause L.C

In this L.C, the exporter’s bank provide loan to the exporter for packing and transportation of

goods before the shipment of goods. The statement containing the details of order is written

with the red ink.

12. Green clause L.C

In this L.C, the exporter’s bank provide loan to the exporter for not only packing and

transportation but also for the storage of goods as well. The statement containing the details

of order is written with the green ink.

13. Freely negotiable L.C

Under this letter of credit the exporter can get the money by showing the concerned

documents to any bank.

14. Back to back L.C

Under this L.C there are two separate credits the first document is issued in the favour of

seller who is middleman. On the basis of first L.C the middleman requests his bank to issue

second letter of credit in favour of actual supplier.

15. Omnibus L.C

Under this L.C the exporter can get the funds just after the shipment of goods for further

dealing. The movable and immovable property of exporter is given to banker as security

against loan



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Q #27

What is business finance? What are the main types of

business finance?

Business Finance

Business finance is the flow of capital and credit that makes the business possible. Finance

includes raising of funds through debt or equity finance.

Business finance is the life blood of every business. In sole proprietorship and partnership

less amount of finance is needed. Due to small scale of business, but in companies large

amount of finance is required because of large size of business activities.

Definition

According to B.O wheeler “business finance is the concerned with the acquisition and

utilization of capital funds in meeting the financial needs and overall objectives of the

business.

Types of business finance

Business finance can be categorized into the two main heads

1. On the basis of time

2. On the basis of source


A. Short term finance

Short term finance is obtained for the period of one year or less than one year. it is obtained

to meet the day to day operating expenses of business such as payment to creditors, wages,

salaries, utility bills etc,

Following are some forms of short term finance



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a. Bank overdraft

Bank allows its customer who has current in the bank to withdraw more than the credit in the

account. This loan facility is given to meet the daily cash needs. The bank charges interest on

overdraft.

b. Cash credit

It is very common form of short term finance. Borrower can obtain loan against the security

of goods. The borrower is allowed to withdraw cash within the limit specified by the bank.

The interest is charged on the amount withdrawn.

c. Discounting of bills

Another form of short term loan is the discounting of bill. The bank purchases the bill of

exchange and provides finance to the customer. The bank get back the amount of loan on the

maturity of bill

d. Trade credit

Trade credit is allowed by the seller to the buyer. The goods and services are supplied on the

credit and the amount is collected as per agreement.

e. Advances from customers

Sometimes the business gets advance payments from their customers and agents. These

advances are not loan, yet they are a source of finance.

B. Medium term finance

Medium term finance is obtained to meet medium term needs that can be from 1 year to 5

year. The following are the sources of medium term finance.

1. Commercial banks

Commercial banks are the main source of medium term loan. Loans are generally provided

against the security of assets. Businessman can use the amount of loan to meet the business

needs.

2. Loan from financial institutions



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Businessman cal obtain loan from financial institutions other than bank, IDBP, ICP, NDFC

are proving credit facility to the businessmen

3. Debentures

Joint stock companies can obtain loan by issuing debentures. Debenture is an instrument

issued by company to obtain loan from general public.

4. Life insurance policy

The insurance companies provide medium term loan to its policyholders out of premium

received.

C. Long term finance

Long term finance is obtained to invest in the fixed asset like land, building, plant and

machinery. Long term loan can be for a period longer than ten years. Following are the main

source of business finance

1. Equity shares

The equity share is the most important source of long term finance. Joint Stock Company can

issue shares for fund raising. Amount of shares is paid back only on the winding up of the

company.

2. Use of profits

Every company maintains reserve out of its profit that can be used for the development and

expansion of business. It is a useful source of getting extra capital for building and expansion

of business.

3. Issue of right shares

A public company can increase its capital by issuing right shares. Existing share holders are

offered to buy shares in proportion to the shares held.


Company can obtain loan from financial institutions like IDBP, NDFC etc.



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5. Leasing

Leasing is now a popular form of long term finance. A business may get plant equipment,

land. The business in this way uses the asset which it does not own. Businessman has to pay

the regular installments.


On the basis of source, the business finance has two types

1. Equity finance

Equity finance is also known as the owner finance. The finance which is provided by the

owner from his personal source is called equity finance. Owner may provide long term or

short term finance.

2. Debt finance

The second source of fund raising is the credit financing or debt financing. Most of the

business is not in a position to finance all the funds from personal sources, so they can obtain

loan from financial institutions and banks. Loans can be obtained for short medium and long

terms.





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Q #28

What is business finance? What are the main types of

business finance?

Business Finance

Business finance is the flow of capital and credit that makes the business possible. Finance

includes raising of funds through debt or equity finance.

Business finance is the life blood of every business. In sole proprietorship and partnership

less amount of finance is needed. Due to small scale of business, but in companies large

amount of finance is required because of large size of business activities.

Definition

According to B.O wheeler “business finance is the concerned with the acquisition and

utilization of capital funds in meeting the financial needs and overall objectives of the

business.

Types of business finance

Business finance can be categorized into the two main heads




D. Short term finance

Short term finance is obtained for the period of one year or less than one year. it is obtained

to meet the day to day operating expenses of business such as payment to creditors, wages,

salaries, utility bills etc,

Following are some forms of short term finance



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f. Bank overdraft

Bank allows its customer who has current in the bank to withdraw more than the credit in the

account. This loan facility is given to meet the daily cash needs. The bank charges interest on

overdraft.

g. Cash credit

It is very common form of short term finance. Borrower can obtain loan against the security

of goods. The borrower is allowed to withdraw cash within the limit specified by the bank.

The interest is charged on the amount withdrawn.

h. Discounting of bills

Another form of short term loan is the discounting of bill. The bank purchases the bill of

exchange and provides finance to the customer. The bank get back the amount of loan on the

maturity of bill

i. Trade credit

Trade credit is allowed by the seller to the buyer. The goods and services are supplied on the

credit and the amount is collected as per agreement.

j. Advances from customers

Sometimes the business gets advance payments from their customers and agents. These

advances are not loan, yet they are a source of finance.

E. Medium term finance

Medium term finance is obtained to meet medium term needs that can be from 1 year to 5

year. The following are the sources of medium term finance.

5. Commercial banks

Commercial banks are the main source of medium term loan. Loans are generally provided

against the security of assets. Businessman can use the amount of loan to meet the business

needs.




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Businessman cal obtain loan from financial institutions other than bank, IDBP, ICP, NDFC

are proving credit facility to the businessmen

7. Debentures

Joint stock companies can obtain loan by issuing debentures. Debenture is an instrument

issued by company to obtain loan from general public.

8. Life insurance policy

The insurance companies provide medium term loan to its policyholders out of premium

received.

F. Long term finance

Long term finance is obtained to invest in the fixed asset like land, building, plant and

machinery. Long term loan can be for a period longer than ten years. Following are the main

source of business finance

6. Equity shares

The equity share is the most important source of long term finance. Joint Stock Company can

issue shares for fund raising. Amount of shares is paid back only on the winding up of the

company.

7. Use of profits

Every company maintains reserve out of its profit that can be used for the development and

expansion of business. It is a useful source of getting extra capital for building and expansion

of business.

8. Issue of right shares

A public company can increase its capital by issuing right shares. Existing share holders are

offered to buy shares in proportion to the shares held.


Company can obtain loan from financial institutions like IDBP, NDFC etc.



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10. Leasing

Leasing is now a popular form of long term finance. A business may get plant equipment,

land. The business in this way uses the asset which it does not own. Businessman has to pay

the regular installments.


On the basis of source, the business finance has two types

3. Equity finance


owner from his personal source is called equity finance. Owner may provide long term or

short term finance.

4. Debt finance

The second source of fund raising is the credit financing or debt financing. Most of the

business is not in a position to finance all the funds from personal sources, so they can obtain

loan from financial institutions and banks. Loans can be obtained for short medium and long

terms.





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Q #29

Define owner (equity) and debt finance. What are the advantages

and disadvantages of debt and equity finance?

(Or)

What are the sources of business finance? Explain the merits and

demerits.

There are two main sources of business finance

A. Equity / owner finance

B. Debt finance

A. Equity finance


owners from their personal resources is called equity finance. It is also known as internal

equity or internal finance. This finance is generally provided for meeting the short term and

long term financial needs.

Merits of Equity Finance

1. Long term capital

The equity finance is a long term capital available to the business. Repayment of capital is

made only on the winding up of the business.

2. No interest

Equity finance is free from the payment of interest. The business concern has not to pay the

inertest charges on equity capital.

3. Repayment of funds



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There is no need of repayment as the finance is provided by the owner from his personal

resources.

4. High rate of profit

Equity finance provide high rate of profit as there is no fixed interest payment so the rate of

profit is high.

5. Minimum losses

There is minimum loss to owners during depression. The interest on loan increases the losses.

In case of equity finance there is no interst so losses remain low.

6. Freedom of control

The owners of business enjoy the freedom of control because one man can claim his right on

the assets of the company.

7. Full profit

In case of equity finance, the owners of business enjoy and share full profit of business they

are free from the loan payment and interest payment.

8. Low operating cost

In case of equity of finance the operating cost is low as there is no burden of interest.

9. Financial base

The equity finance provides a sound financial base to the capital structure of a business by

reducing the financial risk.

10. Liquidation of business

In case of liquidation of business, the assets of the business remain with the owners.

11. Financial worries

It is a benefit of equity finance that there are no financial worries of borrowing when the

supply of money is short and interest rate is high.

12. Attention to business



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In case of equity finance, the owner of the business enjoy the freedom of control because they

are free from the tension of interest an repayment of loan, so they can pay full attention to the

business.

Demerits of Equity Finance

1. High rate of tax

The rate of profit is high as interest is not charged. When profit is high, the rate of tax is also

high. The government earns more income.

2. No innovation

The owner do not invests his money in risky business. They work on the basis of their

experience; they do not start the new and risky business, so there is no innovation.

3. No advantage of debt

If a company only invests equity finance it cannot enjoy the benefit of debt finance. Owner

may loss the opportunity to obtain the loan at low interest rate.

4. Deficiency of capital

There is possibility of deficiency of capital because owner invests from his limited resources.

Business may feel problem in making payments due to the shortage of capital

5. Low rate of return

When owner uses their own capital for the investment in business, it avoids taking risky

projects. The return on safe investment is normally low.

6. No aggressiveness of management

A firm without management shows aggressiveness in managing the business affairs, which

result in low return on investment.

7. Over capitalization

If a company issues more equity shares than actually required by it, then it is likely to result

in over capitalization, which may create problem for the company.



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Debt Financing

Debt financing is the second main source for the fund rising. Amount of capital can be

borrowed from creditors. It is also known as credit financing. Most of the businesses are not

able to finance all of the capital from their own resources, so they can enter into an agreement

with the lenders and banks to obtain loans.

Merits of debt financing

1. Expansion of business

The business activities can be expanded easily due to the large capital. Borrowed amount

helps the business to start the production at large scale which results in low cost of

production.

2. No interference of creditors

Creditors cannot interfere in the affairs of business. The owners of business design policies

for the utilization of the borrowed amount.

3. More profit

The business concern with the help of borrowed capital can earn more profit, as the rate of

return on borrowed amount is higher than the rate of interest.

4. Urgent cash requirement

The business can take the short term loans for meeting the urgent funds requirement.

5. Solvency of business

The debt financing provides the solvency to the business. The funds are available to meet the

obligations on due date.

6. More innovation

Innovation demands huge funds. Debt financing provide funds for innovation.

7. Low interest



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In case of debt financing the interest charged on debt is lower than the rate of return paid to

the shareholders in form of dividend

8. Flexible finance policy

Debt financing enable the management to frame a flexible financing policy. Whenever they

want to expand the business they can raise funds by obtaining loan.

Demerits of debt financing

1. Payment of interest

Businessman has to pay the amount of interest on this type of finance, regardless of the

financial position of the business.

2. Business can be sued

If the amount of interest and borrowed amount is not paid at the maturity date, the creditors

may sue the business.

3. losses

In case of loss, the business concern even than has to pay the interest. This increases the

losses of business

4. Repayment of loan

Repayment of loan is the liability of the business that is to be paid on the due date.

Repayment of loan may put the business into the financial difficulty.

5. Dissatisfaction of shareholders

If the company decides to repay the amount of loan out of profits, the payment of dividend to

shareholders is reduced. It creates dissatisfaction among them.

6. Winding up of business

In case of winding up of business, the creditors have the prior claim on the assets of the

business, so the shareholders may suffer loss.

7. Attraction of funds

In times of depression, the rate of return on investment is lower than the rate of interest on

loan. Therefore the new investors will not contribute their funds in the business.



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Q #30

Explain the various types of interest free or non interest

modes of financing (or) explain the Islamic mode of

financing.

Interest free mode of financing

Interest free mode of financing means the financing free from the interest. In Islamic mode

of financing interest in all fields and all ways is prohibited. Following are the main types of

interest free mode of financing

A. Lending mode of financing

B. Trade related mode of financing

C. Investment mode of financing

A. Lending mode of financing

1. Interest free loan with service charges

Under this mode of financing, the bank provides funds free from the interest. The bank

charges only the service charges from the borrower. The rate of service charges is fixed by

the state bank of Pakistan. Interest free loans are generally provided to the small farmers,

small businessmen and salaried persons.

2. Qarze – Husna

Under this scheme the loan is provided to the poor people for medical treatment and to the

students who are less than 35 years of age. The students are allowed a grace period of two

years after the completion of studies to repay the amount of loan.

B. Trade related mode of financing



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The state bank of Pakistan has approved five trade related mode of financing that are given

below

1. Mark up

Mark up is the purchase of goods by the bank and their sale to the client at some mark up

(profit) on differed payment basis. The bank purchases the required goods on the request of

the client and sells these goods to him on the price mutually agreed between the bank and the

client. The agreed price contains the cost plus mark up (profit margin).

2. Mark down

It is the purchase of property by bank from customer with buy back agreement. Under this

scheme, the customer sells his property to the bank with a promise to buy back the same

property from bank on future date. The difference between the purchase price and sale price

is the profit of bank.

3. Hire purchase

The bank purchases the specified goods on the request of customer and hires them to the

customer on the payment of periodical installments. The installments are calculated in such a

manner that the actual price plus bank charges are covered during the fixed period.

4. Leasing

In this mode of financing, one person (lessee) acquires an asset from the other person

(Lessor) for a fixed agreed period of time. The period of lease range from 5 to 20 years,

depending upon the useful life of asset. The lessee will have to pay fixed amount after regular

intervals. The ownership of the property remains with the Lessor.

5. Development charges

In this trade related mode of financing the bank advances money to the customer for the

development of land and property. The bank takes a share in the developed property. The

share in the developed property is named as development charges.

C. Investment modes of financing



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Following are the five types of investment modes of financing.

1. Musharika

Musharika is an agreement between the bank and his client to participate in the business as a

temporary partner to share profit and losses of the business during a specified period of time.

In this agreement the, business is run by the client and the profits are shared in an agreed

ratio.

Features of Musharika

The funds of the banks on the basis of Musharika are secured

A certain portion of the profit is paid to the client as management fee

The profit is shared according to the agreed ratio.

In case of loss, it is shared by the bank and client according to the financee

provided by them

2. Modaraba

Modaraba is an agreement in which one part invests his funds and the other party with his

knowledge and skills. Profits are shared between the parties in an agreed ratio. In case of loss

the bank which supplies capital bears full loss.

Features of Modaraba

Modaraba must be registered under Modaraba ordinance

Profit is shared in agreed ratio

Modaraba certificate is transferable

Modaraba may be for specific purpose or multi purpose

3. Participation term certificate

The participation term certificate was designed to replace debenture financing in the

financing of industrial investment.

Features

Participation term certificates are transferable.



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Only joint stock company can issue such certificate

Profits are shared in agreed ratio

Losses are shared in the ratio of investment

Certificate holder has right to participate in the meetings of the company

These certificates provide medium and long term finance

4. Equity finance

The bank can participate in equity by purchase of shares of limited companies. The bankers

can become the shareholders instead of creditors.

Features of equity finance

The investors purchase the shares to participate in equity

The profits are distributed as dividend

The banks and financial institutions may become the shareholders

5. Rent sharing

Rent sharing system provides the finance for the purchase or construction of houses. The

financer becomes the joint owner of the property. The principal amount and profit in shape of

rent is received for fixed period.

Features

The bank and customer both contribute their funds

The period of joint ownership is stated in the agreement

The rental value of house is determined on the base of locality and quality of

construction.

The gain on sale of house is shared proportionately.



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Q #31

What are the advantages and disadvantages of

nationalization of banks in Pakistan

Nationalization

Nationalization means the transfer of ownership, management and control to the state. In

1974, 13 banks were nationalized under nationalization of banks act 1974.

Definition

According to Alan Isaacs; “nationalization is the process of bringing the assets of a company

into the ownership of state.

According to the Robert Millard; nationalization is the act of converting the privately owned

resources into the one owned by the central government

Advantages of Nationalization

1. Distribution of credit

Nationalized helped in the fair distribution of credit. Before nationalization the credit was

concentrated in few hands. Nationalization ensured the fair distribution of wealth.

2. Banking management

The government has setup and executive board to look after the administrative work of the

banks. The business of banking has improved due to better management.

3. End of monopoly

There was complete control of few industrialists over the banking system. They used bank

assets and deposits of public for their personal interest. With the nationalization of banks

their monopoly come to an end

4. Benefit to employees



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Before the nationalization the rights of employees were not protected. Employees’ rights are

protected by the nationalization of banks. They are promoted on merit basis nationalization

increased the job security and job satisfaction.

5. Control over expenses

Nationalization of banks has controlled non- development expenses to a large extent. The

useless expenses on entertainment and advertisement have been reduced which improved the

rate of profit for commercial banks

6. Increase in employment

Nationalization resulted in creation of jobs opportunities for talented and educated people in

the banks. As far as new branches are opened, hundreds of people got employment.

7. Rural bank branches

The nationalized banks have opened many branches in rural areas. It is due to the rural

branches that the idle funds are being used into the productive sectors.

8. Foreign bank branches

The performance of foreign bank branches has also increased; the employees are posted on

the merit basis. Number of branches has also increased to promote banking at international

level.

9. Increase in government income

Before nationalization the income of the bank was gone into the hands of their owners. Now

the income of the banks is transferred to the government treasury which can be used for the

common interest of the nation.

10. Increase in public confidence

Nationalization helped in increasing the public confidence. They do not feel hesitation in

depositing their savings in banks because they know that the banks are working under the

supervision of government.

11. Black money



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Before the nationalization the corrupt officers and traders were used to keep their black

money in banks. But now the protection to black money is not possible because the

government can check the amounts of bank at any time.

12. Control over credit

Commercial bank can create credit, but unnecessary expansion of credit can create inflation.

Nationalization enables the state bank of Pakistan to control the activities of commercial

banks.

13. Economic development

Nationalization increased the resources of the government. The government was in a position

to start long term projects which leads towards the economic development.

14. Development of agricultural sector

Before the nationalization, considerable attention was not given to the agricultural sector.

However after nationalization special attention was given to the agricultural credit, which

helped in development of agricultural sector.

Disadvantages of nationalization

1. Lack of competition

Healthy competition is necessary for the development and promotion. Nationalized banks

were run by the state so less attention was given to effective policies and competition.

2. Corruption and bad debts

Nationalization resulted in high level of corruption by the top management. Credit was

generally misused and in some cases the amount of loan was not returned.

3. Favoritism

Nationalization has resulted in favoritism, incompetent and unqualified staff is appointed.

The favoritism has badly affected the performance of banks

4. Political pressure



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After nationalization the political interference has increased in the bank management has

increased. Loans are granted on political pressure rather than on merit basis.

5. Low efficiency of employees

Nationalization transferred the bank officials into the government officials. There jobs were

fully secured which reduces the efficiency of employees.

6. Unfair distribution of credit

It was announced at the time of nationalization that the unfair distribution of credit should be

eliminated. But in actual, the big capitalist have obtained loan by using their powerful

resources.

7. Complex procedures

After nationalization the procedure of getting loan became complicated, due to which the

needy people and business community could not get loans and the country remained

underdeveloped in many sectors.





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Q #32

What are the causes of nationalization of banks in

Pakistan?

Causes of nationalization of banks

1. Credit control

Commercial bank can create credit, but unnecessary creation of credit can create problems.

State bank of Pakistan keeps an eye on the credit creation but it has an indirect link.

Commercial banks were creating credit for their personal benefit

2. Distribution of loan

Loans were advanced to the rich people and. The middle class and low class was greatly

ignored which created the class conflicts.

3. Discrimination of sectors

The commercial banks had been advancing most of the loan to the big importers and

exporters. It was ignoring small but important sectors of economy.

4. Loan to relatives

The high ranking bank officials used the bank reserves for their personal benefit. They issued

a large amount to their relatives and the major amount of loan was not returned.

5. Lack of uniformity in rules

There were no consistent and uniform service rules. The promotion and increments were

given on the personal liking and disliking and there was no job security

6. Misuse of credit

The commercial bank issued loans almost blindly. The loans issued were used for speculation

and black marketing.

7. Central bank control



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There was ineffective control of state bank of Pakistan for providing loans. They did not care

for the rate of margin requirement and other policies of state bank of Pakistan.

8. Banking profit

Earning of high profit was the first propriety of every bank. Banks were not focusing on the

economic growth. The savings of the people were used for the personal interests of banks not

for the national interest.

9. Overseas branches

The performance of overseas branches was poor; most of them were even working at loss.

10. Wasteful competition

Banks were busy in wasteful competition. They were spending huge amount on the

advertisement and entertainment. There was rush of braches in trading centers but no

branches in rural areas.

11. Protection of black money

The private banks protected the black money; this resulted in the contraction of funds in few

hands. It was failed to check the unfair means of income, even the government was not

allowed to check the balance of such account. Tax collection was not possible on such

accounts.



mbf all in one

Economy & Finance