Q4

Financial Intermediary'
An institution that acts as the middleman between investors and firms raising funds. Often
referred to as financial institutions.

types

1. Depository intermederies

banks

It is a institution that provides transactional, savings, and money market accounts and that accepts time
deposits

credit union

A credit union is a member-owned financial cooperative, democratically controlled by its members, and
operated for the purpose of promoting thrift, providing credit at competitive rates, and providing other
financial services to its members.

A savings and loan association

S&L, also known as a thrift, is a financial institution that specializes in accepting savings deposits and
making mortgage and other loans.

A savings bank is a financial institution whose primary purpose is accepting savings deposits. It may
also perform some other functions.

2. Non depository

Insurance Companies

Insurance companies protect their customers from the financial distress that can
be caused by unforeseen events, such as accidents or premature death. They pool
the small premiums of the insured to pay the larger claims to those who have
losses. The premium payments are regular while the losses are irregular, both in
timing and amount. An insurance company can profit because it can accurately
estimate the payment of claims over a large group by using statistics and it can
invest its surplus for greater returns, which helps to lower premiums to be
competitive.
Pension Funds

Pension funds receive contributions from individuals and/or employers during

their employment to provide a retirement income for the individuals. Most pension
funds are provided by employers for employees. The employer may also pay part
or all of the contribution, but an employee must work a minimum number of years
to be vested—qualified to receive the benefits of the pension. Self-employed
people can also set up a pension fund for themselves through individual
retirement accounts (IRAs) or other types of programs sanctioned by the federal
government.

Securities Firms

Securities firms are companies that provide institutional support for the buying
and selling of securities. Investment companies, brokerages, and investment banks
are the major types of securities firms.

Federal Government-Sponsored Enterprises (GSEs)

There are a number of government agencies or private corporations chartered by

the federal government that also act as financial intermediaries. These agencies
were created ad hoc by Congress to provide credit to specific constituencies that
Congress has argued were not being addressed adequately by the free market.

Finance Companies

Finance companies provide loans to people or businesses using the issuance of

short-term securities, especially commercial paper, as a source of
funds. Consumer finance companies provide consumer loans and sometimes
mortgages. They also provide the instant credit offered by so many retail stores,
where the customer receives the item but doesn't have to pay for a stipulated
amount of time.
Q5

Fiscal policy is the means by which a government adjusts its levels of spending in order to
monitor and influence a nation's economy. It is the sister strategy to monetary policy with
which a central bank influences a nation's money supply.

functions

The development of a fiscal policy generally has four primary purposes or functions.

Allocation
The first major function of fiscal policy is to determine exactly how funds will be allocated. This is closely
related to the issues of taxation and spending, because the allocation of funds depends upon the
collection of taxes and the government using that revenue for specific purposes. The national budget
determines how funds are allocated. This means that a specific amount of funds is set aside for purposes
specifically laid out by the government. This has a direct economic impact on the country.

Distribution
Whereas allocation determines how much will be set aside and for what purpose, the distribution function
of fiscal policy is to determine more specifically how those funds will be distributed throughout each
segment of the economy. For instance, the government might allocate $1 billion toward social welfare
programs, but $100 million could be distributed to food stamp programs, while another $250 million is
distributed among low-cost housing authority agencies. Distribution provides the specific explanation of
what allocation was intended for in the first place.

Stabilization
Stabilization is another important function of fiscal policy in that the purpose of budgeting is to provide
stable economic growth. Without some restraints on spending, the economic growth of the nation could
become unstable, resulting in periods of unrestrained growth and contraction. While many might frown
upon governmental restraint of growth, the stock market crash of 1929 made it clear that unfettered
growth could have serious consequences. The cyclical nature of the market means that unrestrained
growth cannot continue for an indefinite period. When growth periods end, they are followed by
contraction in the form of recessions or prolonged recessions known as depressions. Fiscal policy is
designed to anticipate and mitigate the effects of such economic lulls.

Development
The fourth major function of fiscal policy is that of development. Development seems to indicate economic
growth, and that is, in fact, its overall purpose. However, fiscal policy is far more complicated than
determining how much the government will tax citizens one year and then determining how that money
will be spent. True economic growth occurs when various projects are financed and carried out using
borrowed funds. This stems from the the belief that the private sector cannot grow the economy by itself.
Instead, some government input and influence are needed. Borrowing funds for this economic growth is
one way in which the government brings about development. This economic model developed by John
Maynard Keynes has been adopted in various forms since the World War II era.
Q6
Monetary policy is the process by which the monetary authority of a country controls the supply of
money, often targeting a rate of interest for the purpose of promoting economic growth and
[1][2]
stability. The official goals usually include relatively stable prices and low unemployment. Monetary
theory provides insight into how to craft optimal monetary policy.

function

High employment
Price stability;
Economic growth
Interest rate stability
Financial market stability
Foreign exchange market stability
Conflicts among goals

Q7

Role of central bank

Function of a central bank

1. Monopoly of note issue

Note issue primarily is the main function of a central bank in every country. These days, in all the

countries where there is a central bank generally it has got the monopoly of the sole right of note issue. In

the beginning this was not the function of central bank, but gradually all the central bank gas acquires this

function.

There are many advantages of the note issue by central banks some important ones are as follow:

1. Central bank controls the credit creating power of commercial bank. By controlling the amount of
currency in circulation, the volume of credit can be controlled to quite a large extent.

2. People have more confidence in the currency issued by the control bank because it has the protection

and recognition of the government.

3. In the event of monopoly of note issue of central bank, there will be uniformity in the currency system

in the country.

4. The currency of the country will be flexible if the central bank of the country has the monopoly of

note issue because central bank can bring about changes very early in the volume of paper money

according to the needs of business, industry and messes.

5. The system of note issue has some advantages. If the central bank of the country has the monopoly

of note issue, all such advantages will accrue to the government.

2. Bankers, Agent and Adviser to the Government
As banker to the government, central bank provides all those service and facilities to the government

which public gets from the ordinary banks. It operates the account of the public enterprise. It mangers

government departmental undertaking and government funds and where there is a need gives loan to the

government. From time to time, central bank advice the government on monetary, banking and financial

matters.

3. Custodian of Cash Reserve of Commercial Bank

Central bank is the bank of banks. This signifies that it has the same relationship with the commercial

banks in the country that they gave with their customers. It provides security to their cash reserves, give

them loan at the time of need, gives them advice on financial and economic matter and work as clearing

house among various members bank.

4. Custodian of Nation’s Reserve of International

Central bank is the custodian of the foreign currency obtained from various countries. This has become an

important function of central bank. These days, because with its help it can stabilize the external value of

the currency.

5. Lender of The Last Resort

Central bank works as lender of the last resort for commercial banks because in the time of need it

provides them financial assistance and accommodation. Whenever a commercial bank faces financial

crisis, central bank as lender of the last resort comes to its rescue by advancing loans and the bank is

saved from being failed.

6. Clearing House Function

All commercial bank have their accounts with the central bank. Therefore, central bank settles the mutual

transactions of banks and thus saves all banks controlling each other individually for setting their

individual transaction.

7. Credit Control

These days, the most important function of a central bank is to control the volume of credit for bringing

about stability in the general price level and accomplishing various other socio economic objectives. The

significance of this function has increased so much that for property understanding it. The central bank

has acquired the rights and powers of controlling the entire banking.

A central bank can adopt various quantitative and qualitative methods for credit control such as bank rate,

open market operation, changes in reserve ratio selective controls, moral situation etc.

Other Functions

Besides the 7 functions explained above, central banks perform many other functions that are as follows:
8. Collection of Data
Central banks in almost all the countries collects statistical data regularly relating to economic aspects of

money, credit, foreign exchange, banking etc. from time to time, committees and commission are

appointed for studying various aspects relating to the aforesaid problem.

9. Central Banking in Developing Countries

The basic problem of underdeveloped countries is the problem of lack of capital formation whose main

causes are lack of saving and investment. Therefore, central bank can play an important role by promoting

capital formation through mobilizing saving s and encouraging investment.

Q8

When a central bank is "easing", it triggers an increase in money supply by purchasing government
securities on the open market thus increasing available funds for private banks to loan throughfractional-
reserve banking (the issue of new money through loans) and thus the amount of bank reserves and the
monetary base rise. By purchasing government bonds (especially Treasury Bills), this bids up their prices,
so that interest rates fall at the same time that the monetary base increases. It happens in deflation.

In contrast, when the central bank is "tightening", it slows the process of private bank issue by selling
securities on the open market and pulling money (that could be loaned) out of the private banking sector.
By increasing the supply of bonds, this lowers their prices and raises interest rates at the same time that
the money supply is reduced.

This kind of policy reduces or increases the supply of short term government debt in the hands of banks
and the non-bank public, lowering or raising interest rates. In parallel, it increases or reduces the supply
of loanable funds (money) and thereby the ability of private banks to issue new money through issuing
debt. Such thing happens in inflation
Q9

Tools use by central bank

Bank Rate or Discount Rate:

It is the oldest method of credit control. It was used by the Bank of England in 1839. Bank rate refers

to the rate of interest at which the Central Bank rediscounts approved bills of exchange. I used as

instrument with the assumption that market rate of interest respond to the change in bank rate. When

bank rate is raised, this is called a dear money policy, where as when bank rate is reduced this is

called as cheap money policy. When bank rate is raised the market rate of interest will increase and

vice versa.

Let us understand this in detail. Money held by commercial bank is called reserve. If these reserves

are kept idle, then the returns are nil. Commercial bank tries to keep their reserve as low as possible.

In doing so, they run the risk of running below the Reserve requirement level. In such cases, they sell

the securities in their possessions and deposit the proceeding at Central Bank or directly sell it to

central bank. So, whenever commercial banks are in need the central bank lends reserves directly to

the banks for a charge known as bank rte or discount rate.

Open Market Operation:

It refers to purchase or sale by Central Bank of any securities, to regulate the credit creating capacity

of Commercial Bank. Whenever the Central Bank purchases the securities, it does payment by cheque

to sellers. The seller with deposit it with the Commercial Bank and the bank reserve increases. This is

done when the central bank wants to increase the money supply in the economy. When the reserves

with the Commercial Bank increases, the loan giving capacity of commercial Bank increases. On the

other hand, Central Bank will sell the securities and accept cheque payments by the people who will

be depositing the cheques in Commercial Bank. This leads to decrease in the reserve with commercial

bank; as a result the loan giving capacity will decrease.

Minimum Reserve Requirement:

Every Commercial Bank has to maintain certain amount of reserve with Central Bank. Central bank

has the power to set the reserve requirement to control the lending capacity of Commercial Banks. By

changing the reserve requirement, it can control the money supply. Reserve maintained by

commercial bank is called Statutory Reserve and the reserve over and above the Statutory Reserve is

called ‘Excess Reserve’.

Excess reserve = total reserve – statutory reserve

Statutory Liquidity Requirement (SLR) is the minimum amount of liquid assets maintained by the

banks, which is equal to or not less than a specific percentage of outstanding deposit liabilities.

Cash Reserve Ratio (CRR):

Commercial Bank has to keep a deposit with the Central Bank. This amount of funds is equal to

specific percentage of its own deposit liabilities. This is Cash Reserve Ratio. These reserve

requirements of central bank work as a very strong weapon and cause sharp change in lending

capacity of commercial bank.

1) Credit Rationing: Under this, certain conditions are laid by the Central Bank to see proper

regulation of consumer credit. This is to prevent excess expansion of credit.

2) Direct Action: This includes charging penalty interest rates, qualitative credit ceiling etc. on

Commercial Bank. It has its direction and restrictive measures, which all the concern banks should

follow regarding the lending and investment.

3) Margin Requirement: Here, margin refers to difference between market value and amount

borrowed against the securities. Bank, while advancing loan against security, do not lend the full

amount, but less. This is done keeping in view the difference between the value of security and the

amount of advance to cover any loss.

4) Moral Persuasion: This is used by many countries. It has a great influence over the loan policy of

banks. There is a co-operation between them. Under this, the Central Bank makes an informal request

to Commercial Bank to contract loans in the time of inflation and expand loans in depression. It helps

the Central Bank to secure the willingness and co-operation, but then that depends on the amount of

respect and authority the Central Bank enjoys among the member banks.

Q10

Banks create money by loaning out money that was deposited with them. Here's an example:

Andy deposits $100 at the bank.

The bank then loans out $80 to Bill. The amount of the $100 that the bank received as a deposit that can
be loaned out depends on the required reserve ratio as set by the Fed.
At this point, Andy has $100 and Bill has $80 in purchasing power. So the money supply has essentially
increased from $100 to $180, thus "creating" money.

Further money creation can be achieved if Bill went to a bank and deposited his $80, then that bank could
(assuming the required reserve ratio is 20%) loan out $64 to Carl, etc etc.

Q12

Role of Insurance in Economic Development

For economic development, investments are necessary. Investments are made out of savings. A life
insurance company is a major instrument for the mobilization of savings of people, particularly from the
middle and lower income groups. These savings are channeled into investments for economic growth.

An insurance company’s strength lies in the fact that huge amounts come by way of premiums. Every
premium represents a risk that is covered by that premium. In effect, therefore, these vast amounts
represent pooling of risks. The funds are collected and held in trust for the benefit of the policyholders.
The management of insurance companies is required to keep this aspect in mind and make all its
decisions in ways that benefit the community. This applies also to its investments. This is why successful
insurance companies would not be found investing in speculative ventures. Their investments benefit the
society the society at large.

The system of insurance provides numerous direct and indirect benefits to the individual and his family as
well as to industry and commerce and to the community and the nation as a whole. Those who insure,
both individuals and corporate, are directly benefited because they are protected from the consequences
of the loss that may be caused by the accident or fortuitous event. Insurance, thus, in a sense protects the
capital in industry and releases the capital for further expansion and development of business and
industry.

The very existence of risk that is, uncertainty concerning the future, is a severe handicap in economic
activities. Insurance removes the fear, worry and anxiety associated with this future uncertainty and thus
encourages free investment of capital in business enterprises and promotes efficient use of existing
resources. Thus insurance encourages commercial and industrial development and there by contributes to
a vigorous economy and increased national productivity.

Present day organization of industry, commerce and trade depend entirely on insurance for their
operation, banks and financial institutions lend money to industrial and commercial undertakings only on
the basis of the collateral security of insurance. No bank or financial institution would advance loans on
property unless it is insured against loss or damage by insurable perils.

Insurers are closely associated with several agencies and institutions engaged in fire loss prevention,
cargo loss prevention, industrial safety and road safety.

Before acceptance of a risk, insurers arrange survey and inspection of the property to be insured, by
qualified engineers and other experts. The object of these surveys is not only to assess the risk for rating
purposes but also to suggest and recommend to the insured, various improvements in the risk, which will
attract lower rates of premium and what is more important , reduce the loss potential. For example,
burglary surveyors make recommendation in regard to security measures such as better locking system,
appointment of Watchman, etc. Engineering surveys play a most useful part in accident prevention as
valuable technical advice is provided in respect of plant and machinery.
Insurance ranks with export trade, shipping and banking services as earner of foreign exchange to the
country. It helps to earn foreign exchange and represent invisible exports.
q15

.An individual’s account at a financial intermediary is a direct claim on that intermediary. In turn, theintermediary
pools individual accounts and lends to a firm. As a result, the intermediary has a directcontractual claim on that
firm for the expected cash flows. Since the individual’s funds have inessence been passed through the
intermediary to the firm, the individual has an indirect claim on thefirm. Two separate contracts exist. Should the
individual lend to the firm without the help of anintermediary, he then has a direct claim

Q16

Financial intermediaries provide convenient and safe way to store finds and creates
standardized forms of securities. It also facilitates easy exchange of funds. Due to high volume it
is able to bear transaction and information search cost on behave of savers. Therefore, individual
saver enjoys financial services that enable them to deposit and withdraw funds without
negotiation whereas borrower avoids having to deal with individual investors. Since it has
information available for both lenders and borrowers, it minimizes information cost for
analyzing their data. Without financial intermediaries lenders and borrowers would have to pay
higher transactional and information costs.