Fundamentals of Money & Banking (1414) Semester: Autumn, 2020

Course: Fundamentals of Money & Banking (1414) Semester: Autumn, 2020
Level: Renamed as Associate Degree in Commerce Total Marks: 100
                                                           ASSIGNMENT No. 1
                                                                    (Units: 1-4)
Q.l Define money and describe its importance as a liquid asset.
INTRODUCTION TO MONEY
The word money is derived from Latin word „’Monet”. Money used in economic transactions and also serve as medium of exchange. Money can be defined as “Money can be anything that is generally acceptable as a means of exchange that at the same t acts as a measure of value.” (Crowther) OR
 fees, and fines through
3RTANCE AS A LIQUID ASSETS
icial asset is a documentary claim that has a monetary value. In capitalism, markets offer a mechanism to trade goods and services among the buyers and sellers at an agreed price. There are many types of markets in an economy; fruits markets, cloth markets, commodity markets, auto markets etc. The financial market is also a kind of market that coordinates the activities of all other markets. The financial market is a mechanism to trade financial assets among the buyers and sellers at a mutually agreed price. The working in financial market is carried on by the financial institutions, as mentioned above, to facilitate the buyers and sellers of the financial assets.
There are different types of financial assets traded in financial markets;
Shares are the certificates usually bought on a stock exchange that represent the claim of ownership in a company. The shareholders are entitled to claim of profit called dividend and they can sale their shares at any time to earn a capital gain.
Bonds are the certificates through which investors provide funds to the businesses at an interest rate for a specific period. The bonds are issued by companies as an alternate of shares if they are not willing to share their ownership of business.
Investment Certificates are the term-specific investment tools that offer a periodic return to their holders and are generally issued by the financial institutions to finance a specific project.
Commercial papers are short term investment instruments redeemable at maturity and are purchased by the buyers in order to provide funds to the businesses at an interest rate.
Prize Bonds are financial assets of a fixed value that offer a chance to win a prize in a lottery. These bonds are redeemable at their original value in case of nonwinning a prize.
Futures are the financial assets that derive their value from an underlying asset whose price is agreed at present and settlement is made in future.
Treasury Bills are the investment tolls offered by the government for short term financing requirements that carry an interest rate and are redeemable on maturity.
viii. Trade Notes represent the short-term outstanding amounts payable to the creditors by a business. These notes can be discounted by the creditors though banks before maturity or can be used for mutual settlement with another party.
E-Certificates are offered by the modern online form funds in their projects. These certificates carry an explicit share claim.
Units are the investment tools offered by a mutual fund or another investment scheme that carry the rights of a unit holder to p an investment scheme.
Cheque is a modern banking tool that is usei through bank accounts. Generally, cl loans and payable amounts. 

Q.2 What is barter system? Discuss its difficulties. How were these difficulties
removed by money?
ORIGIN OF BARTER:
The origin of barter may be traced to the human tendency to meet his wants. In the ancient time, man was self-sufficient; he had a few wants, which he satisfied himself. With the passage of time the wants of man increased. He. lost his self-sufficiency. Man engaged himself in the production of only one or some of the goods of his needs and to exchange the surplus goods with those goods which were produced by others and were needed by him. In this way the direct system of exchange of goods known as barter came into being. 

DEFINITION OF BARTER SYSTEM:
Barter is a system in which goods and services are exchanged for other goods and services without the use of money. In a barter system goods buy goods. A few important definitions of barter system are as follows-:
R.H. Parker:
“Barter is the direct exchange of goods and services without the use of money as either the means of payment or a unit of account: ’’
S. H. S. Sloan:
“Barter is the direct exchange of commodity or service for another without the use of money. •' •
G. Thomas:
“Barter is a form of trading in which goods are exchanged directly for other goods without the use of money as an intermediary.”
FEATURES OF BARTER SYSTEM:
The following are the main features of barter system.
CO Barter system is the first stage of monetary development.
Barter system is simply direct exchange of goods and services.
- Barter system requires double coincidence of wants.
Under barter system goods and services are directly exchanged without the use of money. ' ■ ■ .
Barter system generally exists in backward and under developed areas of the world. .
Barter system is possible if the wants of the people are .....
ii) Barter system existed until a full money system has been
INCONVENIENCES OF BARTER ' OR
DIFFICULTIES OF BARTER - OR
DEFECTS OF BARTER OR
REASONS FOR GIVING UP BARTER SYSTEM.
As a method of exchange the barter system suffered for many, inconveniences and difficulties. The main inconveniences are as under;
Lack of double coincidence (non-matching) of wants: The main difficulty of barter system is the lack of double coincidence of wants i.e. non-matching of wants. In a barter system a person who wants to exchange wheat with sugar must find a person who is willing to exchange sugar with wheat. He could not succeed in acquiring sugar until he met some one who not only had sugar but was also willing to barter with wheat.
Lack of common measure: The second shortcoming of barter system is that there is no standard unit to measure the values of goods and services. So difficulties were faced in valuation of goods.
Lack of sub-division: The third serious difficulty of barter system is ‘ the lack of sub-division of commodities. For example of the owner of cow wants to have 5 kilos of sugar. The barter between the person having cow and sugar will not take place because the value of cow is much more than 5 kilos of sugar. As it is not possible to divide his cow, no exchange will be possible between the two persons.
Lack of store of value: The barter system suffered the lack of any reliable method of storing the ’value. Some commodities are perishable which could not be stored for a long period.
Difficulty of future payments: The barter system suffered the difficulty of the future payments. There is no standard method of future payment. .
Difficulty of transfer of wealth: Under barter system there is difficulty of transfer of wealth from one place to another place. Immovable property cannot be transferred to another place.^The transfer of moveable property is very difficult and costly. Suppose a person wants to shift one hundred heads of cattle from Faisalabad to Karachi. You can well imagine the difficulties he would face.
Difficulties in tax collection: The difficulty of barter system is the collection of tax in the form of goods. If the government is able to collect the tax in the form of goods, there would be problem of the storage of goods. No Capital formation: Under barter system people are concerned with their current needs. They do not save and there is no capital
' formation. The difficulty of store of wealth hinders from saving and capital formation.'
No Investment: The barter system suffered the lack of store of value so, there was no saving. Hence investment could not be made.
No division of labour: Under barter system investment could not be made. Goods are produced in small scale. So, there was no division of labour.
No Banking System: Banks deal in money there is no money in barter system, so, there is no concept of banking in barter system. No Industrial Development: The establishment of banks and stock exchanges is necessary for industrial development. Banks and stock • exchanges cannot be established under barter system, so there is nc possibility of industrial development.
REMOVAL OF INCONVENIENCES/DIFFICULTIES/DEFEC^S OR <
BARTER
Money has removed the inconveniences, difficulties an 3
system as under: . ,. _ Double coincidence of wants: Money as me iu 9®
removed the double coincidence-of wants. Un e Vs
goods and services are exchanged for money._ j
wheat, who wants to purchase ghee can se is
Q.3 Explain the following theory of money: (20)
i. Quantity Theory of Money; Fisher’s Transaction Approach ii. Cash Balance Theory of Money
THEORY OF MONEY
Value of money means the purchasing power and capacity to exchange the goods and
services. It refers to the strength of money in the market against which we can buy or sell something. Money is a type of asset in an economy which is used to buy good and service and it serve as store value in an economy. In daily life, we can observe that mere increase in the supply of money does not make us rich rather it hurts the purchasing power of consumers. To know how value of money is determined, we need to understand the following theories:
1. Quantity Theory of Money:
The quantity theory of money presented by Irving Fisher is a relationship between the money supply and the price level. Any change in the money creates an exactly proportionate change in the price level. As per theory, “Other things remaining unchanged, on the quantity of money in circulation increases, the price level also increases in direct proportion and the value of money decreases in direct proportion.
On the other hand if the quantity of money is doubled, the price level will also be double and the value of money will be one half. If the quantity of mon by one half, the level will also be reduced by one half and the value of be twice. It is based on the assumption of full employment in the econ 2. Cash Balance Approach of the Quantity Theory of Money
The cash balance approach was developed by the group of Cambridge economists in England which includes Alfred Marshall. A. C. Pigou, Robertson and J. M. Keynes. The cash balance approach is differing from the Fishers theory as it
focuses on the store of value of function of money. According to them, the value of money is determined by money for a particular time. People want to hold real in different reasons i.e unexpected expenditures. The d portion of real income that people wants to hold i
value of money depends on the cash holdin
3. Modern Theory of Value of Money
ind and supply of cash balances for or money is that y form. Therefore, the
ents in a country.
Milton Friedman and group of economis modern theory of value of money. Mi
is the theory of demand for mon or price level”. According to Fri< consumable services. In Friedma different forms.
iversity of Chicago explained the iedman said that „ ’the quantity theory t the theory of output or money income
man wealth includes the source of income or views, wealth can be held in the following five
a) Money: It includes cu b) Bonds: Bonds are d 13
emand deposits and time deposits.
s a claim for payments that are fixed in nominal units.
defined as a claim for payment that are fixed in real units.
includes inventories of producer and consumer goods.
includes skills, knowledge and experience possessed by an individual. According to Friedman the demand for money is a function of the following factors: a) Rate of returns on shares: if rate of return on shares increases, the demand for money is decreases and vice versa.
Rate of return on bonds: If the rate of return on bonds is increased, the demand for money is decrease and vice versa.
Liquidity: It means how quickly the assets can be converted into cash the liquidity of assets also affects the demand of assets.
Degree of risk: Degree of risk is also affecting demand for an asset.
Q.4 Define Inflation. What are the main causes of inflation in Pakistan? How can it be
controlled? (20)
INFLATION AND ITS TYPES
Inflation is an increase in the general price level of the goods and services in an economy over a period. Inflation occurs when general level of prices and cost are rising. Inflation arises when money income is expending more than proportionate to income earning activity.
Inflation can be classified on the following basis:
a. Inflation based on Causes: Inflation can be classified on the basis of causes as:
Demand Pull Inflation: Demand pull inflation arises in an economy when the demand for goods and services is increased but on the other hand supply of goods and services decreases and the general price level rises. There are many fact cause the demand pull inflation: i. Increase in money supply
Increase in the demand for goods and services iii. Increase in the income level
Cost Push Inflation: Cost push inflation arises when the cost for production and operations increases. There are many factors that create cost push inflation:
Increase in wages.
Increase in cost of raw materials.
Increase in the cost of important components.
b. Inflation based on Employment: Inflation ca employment as
i. Partial Inflation: According to J. M. Key] increases partly due to an increase in the
to rise in supply of money before full ii. Full Inflation: It arises when employment. Increase in money without any increase in producti ssified on the basis of  hen the general price level production of goods and partly due ment stage is called partial inflation.
c. Inflation based on De
my has reached at level of full and general price level also increase, but d employment. control as:
i. Open Inflation: of control for th
ii-measures rationing. d. Inflati 'ontrol: Inflation can be classified on the basis of inflation, general price level rises day by day and gets out ment. tion: In this type of inflation government should take steps and n the rise in general price level through different methods like ased on Rate of Inflation: Inflation on the basis of rate of inflation can identiified as under: ing Inflation: In creeping inflation situation the general price rises with slow rate. In creeping inflation situation the general price level rises up to a rate of 2% per annum.
Walking Inflation: During walking inflation situation the general price level is increased at lesser level as compared to the creeping inflation. On this inflation situation general price level rises approximately 5% annually.
Running Inflation: In running inflation situation the general price level rises approximately 8% to 10% annually.
Hyperinflation: Keynes calls hyperinflation as the final stage of inflation that type 























 









of inflation arises after the level of full employment attained, but price level increases rapidly.

e. Other Types of Inflation:

Monetary Inflation: Monetary inflation arises in an economy due to rapid increase in money supply. If money supply increases in an economy the value of money falls and the economy faces different problems.

Budgetary Inflation: When government of a country overcome the budget deficit through lending and insurance of new currency, that behavior increase the purchasing power and also create rise in the general price level that leads to inflation.

Profit Induced Inflation: Profit induced inflation arises, when the business in monopoly position they increase their rate of profit on their production, they may cause inflation in an economy.

REMEDIES FOR INFLATION

It is the main duty or objectives of every government to take proper measures control the inflation. Two major tools to control the inflation are monetary fiscal policy;

Monetary Policy:

Monitory policy influences the economy through change of mone availability of credit. Monetary policy is set by the central bank o adopts following methods to control the money supply i.e. a. Variation in reserves requirements of commercial banks. b. Variation in bank rates for lending.

Variation in margin requirements for banks.

Credit rationing for allocating capital in various sectors.

Fiscal Policy:

It is the budgetary policy of the government related to the public finance taxes, borrowing and deficit financing. Fiscal policy states the change in the spending and taxes to stimulate the economy by the government. The main fiscal measure is: a. Changes in taxation by lowering tax rates and increasing consumption b. Public borrowing is curtailed, and funds are saved

c. Control of budget deficit is achie1 d. Adopting a general austerity poli iii. Other Measures:

follows. O Qr

Control of smuggling as it reduces supply of goods in country.

Provisions of subsidies to needy sections of society.

Population control to reduce the aggregate demand.

age simple living to reduce demand for expensive items. ;ontrol on the prices of essential items by the government. ige Sunday and Friday markets to offer discounts.









Q.5 How would you measure measurement be accurate?

VALUE OF MONEY

Value of money means the purchasing power and capacity to exchange the goods and services. It refers to the strength of money in the market against which we can buy or something. Money is a type of asset in an economy which is used to buy good and ser and it serve as store value in an economy. In daily life, we can observe that mere incr in the supply of money does not make us rich rather it hurts the purchasing power of consumers.

relationship between value of money and price

The relationship between the value of money and the general price levelj inverse and proportional. When the general price level rises, the valuetf money falls and when general price level falls the value of money rises.

MEASUREMENT OF CHANGES IN VALUE OF MONEY -

INDEX NUMBER

Value of money has shown a tendency to fall over time. In order to have complete knowledge about the extent of fall of value, the index numbers d various types are prepared. Index numbers measure the changes in pricesa value of money between different time periods.

DEFINITION OF INDEX NUMBER

Statistical method of computing the changes in the value of money is called index number.

A few important definitions of index number are given below to have a clear idea of index number. ■ . •<• . ..

I

compared with baselyear^K J

G. Whitehead ’ . ) -

'Index is a statistics which indicates the level of nrices ou,puts and var/ab/es a< given dales, r£ti£?o the level*

Simple definition

'■"nXSberTanVs^ '? *h® Simple as under J one year with the prices oP ,s used to compare the pn°e change in the value ofmoney „nother year in order to measure j


numbers are of two kinds: numb

Simple or un-weighted index number:

equal importance is given to all commodities is J<no— —

nujmber or un-weighted index riumber . •

Weighted index number: The^ index number n|ch

commodities are given due .weight i m p ortan.ce in the .national consurnpttori

number. The weightto be giv-ets—-To determined with reference To'~ffie amou people spend ori~ifiern7~ •— : —




















taTjTtee the general price level in the country. cost of living: Cost of living index numbers can o

-iasure the cost of Hying of different classes of nfiopIe.

le government to rormuTate economic policies. j(>

/ages policy^ Cost of living jndex numbers can 3, government and private entrepreneur to form re a

^glicy of the employees._ ’

/Economic changes^, Index numbers can be used changes of imports, exports, industrial activities,

■■ opportunities, etc.7\ This helps the government o decisions and to form policies with respect to t2ern.=,Q_l to c<- Purchasing power: index numbers can also be u ntry.

purchasing newer of different groups of people in the c ^_^-

- - vaiue Qi money

the economic conditionsclass 'oeoLt ,be-uaed tP measure

—This is necessary to take necessary steoVfo W° different Periods. .

International growth :<£vorld economic growth t

measure the economic growth TnfTafian ' nnl-m?.i lnflfi?V£sargjjsed to andTmaerdeveloped countries' of ThezWnF^T^^F^T~T1^g^^P^d compare the economic growth ofdilfc^r^ountries P 1 kn°W and (viii) Management efficiency: Index numbers can be used to measure the changes in production level of different commodities between two periods. If there is increase in production, it means that the efficient V3*^-»of the management has improved and vice versa iciency

' '^vestment trend: Investment index numbers are used to measure the net yield_on .shares of different companies and investment trend. This helps those investors who are interested in makjng investment.

I raae volume: I he index numbers can be used to measure the V°lume of n^naland international trade. The volume of national and irneri lealiuitSTtrade of cne period can be compared with other period. The increase or decrease in the volume of trade can be used to form

the trade policy..

Sales volum^-5 The sales index numbers can be used to measure J^J/and compare the sales volume of different periods. The increase or ^--decrease of sales volume will qi^rie the management of the business

J^form sales policy- • -

xii) General price level: International price index numbers are used to compare the genera! price level of developed and underdeveloped Countries of the world.


^LIMITATIONS OF INDEX NUMBERS OR •

/DISADVANTAGES OF INDEX NUMBERS OR

DEFECTS OF INDEX NUMBERS
Index numbers suffer from the following limitations and defects:
(i) Approximation: The results of index numbers are just approjdmatipm These are not exact. Hence, we can not pbtain the desired results from index numbers. • . .
 International comparisons: International comparisons are difficult because—different—countries use different base year, different .... commodities and of different quality.
Comparison between different times: Comparisons,of changes o general price level and value of money between different times are hot easy— Because during this period somg_c.Qrrunodities.mus-is very difficult to assign appropriate weigM to different commodities. Thus, the results of weigh e are not accurate.

(V) Misleading results. While ,ete tbe index numbers commodities are taken to c p Therefore, the rest of commodities is not wisely
numucio aic.
Difficult to take decisi _ different results are available % calculating index numbers on the basis of index numb.?' is very difficult to take decisi constructed on the basis 
Sample data: Index numtno( re|jab|e and correct. Fo data; therefore, the result^ar shou|d have been used, ‘p and reliable results complete .
DEPRECIATION
There are two types i. Devaluation 

DEVALUATION OF MONEY
in the value of a currency:
Planned devaluation is come into existence by the government decision to reduce a
relative valu against
ii. De, Mark marke
ir country currency. Government takes devaluation of currency encies for the improvement of trading positions. preciation of Currency:
driven devaluation does not arise by the government, but it arises due to the st position. Due to the monetary crises the value of currency automatically
devalued against the other country currencies.
Effects of Depreciation/Devaluation:
Following are the effects of depreciation and devaluation of currency:
When the currency is devalued, the imports tend to be more expensive and exports tend to cheaper.
Devaluation discourages the investors for making investment in that country whose currency devalued rapidly.
Devaluation makes the country currency less attractive at international level.  In devaluation exports increases and imports decrease, that make the balance of payment favorable.
The increase in exports and decrease in imports reduced the current account deficit.