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MONEY BANKING & FINANCE
Written by; Ahmed Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND
BANKING
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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
11.Lack of common measure of value

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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 #6what 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 profitThe 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 customersCentral 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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