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Q1.: Why Study Banking and Financial Institutions?

It helps us that how money flows through the economy, & how it impacts individuals,
businesses, and governments. They act as intermediaries between people who save money and
those who need loans. This helps in efficient resource allocation.

By studying this, we learn how interest rates, money supply, and inflation are controlled, which
impacts everyday life.

Q2. Why we study money and monetary policy?

We study money and monetary policy to understand how governments control the supply of
money, manage inflation, stabilize the economy, and promote economic growth. It helps in
analyzing the impact of policy decisions on employment, interest rates, and overall economic
stability.

Q3. What is bond, stock & interest rate?

Bond: A bond is a loan given by investors to a government or company. The issuer promises to
pay back the loan amount (principal) on a specific date and makes regular interest payments
(called coupon payments) to the investor until maturity.

Stock: A stock is a share in the ownership of a company. Owning a stock means you own part of
the company and may receive profits (dividends) or experience changes in the stock’s value.

Interest Rate: An interest rate is the percentage charged by lenders for borrowing money or
earned by investors for saving money. It represents the cost of credit or the return on savings.

Q4. What is Real Interest Rate and Nominal

Nominal Interest Rate: The nominal interest rate is the stated rate without adjusting for
inflation. It represents the percentage charged by lenders or earned by investors in current terms.

Real Interest Rate: The real interest rate is the nominal interest rate adjusted for inflation. It
reflects the true purchasing power of the interest earned or paid.

Formula:

Real Interest Rate=Nominal Interest Rate−Inflation Rate

Example: If the nominal interest rate is 8% and inflation is 3%, then the real interest rate is:

8 %−3 %=5 %
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Q5. What is GDP Deflator

The GDP Deflator is an economic indicator used to measure the level of price changes (inflation
or deflation) in the economy. It compares the nominal GDP (total market value of goods and
services at current prices) to the real GDP (total market value of goods and services at constant
prices, adjusted for inflation).

Formula:

Nominal GDP
GDP Deflator= × 100
Real GDP

Q6. What is the function of financial market (Diagram)

Financial markets move money from people who save to people who need it. This helps
businesses grow, creates jobs, and allows people to buy things like houses or start businesses. It
makes the economy work better and improves everyone's life.
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Q7. What is the structure of financial marke?

Financial Market Structure:

The financial market consists of two main components: the money market and the capital
market. The capital market is further divided into primary and secondary markets.

Money Market: The money market deals with short-term financial instruments with maturities
of less than one year. It facilitates the borrowing and lending of funds between banks and
financial institutions.

Capital Markets: The capital market deals with long-term financial instruments with maturities
of more than one year. It includes the primary market, where new securities are issued, and the
secondary market, where existing securities are traded.

Q8. What are the function of Financial Intermediaries

Functions of Financial Intermediaries

Financial intermediaries are institutions like banks, insurance companies, and mutual funds that
act as a bridge between savers and borrowers. They provide important services in the financial
system, including the following:

1. Reducing Transaction Costs: Financial intermediaries help reduce the costs of making
financial transactions, such as time, effort, and money spent in searching for lenders or
borrowers used to measure the level of price changes (inflation or deflation) in the economy. It
compares the nominal GDP (total market value of goods and services at current prices) to the
real GDP (total market value of goods and services at constant prices, adjusted for inflation).

Example: A bank collects savings from many people and lends to businesses, saving individuals
the trouble of finding trustworthy borrowers.

2. Risk Sharing: They help spread and manage risks by pooling funds from many investors and
investing in a variety of projects or assets.

Example: A mutual fund invests in different stocks and bonds, reducing the risk for individual
investors.

3. Addressing Asymmetric Information: Asymmetric information occurs when one party in a

transaction has more information than the other.
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Financial intermediaries collect and analyze information about borrowers and reduce the
information gap between lenders and borrowers.

4. Adverse Selection

Adverse selection happens before a transaction, where high-risk borrowers are more likely to
seek loans than low-risk ones.

Financial intermediaries screen potential borrowers and ensure that only creditworthy individuals
or businesses get loans.

5. Moral Hazard

Moral hazard occurs after a transaction, where borrowers might engage in risky activities
because they don’t bear the full consequences.

Financial intermediaries monitor borrowers to ensure they use the funds responsibly and reduce
the chances of default.

Q9. What is Money

Money: Money is anything that people accept as a medium of exchange for goods and services.
It is used to measure value, store wealth, and make transactions easier.

Money has three main functions:

Medium of Exchange: People use it to buy and sell things.

Store of Value: It can be saved and used in the future without losing much value.

Unit of Account: It helps measure and compare the value of different goods and services.
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Long Questions:

Q1. Why have some economists described money during a Hyperinflation as a “hot potato”
that is quickly passed from one person to another?

Money as a “Hot Potato” During Hyperinflation:

Hyperinflation is a situation where the prices of goods and services rise at an extremely high rate
in a very short period. During hyperinflation, money loses its purchasing power very quickly.
For example, the amount of money that could buy a loaf of bread today might not even buy a
slice tomorrow. As a result, people try to avoid holding money for too long because its value
keeps dropping.

Instead of saving money, individuals rush to spend it on goods and services as soon as they
receive it. This behavior is like holding a hot potato — nobody wants to hold onto it because it is
“too risky” or “uncomfortable.” The quicker people get rid of the money, the better they feel
because they can at least secure some value before the money becomes even less valuable.

Reasons for “Hot Potato” Behavior

Loss of Confidence: People lose trust in the currency because it cannot store value over time.

Rising Prices: As prices increase rapidly, waiting to spend money means you can buy less with
the same amount later.

Currency Substitution: People may prefer to use foreign currency or barter goods instead of the
local currency.

Speculative Demand for Goods: People buy goods not just for use but also to protect
themselves from further price increases.

Examples:

A famous example of hyperinflation occurred in Germany after World War I (1923). The value
of the German mark dropped so much that people used wheelbarrows to carry money to buy
basic items. In Zimbabwe (2008), hyperinflation reached unimaginable levels, making their
currency almost useless. In these cases, people treated money like a “hot potato,” spending it as
soon as possible.
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Q2. When was the most recent recession?

1. Most Recession
The most recent recession occurred in 2020 due to the outbreak of the
COVID-19 pandemic. The pandemic caused countries around the world to
implement lockdowns and restrictions to limit the spread of the virus. This
led to the closure of businesses, reduced consumer spending, and disrupted
global trade, all of which contributed to a sharp decline in economic activity.

2. Impact on Businesses
Many businesses, especially in industries like travel, tourism, hospitality,
retail, and entertainment, were severely affected. Travel restrictions led to a
collapse in tourism, while social distancing measures forced restaurants,
stores, and other service-based businesses to close or operate at reduced
capacity. Some businesses, especially small ones, struggled to survive and
had to lay off workers or close down completely.

3. Unemployment and Job Losses

As businesses shut down or reduced operations, unemployment rates soared
globally. Millions of people lost their jobs, particularly in sectors directly
affected by the pandemic. Workers in retail, hospitality, and manufacturing
faced the most significant job losses. In response, many governments
introduced financial support programs, such as unemployment benefits and
wage subsidies, to help workers during this difficult period.

4. Global Supply Chain Disruptions

The pandemic also disrupted global supply chains. Manufacturing plants
were forced to close, and transportation was slowed due to lockdowns and
reduced travel. This led to shortages of goods and delays in production and
delivery, further weakening economies. Countries that rely on imports for
essential goods like medical supplies, electronics, and raw materials were
especially affected.

5. Government and Monetary Response

To combat the recession, governments around the world implemented large-
scale fiscal stimulus packages. These included direct financial assistance to
businesses, workers, and families, as well as loans and grants to keep
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businesses afloat. Central banks also took action by lowering interest rates
and injecting money into the economy through measures like quantitative
easing. These steps were designed to encourage spending, support
businesses, and stabilize financial markets.

6. Shift in Consumer Behavior

The pandemic led to significant changes in consumer behavior. With
restrictions on movement and fear of the virus, people reduced spending on
non-essential goods and services. However, there was an increase in online
shopping, home delivery services, and demand for products related to health
and safety, such as cleaning supplies and personal protective equipment
(PPE). Many businesses had to adapt quickly to digital platforms to survive.

7. Global Trade and Investment

The pandemic also led to a decline in global trade. With factories closed,
goods couldn’t be produced and shipped as usual. International investment
slowed down, as companies faced uncertainty about the future and countries
focused on managing the crisis at home. Many countries also experienced a
decline in foreign direct investment (FDI) as global uncertainty made
investors more cautious.

8. Economic Inequality
The recession deepened economic inequality, as lower-income workers and
vulnerable populations were hit the hardest. People in informal jobs, those
without health insurance, and those working in hard-hit sectors suffered
disproportionately. On the other hand, wealthier individuals and certain
sectors, like technology and e-commerce, often saw growth during the
pandemic. This inequality has raised concerns about long-term social and
economic consequences.

9. Economic Recovery
By the end of 2020 and into 2021, many countries began to show signs of
recovery. Governments rolled out vaccination programs, which allowed
businesses to reopen and people to return to work. However, the recovery
has been uneven, with some regions and sectors bouncing back quickly while
others continue to struggle. The vaccine rollout and the ability to control the
virus’s spread have played a significant role in the pace of recovery.
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Q3. When interest rates fall, how might you change your economic behavior?

When interest rates fall, it becomes cheaper to borrow money. So, you might
do the following:

 Borrow More: You may decide to take out loans for things like
buying a house, car, or starting a business because the cost of
borrowing is lower.

 Spend More: Since loans are cheaper and saving money earns you
less interest, you might spend more on goods and services.

 Invest More: Lower interest rates can make bonds and savings
accounts less attractive. So, you might choose to invest in stocks or
other investments that offer higher returns.

 Save Less: With lower interest rates, the return on savings

decreases. You might decide to save less money in banks and look for
other ways to use your money.

In short, when interest rates fall, you might borrow, spend, and invest more,
while saving less.

Q4. Is everybody worse off when interest rates rise?

No, not everybody is worse off when interest rates rise. It depends on the
situation.

 People with savings: If you have money saved in a bank

account, you may benefit from higher interest rates because you will
earn more on your savings.
 Borrowers: If you have a loan or plan to borrow money, higher
interest rates can make it more expensive to borrow. This can make
things harder for you because you will have to pay more interest.
 Economy: In general, central banks raise interest rates to control
inflation. This can slow down the economy and reduce spending, which
can hurt businesses and workers in the short term.

So, it’s not the same for everyone. Some people may benefit, while others
may struggle.
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Q5. What is the basic activity of banks?

The basic activity of banks is to provide financial services that help

individuals, businesses, and governments manage money. Banks perform
various functions, but their core activities include:

 Accepting Deposits: Banks allow people and businesses to

deposit their money in different types of accounts, such as savings
accounts, checking accounts, and fixed deposits. This money is kept
safe in the bank, and account holders can withdraw or transfer it when
needed.

 Providing Loans: Banks lend money to individuals, businesses,

and sometimes governments. These loans help people buy homes,
start or expand businesses, or finance education. Banks charge
interest on these loans, which is one of the ways they make money.

 Facilitating Payments and Transfers: Banks offer services to

help customers send and receive money, both locally and
internationally. This includes electronic transfers, wire transfers, and
services like credit and debit card payments. These services make it
easier for people to buy goods and services or pay for bills.

 Investment Services: Banks also provide investment products

such as mutual funds, bonds, and stocks to customers. They help
individuals and businesses invest their money for future growth.

 Managing Risk: Banks offer services like insurance, where they

help individuals and businesses protect themselves against financial
risks, such as accidents or health issues. Banks also help manage risks
by providing hedging tools or advice for businesses in uncertain
markets.

Overall, banks act as intermediaries in the economy, connecting people who

have money (depositors) with those who need money (borrowers). They
ensure the smooth flow of money, which helps businesses grow, supports
economic development, and contributes to financial stability in society.

Q6. Why are financial markets important to the health of the economy?
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Financial markets are very important for the health of an economy. These
markets allow people, businesses, and governments to buy and sell financial
assets like stocks, bonds, and currencies. Here are some key reasons why
they are important:

1. Facilitating Investment and Savings

Financial markets help people and businesses invest their money in projects
or companies that can grow. When individuals save their money, they can
invest it in stocks, bonds, or other financial instruments. These investments
help businesses get the money they need to expand, improve technology, or
create new products. Without these markets, it would be hard for businesses
to find money for their growth.

2. Efficient Allocation of Resources

Financial markets make sure that money is used in the best possible way.
When companies or governments need money, financial markets help direct
the money to the most productive places. For example, if a business is doing
well and has growth potential, investors may put their money there, helping
that company grow faster. This efficient allocation of money supports
economic growth.

3. Price Discovery
Financial markets help set the price of assets like stocks, bonds, and
commodities. The prices of these assets are determined by supply and
demand. If more people want to buy a stock, its price will rise, and if more
people want to sell, the price will fall. This process is called price discovery.
Having clear prices helps businesses and governments make informed
decisions and allows investors to understand the value of their investments.

4. Liquidity
Financial markets provide liquidity, which means people can buy or sell
assets easily. For example, if someone owns shares in a company, they can
sell them quickly in the stock market and get cash. This liquidity makes it
easier for individuals and businesses to move their money when they need it,
ensuring the smooth flow of money in the economy.

5. Risk Management
Financial markets allow people and businesses to manage risk by diversifying
their investments. By spreading investments across different types of assets,
like stocks, bonds, and real estate, they can reduce the risk of losing all their
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money if one investment performs poorly. This helps keep the economy
stable, as businesses and individuals are less likely to face financial
difficulties.

6. Supporting Economic Growth

Financial markets help increase the overall wealth of an economy. When
businesses can easily access funds to invest in growth, they can create more
jobs, increase production, and drive innovation. This overall growth in
businesses leads to higher income, more jobs, and better living standards for
people.

7. Government Financing
Governments use financial markets to borrow money by issuing bonds. This
borrowing is essential for funding public projects like infrastructure,
healthcare, and education. Financial markets help governments raise the
money needed for these projects, which contribute to economic development
and improve the lives of citizens.

8. Economic Stability
Financial markets also play a role in maintaining economic stability. When
markets are functioning well, they can signal any problems early, such as an
economic slowdown or inflation. This helps governments and central banks
make the necessary changes, like adjusting interest rates or providing more
financial support, to avoid deeper economic problems.