Monetary and Financial System Q&A

Module 1: Money and Monetary System

• Why is the unit-of-account function of money crucial to the operation of an economy?
• Explain how money functions as a standard of deferred payments.
• Explain how money functions as a store of value. Is money the only store of value? What is the difference between money as a store of value and the other assets? Are long-term bonds a store of value?
• Rank the following financial assets in terms of their liquidity: coins and paper currency, common stock, demand deposits, long-term government bonds, long-term corporate bonds, saving deposits at deposit institutions, Treasury bills. Explain your ranking.
• What effect does inflation have on the use of money as a unit of account, a medium of exchange, a standard for deferred payment, and a store of value?
• Identify which function of money is emphasized in different situations such as calculating opportunity cost, checking prices, increasing savings, etc.
• Which of the Central Bank measures of the monetary aggregates – M1 or M2 – is composed of the most liquid assets? Which is the larger measure?
• For each of the following assets, indicate which of the monetary aggregates (M1, M2) they are included in: coins and currency, demand deposits, other checkable deposits, traveler’s checks, savings deposits, small time deposits, money market deposit accounts, and money market mutual funds.
• Explain the process by which the banking system creates money. Include a numerical example.
• What is the simple deposit multiplier? How does it relate to the money multiplier?
• Describe the real-world factors that affect the money multiplier, such as currency drain and excess reserves.
• What are the roles of the central bank in the monetary system?

Module 2: Payment System

• How come the payment system is different from the financial system and the monetary system?
• Describe the evolution of the payment system.
• Describe different components of EFT (Electronic Funds Transfer) payment.
• State the advantages and disadvantages of card payment systems.
• State the advantages and disadvantages of the Mobile Payment System.
• Write short notes on BACH (Bangladesh Automated Clearing House), RTGS (Real Time Gross Settlement), NPS (National Payment Switch), and POS (Point of Sale).

Module 3: Financial System

• Write down the formula used to calculate the yield to maturity on a 20-year 10% coupon bond with Tk.1000 face value that sells for Tk.2000.
• If there is a decline in interest rates, which would you rather be holding, long-term bonds or short-term bonds? Why? Which type of bond has the greater interest-rate risk?
• A financial adviser has just given you the following advice: “Long-term bonds are a great investment because their interest rate is over 20%”. Is the financial adviser necessarily right?
• If mortgage rates rise from 5% to 10% but the expected rate of increase in housing prices rises from 2% to 9%, are people more or less likely to buy a house?
• “The more risk-averse people are, the more likely they are to diversify”. Is this statement true, false, or uncertain? Explain your answer.
• An important way in which a Central Bank decreases the money supply is by selling bonds to the public. Using a supply and demand analysis for bonds, show what effect this action has on interest rates.
• Using the supply and demand for bonds framework, show why interest rates are procyclical (rising when the economy is expanding and falling during recessions).
• Why should a rise in the price level (but not in expected inflation) cause interest rates to rise when the nominal money supply is fixed?
• Explain what effect a large government deficit might have on interest rates.
• Using a supply and demand analysis for bonds, show what the effect is on interest rates when the riskiness of bonds rises.
• What characteristics define the money markets?
• Why do governments and businesses use the money markets?
• Which of the money market securities is the most liquid and considered the most risk-free? Why?
• Who issues commercial paper and for what purpose?
• Contrast investors’ use of capital markets with their use of money markets.
• Distinguish between the primary market and the secondary market for securities.
• What basic principle of finance can be applied to the valuation of any investment asset?
• Discuss the features that differentiate organized exchanges from the over-the-counter market.

Module 4: Financial Institutions

• Why we cannot write cheques against the liabilities of non-bank financial institutions?
• What is the precondition for successful intermediation activities of banking financial institutions?
• In spite of the existence of so many financial intermediaries, why would banks be needed at all?
• Explain briefly the “delegated monitoring theory” in relation to the significance of banking financial institutions in a financial system.
• Explain the intermediation and payment roles of banks in an economy.
• Explain the agency and policy roles of banks in an economy. Do these represent core banking roles in an economy?
• Banks’ intermediation may be treated as “risk arbitrage”. What does it mean?
• What is meant by the simple deposit multiplier?
• The commercial banking system of the developing countries before the Second World War was mainly comprising of “expatriate banks”. State the characteristics of the expatriate banks.
• Describe the trends of commercial banking in developing countries after the end of the Second World War till today.
• The pattern of commercial banking in developing countries after the Second World War had undergone a lot of changes, especially in the “functional sphere”. Describe those changes in the context of the functional sphere.
• Distinguish among “Real Bills Doctrine”, “Shiftability Theory” and “Anticipated Income Theory” of bank lending.
• Explain the basis of providing long-term lending according to Anticipated Income Theory.
• Show how a bank balances between its liquidity and medium-term lending according to Shiftability Theory.
• Explain the “Real Bills Doctrine” in terms of providing short-term loans.
• In the course of the evolution of commercial banking in developing countries, they were asked to participate in the economic development process of those countries. How did they (commercial banks) do it?
• During the 70s and 80s, commercial banks in many developing countries were “nationalized”. State the background and objectives of banks' nationalization in developing countries.
• State the consequences of banks' nationalization and the subsequent steps of the government of developing countries in order to improve the overall performance of the banks.
• Explain the trends/factors which are reshaping commercial banking all over the world nowadays.
• What do you mean by Globalization of Banking? Explain the factors that may cause the globalization of banking. Does globalization increase the risk of failure of banks?
• Why is it argued that banks are dying?
• Why is it argued that banks are special?
• How do you differentiate between the Pool of Fund and Conversion of Fund Approach for the matter of fund management in financial institutions?
• How do you define the Multiple Deposit Creation Process?
• How do you differentiate between Inside and Outside liability and Earning and Non-earning assets?
• Give examples of the following roles of banks: Policy role, Payment role.

Module 5: Financial Markets

• Write down the formula that is used to calculate the yield to maturity on a 20-year 10% coupon bond with Tk.1000 face value that sells for Tk.2000.
• If there is a decline in interest rates, which would you rather be holding, long-term bonds or short-term bonds? Why? Which type of bond has the greater interest-rate risk?
• A financial adviser has just given you the following advice: “Long-term bonds are a great investment because their interest rate is over 20%”. Is the financial adviser necessarily right?
• If mortgage rates rise from 5% to 10% but the expected rate of increase in housing prices rises from 2% to 9%, are people more or less likely to buy a house?
• “The more risk-averse people are, the more likely they are to diversify”. Is this statement true, false, or uncertain? Explain your answer.
• An important way in which a Central Bank decreases the money supply is by selling bonds to the public. Using a supply and demand analysis for bonds, show what effect this action has on interest rates.
• Using the supply and demand for bonds framework, show why interest rates are procyclical (rising when the economy is expanding and falling during recessions).
• Why should a rise in the price level (but not in expected inflation) cause interest rates to rise when the nominal money supply is fixed?
• Explain what effect a large government deficit might have on interest rates.
• Using a supply and demand analysis for bonds, show what the effect is on interest rates when the riskiness of bonds rises.
• What characteristics define the money markets?
• Why do governments and businesses use the money markets?
• Which of the money market securities is the most liquid and considered the most risk-free? Why?
• Who issues commercial paper and for what purpose?
• Contrast investors’ use of capital markets with their use of money markets.
• Distinguish between the primary market and the secondary market for securities.
• What basic principle of finance can be applied to the valuation of any investment asset?
• Discuss the features that differentiate organized exchanges from the over-the-counter market.

Module 6: Islamic Financial System

• State and briefly explain the key principles that directly set down the central structure of Islamic economics and finance.
• What do you mean by Riba? How is it interpreted in Islam and what are the significant implications of prohibiting Riba in Islam?
• Explain the principle of Gharar and how it is different from Maysir or Qimar.
• What is the role of Zakat in establishing equality in society?
• State and explain the basic features of the Islamic worldview of economics.
• What is the concern of “tazkiyah” and what is its end result?
• What is Islamic Economics and how come it is different from and similar to conventional western economies?
• Islam is perceived to be comprising of certain basic elements. State and briefly explain those elements.
• What do you mean by Muamalat? What role does it play in Islam?
• State and explain the fundamental sources of Shariah law.
• How come Ijma and Qiyas (as sources of Shariah Law) are different from Quaran and Sunnah?
• State and explain the principles of the Islamic financial system.
• Explain the role of “Money” in Islamic economics.
• Why is money treated as “potential capital” and is trading of money prohibited in Islam?
• Please state OIC's definition of Islamic Banking. Why is it also known as PLS banking?
• Islamic Banks have served distinctive features as compared to its conventional counterpart. State and explain those features.

Module 7: Regulatory Framework for Financial and Monetary System

• Explain the concern of financial regulations.
• Why is there a need for financial system regulations?
• Describe the types of financial system regulations.
• What is the central bank? Describe its history.
• What are the objectives of the central bank?
• What are the core policies of the central bank?
• Explain the functions of the central bank in terms of monetary management, banking supervision, and developmental functions.
• Should the central bank be independent? Discuss.
• Who are the regulators of the financial system of Bangladesh? Describe their roles.
• Explain the reserve management strategy of the central bank.
• What is the interest rate policy of the central bank?
• Discuss capital adequacy for banks and financial institutions.
• What is the role of deposit insurance in the financial system?
• Who regulates insurance companies in Bangladesh?
• Who regulates capital market intermediaries in Bangladesh?
• Who regulates microfinance institutions in Bangladesh?

Answers

Module 1: Money and Monetary System

Question 1: Why is the unit-of-account function of money crucial to the operation of an economy?

The unit-of-account function of money is critical because it provides a common measure for valuing goods and services, which simplifies trade, accounting, and economic planning. Here’s why it’s crucial:

• Standardized Measurement of Value:
  • Uniform Pricing: Provides a consistent method of pricing goods and services, enabling easier comparison and trade.
  • Simplifies Transactions: Facilitates straightforward buying and selling, eliminating the complexities of barter.
• Facilitates Economic Calculation:
  • Business Planning: Helps businesses budget, forecast, and analyze costs effectively.
  • Investment Decisions: Enables investors to compare the monetary value of returns across different opportunities.
• Enables Record Keeping:
  • Financial Statements: Essential for preparing accurate financial records and statements.
  • Taxation and Regulation: Simplifies tax assessment and compliance with regulations.
• Enhances Market Efficiency:
  • Price Signals: Reflects supply and demand conditions, guiding consumers and producers.
  • Resource Allocation: Supports efficient allocation of resources by providing clear cost and benefit measures.
• Reduces Transaction Costs:
  • Minimizes Barter Costs: Eliminates the need for a double coincidence of wants.
  • Simplifies Contracts: Legal and financial contracts become more straightforward, reducing legal costs.
• Supports Monetary Policy:
  • Inflation Measurement: Central banks use it to measure inflation and adjust policies accordingly.
  • Economic Indicators: Provides a basis for economic analysis and policy-making.
• Enhances Consumer Decision-Making:
  • Comparison Shopping: Helps consumers make cost-effective purchasing decisions.
  • Budgeting: Assists households in managing budgets and living within their means.
• Facilitates Credit Transactions:
  • Loan Agreements: Clarifies the terms of loans and repayments.
  • Interest Rates: Standardizes the cost of borrowing.

In conclusion, the unit-of-account function of money simplifies trade, enhances market efficiency, supports economic planning, and underpins effective monetary policy, making it indispensable to the functioning of an economy.

Question 2: Explain how money functions as a standard of deferred payments.

Money’s function as a standard of deferred payments allows for the settlement of debts and financial obligations in the future. This function is critical for facilitating credit and financial planning. Here’s how it works:

• Enabling Credit Transactions:
  • Lending and Borrowing: Facilitates loans and repayment agreements in monetary terms.
  • Installment Plans: Allows consumers to purchase goods and services on credit.
• Facilitating Business Operations:
  • Trade Credit: Businesses can buy supplies on credit, aiding cash flow management.
  • Investment: Companies finance projects through bonds or loans, repaid in the future.
• Legal and Contractual Clarity:
  • Contracts: Specifies payment terms clearly in monetary units, ensuring mutual understanding.
  • Court Settlements: Legal judgments often involve future monetary settlements.
• Economic Stability and Planning:
  • Inflation and Interest Rates: Central banks stabilize the value of money over time, crucial for deferred payments.
  • Financial Planning: Enables individuals and organizations to plan future finances.
• Consumer Benefits:
  • Affordability: Makes expensive items accessible through deferred payments.
  • Credit Access: Provides a safety net for emergencies and investment opportunities.
• Promoting Economic Activity:
  • Business Expansion: Encourages investments by providing access to deferred payments.
  • Consumer Spending: Boosts demand by allowing deferred payments.
• Modern Financial Instruments:
  • Loans and Mortgages: Classic examples where repayment terms are set in money.
  • Bonds: Governments and companies issue bonds with future repayment.
• Challenges and Risks:
  • Inflation: Can erode the value of deferred payments.
  • Credit Risk: The ability and willingness to repay debts are critical.

In summary, money as a standard of deferred payments is essential for credit transactions, business operations, legal clarity, and economic stability. It underpins the functioning of credit markets and financial planning, driving economic growth.