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Question: How financial system promotes economic efficiency?
Answer: The financial system promotes economic efficiency by facilitating payments, by transferring funds from savers to borrowers and by sharing the risk.

Question: How to define liquidity?
Answer: Liquidity is defined as an ease of extracting an asset into money. In other words, an asset is highly liquid if it can be converted into money more quickly e-g cash. If it takes time to convert into money then it is said to be less liquid or in some cases illiquid asset e-g physical properties.

Question: What are the types of money?
Answer: There are two types of money. 1-Commodity money: In earlier times, traders used precious metals such as gold and silver as mediums of exchange. These physical goods were the only means by which trade was accomplished and were known as commodity money. This money has intrinsic value. 2-Fiat money: This is the paper money that we use now-a-days. Its value comes from government decree. This is generally accepted as payment of goods and services because of the “legal tender” printed on the notes.

Question: What are financial markets and what is the purpose of these markets?
Answer: There are different forms of financial markets like money market, capital market, bond market, stock market, over the counter market etc. Financial instruments are traded in these markets quickly and cheaply. With the help of these markets transactions are much more cheaper now. Stock exchange market is also a financial market where shares are traded. In Pakistan, there are three stock exchange markets i-e Islamabad Stock Exchange (ISE), Karachi Stock Exchange (KSE), and Lahore Stock Exchange (LSE). KSE is the biggest stock market in Pakistan. New York Stock Exchange (NYSE) is the biggest stock market in the world.

Question: How to measure money?
Answer: There are several measures of money called the monetary aggregates. These are M1, M2 and M3. M1 Aggregate: The narrowest aggregate measure of money is M1. M1 measures money as the traditional medium of exchange. It includes currency, traveler’s checks and checking account deposits. M2 Aggregate: M2 is slightly broader than M1. In addition to the assets included in M1, it covers short term investment accounts. These accounts cannot be used directly as a means of payment and are difficult to turn into currency quickly. M3 Aggregate: M3 includes more assets than M1 and M2. In addition to the assets included in M1 and M2, it covers such less liquid assets as large-denomination time deposits, institutional money market mutual fund balances, term repurchase agreements, and Eurodollars.

Question: How to measure inflation?
Answer: There are two methods of measuring inflation. Consumer Price Index (CPI): CPI is the fixed weight index. It measures the changes in the prices of consumer goods in current time period relative to the base period. It also measures the changes in the household’s cost of living. CPI is measured by the following formula. CPI=(Prices of consumer goods in current period / Prices of consumer goods in base period) ×100 GDP Deflator: Deflator is the technique of adjusting the changes in the price level. GDP deflator also called the implicit price deflator measures the prices of output produced in an economy relative to its price in the base year. Thus it measures the changes in the overall level of prices in the economy. GDP deflator is measured by the following formula. GDP deflator= (Nominal GDP / Real GDP) ×100 Where, Nominal GDP is GDP measured at current year prices. Real GDP is GDP measured at base year prices.

Question: Define Financial Intermediaries and the process of Financial Intermediation?
Answer: There are some financial institutions in the financial system that provides financial resources to the borrowers indirectly. These are called financial intermediaries. These institutions facilitate financial trade by raising funds from savers and investing in the debt or equity claims of borrowers. This indirect form of finance is known as financial intermediation. Like financial markets, financial intermediaries have two tasks: 1-matching savers and borrowers 2-providing risk-sharing, liquidity and information services

Question: Differentiate b/w direct and indirect finance?
Answer: In the direct finance, borrowers get funds by selling securities directly to the lenders in the financial markets. While in indirect finance, borrowers get funds indirectly through financial intermediaries. A financial institution like a bank borrows from the lender and then gives it to the borrowers.

Question: What are different types of financial instruments?
Answer: There are two types of financial instruments. 1-Underlying instruments: These are primary or primitive securities e-g bonds and stocks. 2-Derivative instruments: Their value is derived from the behavior of the underlying instruments e-g futures and options.

Question: What is the difference b/w primary market and secondary market?
Answer: Primary market is the market where newly issued securities are traded. While secondary market is the market where old and existing securities are traded.

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Replies to This Discussion

Question: Differentiate b/w depository and non-depository institutions?
Answer: Depository institutions take deposits and make loans e-g commercial banks, savings banks and credit unions Non depository institutions are insurance companies, securities firms, mutual fund companies, finance companies and pension funds.

Question: Define present and future value?
Answer: Present value is the value of a payment today that is promised to be made in the future. Future value is the value on some future date of an investment made today.

Question: What are the five parts of the financial system?
Answer: The five parts of the financial system includes money, financial instruments, financial markets, financial institutions and central banks.

Question: Define the payment system?
Answer: Money facilitates transactions in the economy. The mechanism for conducting such transactions is known as a payment system. The payment system has evolved over time from precious metals to currency and cheques to electronic funds transfer services.

Question: What are some other forms of payment besides money?
Answer: Electronic telecommunication breakthroughs have improved the efficiency of the payments system, reducing the time needed for clearing checks and the cost of paper flow for making payments. Settling and clearing transactions can now be done with computers in electronic funds transfer system, computerized payment clearing devices. Important examples: Debit card, Credit card, E money, Stored-value card and etc.

Question: Define Cheques?
Answer: Cheques are another way of paying for things but they are not legal tender. Cheques are promises to pay money on demand and are drawn on money deposited with a financial institution. They can be written for any amount and are a convenient way to settle transactions.

Question: What are financial instruments and why we need these instruments?
Answer: To carry on certain financial system we need some instruments, these can be bonds, stocks, shares etc. we need these instruments to transfer wealth from savers to borrowers and to transfer risk to those who have the potential to bear it.

Question: What is the importance of studying Money and Banking?
Answer: The study of money & Banking is an extremely important part of both economics and finance. Research has found money to play an important role in the determination of aggregate output, the aggregate price level, the rate of inflation, and the level of interest rates. It provides the basic rules of monetary, financial and banking system. It also gives the information of how banking system operates and how bank creates money in the economy.

Question: What is the most commonly used definition of money?
Answer: Money is defined to be an asset that is generally accepted as payment for goods and services or repayment of debt.

Question: What are different forms of Financial Institutions?
Answer: To carry out financial transactions, we need financial institutions. Financial institutions may be grouped in a variety of different ways. 1-Depository Institutions (Commercial banks, savings and loan associations, saving banks and credit unions) 2-Contractual Institutions (Insurance companies and pension funds) 3-Investment Institutions (Investment companies, money market funds and real estate investment trusts)
Question: Is the money same as wealth and income?
Answer: Money, income and wealth are all measured in same currency unit but there exist some difference among these terms. Money is a component of wealth that is held in a readily spend able form. Wealth is obtained from the assets that can be converted into currency. Income is the amount of currency that is obtained from work or investments over a period of time. Money is made up of coin & currency, chequeing account balances, and other assets that can be converted into cash.

Question: Why we need money?
Answer: We need money to carry out our day to day transactions. Money can be in the form of currency notes (Paper money), Coins, and credit cards (Plastic money).

Question: What are the basic principles of Money and Banking?
Answer: There are five basic principles of money and banking. 1-Time has value. 2-Risk requires compensation 3-Information is the basis for decisions 4-Markets set prices and allocate resources 5-Stability improves welfare

Question: What are the functions performed by money?
Answer: Money performs three basic functions. 1-It is used as a medium of exchange. 2-It is used as a unit of account. 3-It is used as a store of value.

Question: Why households, firms and policy makers are interested in measuring the money?
Answer: Households, firms and policy makers are all interested in measuring the money because changes in the quantity of money in the economy are associated with changes in interest rates, inflation and economic growth.

Question: How to define inflation?
Answer: Inflation is the persistent rise in the prices of goods and services. It can also be defined as the situation when too much money chasing too few goods. When quantity of money exceeds the quantity of goods and services produced then there occurs inflation.

Question: How the payment system is made in the money and banking, what is the process of that payment?
Answer: Money facilitates transactions in the economy. The mechanism for conducting such transactions is known as a payment system. The payment system has evolved over time from precious metals to currency and cheques to electronic funds transfer services. When we go to purchase some thing then we made a payment of that thing in terms of money. Money is accepted as payment every where because of the legal tender printed on it and it is issued by the government. Besides money payment can also be made through many other different ways. We can made payment by cheques. Cheques are promises to pay money on demand and are drawn on money deposited with a financial institution. They can be written for any amount and are a convenient way to settle transactions. For example, you purchase goods and services from someone and give him a paper cheque, he deposits that cheque in his bank account, and bank will transfer money from your account to the account of that person. In this way payment will be made. Debit cards are also like cheques but a certain fee is charged for it. Payment can also be made through credit cards. It is just like a loan. Bank made the payment of credit card holder and credit card holder have to repay that payment to the bank. Payment can also be made electronically and by cellular prepaid cards.

Question: Discuss about the functions and basic purpose of intermediaries and also mention that the Treasury bill issued by government is more secure or the common paper bonds by any corporation.
Answer: Financial Intermediaries are the financial institutions that are responsible for the transfer of funds from savers to borrowers. This is indirect finance. A financial institution like a bank borrows from the lender and then transfer that fund to the borrower. For example, you want to buy a car but you have no money then you will go to the bank and ask for loan, bank will give you the money. You will buy a car and that car will become your asset, but the loan is your liability because you have to repay it to the bank. The basic purpose of these financial institutions or intermediaries is to promote economic efficiency. Because people who want to invest but they have no money they can invest by taking loan through financial intermediaries. Treasury bills are more secure because these are issued by the government and government is reliable sector so there is no risk of default. On the other hand, firms or corporations may be default. It might be possible that they would be unable to pay the amount. So, there is risk involved.

Question: Explain difference between financial institutions and financial markets?
Answer: A market is the place where buyers and sellers meet together to complete their transactions. Financial markets are the places where financial instruments like bonds, shares, stocks are bought and sold. In Pakistan, Securities & Exchange Commission of Pakistan (SECP) is a financial market where securities and shares are traded. Financial institutions are the firms that provide access to the financial markets. These are also known as financial intermediaries. They provide funds from savers to borrowers and thus promotes economic efficiency e-g banks, insurance companies etc. We need financial institutions in order to carry out our transactions.

Question: Explain “monetary aggregates” in detail with examples?
Answer: We need to measure the money because changes in the quantity of money are related to changes in interest rate, inflation rate and economic growth. For measurement of money, Federal Reserve System defines monetary aggregates. Monetary aggregates measure the stock of money in circulation outside the banking system. These monetary aggregates are M1, M2, and M3.M1 is a measure of money supply including all coins and notes plus personal money in current accounts. M1 is the narrowest definition of money and includes only currency and various deposit accounts on which people can write cheques. It includes Currency in the hands of the public, Traveler’s cheques, Demand deposits and other chequeable deposits. M2 is M1 plus assets that cannot be used directly as a means of payment and are difficult to turn into currency quickly. It is also called broad money and it includes Small-denomination time deposits, Money market deposit accounts, and Money market mutual fund shares. M3 adds to M2 other assets that are important to large institutions. It includes Large-denomination time deposits, Institutional money market mutual fund shares, Repurchase agreements and Eurodollars.
Question: Explain how stocks, bonds and insurance are financial instruments and why is the payment made later?
Answer: A financial instrument is the written legal obligation of one party to transfer money to another party at some future date under some terms and conditions. Bonds, Stocks and insurance are the financial instruments. Bond is the debt instrument that is issued for a certain period of time called the maturity date. It means bond will expire after that maturity date. The purpose of issuing the bond is to raise the capital. A firm issues the bond and made the principle amount plus interest on that bond at the maturity date. Payment by the firm is delayed till the maturity date. There is no risk on the bond because interest rate is written on the bond that must be paid by the issuing firm. Stocks are the shares of different companies. People buy the shares of a company and get dividend from the profit of that company. Gain in case of shares is subject to the rise and fall in prices of the shares therefore risk is involved here. Insurance is also a financial instrument but the payment of insurance is subject to the happening of certain event i-e death in case of life insurance, accidents, fire etc.

Question: What is the difference between scheduled banks and commercial banks?
Answer: Commercial banks are depository institutions. These are financial intermediaries that accept deposits and make loans. They offer risk sharing, liquidity and information services that benefit savers and borrowers. Savers obtain risk sharing benefits from bank's diversified portfolios of loans; borrowers can obtain needed funds to finance the purchase of cars, inventories, or plants and equipment. Banks also provide liquidity services through checking accounts in which saver's deposits are available on demand. Scheduled banks are those banks which are registered in the Central Bank. In Pakistan, all commercial banks are registered in State Bank of Pakistan so they are scheduled banks. Public sector Commercial Banks are Muslim Commercial Bank (MCB), National Bank of Pakistan (NBP), The Bank of Punjab (BOP), First Women Bank, and The Bank of Khyber. Private sector Commercial Banks are Allied Bank Limited (ABL), Habib Bank Limited (HBL), and United Bank Limited (UBL) and so on.

Question: Explain the Discount rate. Why people with low discount rate save more and people with high discount rate save less?
Answer: The present value of an investment is calculated by the following formula: PV = FV/ (1+i)n Here, an interest rate i is used to calculate the present value, this interest rate is called the discount rate and the process of finding the present value is called discounting. Because we have to discount or reduce the future payments to their equivalent value today. All people have their personal discount rates. If people have lower discount rate it means that their income is more than their consumption so they can save more. On the other hand, if people have higher discount rate it means that their income is less than their consumption so they will save less rather they will borrow in order to fulfill their consumption. This gives the statement that lowers the discount rate, higher will be the savings and vice versa. Similarly, if the market interest rate is higher than the individual's personal discount rate then people will tend to save more and vice versa. This market interest rate is the interest given by the banks on savings. That's why people will save their money in banks if they expect to earn more interest income.

Question: Tell the exact formula to calculate the Inflation rate. Can we find the inflation rate by simply subtracting the Current CPI with Last year CPI, is it a right calculation of Inflation.
Answer: Inflation is the continuous rise in the price level. It can be calculated by the Consumer Price Index. Consumer price index (CPI) measures the relative change in the prices of consumer goods. It also measures the changes in the typical household's cost of living. If we have given the prices of basket of goods then we can calculate the inflation rate by following these steps. 1-First we calculate the cost of basket of goods. The cost of basket of goods can be calculated by simply multiplying the quantity of each good by its price in the respective year and then add up this product. 2-Then calculate the CPI. CPI is calculated as cost of basket in the current year by the cost of basket in the base year and multiplies by 100. We can take any of the years as base year. 3-And from the CPI we then calculate the inflation rate. The exact formula for calculating inflation rate is Inflation Rate = {(CPI in the current year - CPI in the previous year)/ CPI in the previous year} × 100 For example if we want to calculate the Inflation rate from 2002 to 2005 then the formula of inflation rate for the year 2003 will be Inflation Rate = {(CPI in 2003 - CPI in 2002)/ CPI in 2002} × 100 And same will be for the year 2004 and 2005.

Question: Discuss the concept of Default Risk?
Answer: Default risk is the possibility that a bond issuer will default by failing to repay principal and interest after a specified period of time. Bonds issued by the federal government, for the most part, are protected from default. It means if you purchase bonds from the government then default risk will be zero, government can not be defaulted, because it can fulfill the need by printing new money. Bonds issued by corporations are more likely to be defaulted on, since companies often go bankrupt. In more simple words, default risk is the risk of non payment. For example, you buy the bonds issued by a corporation which promised to pay the principal amount plus interest after 1 year. But company is going to be bankrupt after 1 year and it does not pay you the principal amount and interest, it means that the company has been defaulted.

Question: Discuss the concept of Bond Ratings?
Answer: Bond rating is a measure of the quality and safety of a bond, based on the issuer's financial condition. More specifically, an evaluation from a rating service indicating the likelihood that a debt issuer will be able to meet scheduled interest and principal repayments. Bond rating and credit rating agencies have come into existence to assess the default risk of different issuers. Bond Rating Agencies, such as Standard & Poors and Moodys, provide a valuable service to bond investors. These resources tell how to read bond ratings and a list of the large bond rating agencies. Typically, AAA is highest (best), and D is lowest (worst).

Question: What will be the effect on bond demand, bond supply and the equilibrium if there is a decrease in inflation?
Answer: A fall in expected inflation increases the bond demand and shifts the bond demand curve to the right, decreases bond supply and shift bond supply curve to the left. Due to increase in demand, price of bond increases and interest rate falls.

Question: According to Islam prevailing concept of Insurance is right or wrong?
Answer: Insurance is a contract in which one party pay the premium to the other party in return for a money with some corresponding benefit upon the occurrence of an event specified in the contract. A large number of contemporary Muslim jurists regard modern commercial insurance invalid and incompatible with the injunctions of Islamic law. Islamic law does not allow gharar (uncertain) transactions in which the seller does not know what he has sold and the purchaser does not know what he has purchased. In insurance, the buyer of insurance policy does not know what he has bought by his premium. The time of the occurrence of event is also uncertain for the parties. As such, insurance is primarily an uncertain contract. We can take the example of car insurance regarding uncertainty. In this type of insurance, the insured person drives the car throughout the year. If he does not come across any accident, he can make no claim against the insurance company and thus his premium money is wasted without any material benefit occurring to him. On the other hand, if he comes across a serious accident which causes extensive damage to his car, in that case the company pays him several times greater than the premium he has paid. This shows that the insured does not know at the time of contract what he buys by the amount of premium. This means that he gets nothing if the accident does not occur. On the other hand, he gets several times greater than the premium he paid, if he comes across serious accident. Both these situations are uncertain for him. Takaful or mutual guarantee is generally considered as an Islamic alternative to the modern insurance business. Takaful refers to an agreement among group of people to guarantee that if any of them suffer a catastrophe or disaster, he would receive certain sum of money to meet the loss or damage. Thus it is a method of mutual help. Since the contributions in Takaful business are invested on the basis of mudarabah, it is also known as solidarity mudarabah.

Question: What is IPO?
Answer: An initial public offering (IPO) is the first sale of a corporation's common shares to public investors. The main purpose of an IPO is to raise capital for the corporation. While IPO’s are effective at raising capital, they also impose heavy regulatory compliance and reporting requirements. The term only refers to the first public issuance of a company's shares; any later public issuance of shares is referred to as a Secondary Market Offering.

Question: How is “bank capital” a liability for the commercial bank?
Answer: Bank Capital is the net worth of banks. It is owner’s stake or investment in the bank. Capital invested by owner in the bank is liability of the bank. Capital is the investment of the owner and bank or any firm has to return it to the owner at the time when owner or partner leave the bank or firm therefore it is treated as liability for bank or firms.

Question: Explain the too-big-to-fail policy?
Answer: If large banking organizations were to get in trouble or they are going to fail, the government would intervene to prevent its failure or limit the losses to uninsured creditors upon failure. This possibility of a government bailout (help) is commonly referred to as the “too-big-to-fail” policy. Government adopts this policy to reduce or eliminate the bank failure risk.
Question: Discuss policy trade-offs.
Answer: A trade-off usually refers to losing one quality or aspect of something in return for gaining another quality or aspect. It implies a decision to be made with full comprehension of both the upside and downside of a particular choice. A term relating to opportunity cost sometimes to get a desired economic good it is necessary to trade off some other desired economic good for another. A trade-off, then, involves a sacrifice that must be made to obtain.

Question: Tell the difference between “financial intermediaries” and “financial institutions”?
Answer: Financial institutions are the firms that provide access to the financial markets. These institutions sit b/w borrowers and savers so they are also known as financial intermediaries. They work just like a middlemen b/w savers and borrowers. Both are same. There are no difference b/w financial intermediaries and financial institutions.

Question: Is there a difference between financial markets and financial intermediaries?
Answer: Financial markets are the place where financial instruments i-e securities, shares are bought and sold. While financial intermediaries are the firms that helps people in trading. They sit in the financial markets b/w savers and borrowers. These two things are different from each other. Financial market is the place of trading while financial intermediaries are the firms.

Question: Explain in simple terms the “internal rate of return”?
Answer: Internal rate of return is the interest rate that equates the present value of an investment with its cost. OR it is the interest rate that is often used in capital budgeting, it's the interest rate that makes net present value of all cash flows equal to zero. OR The internal rate of return (IRR) is a capital budgeting method used by firms to decide whether they should make long-term investments. The IRR is the return rate which can be earned on the invested capital, i.e. the yield on the investment. If IRR is greater than the rate of interest then it's a good project for investment.

Question: Explain the role of standard deviation in spreading risk?
Answer: Standard deviation is the square root of the variance. It is the measure of risk. The greater the standard deviation the greater will be the risk. It does not spread the risk rather it measures the risk. The standard deviation is often used by investors to measure the risk of a stock or a stock portfolio. The basic idea is that the standard deviation is a measure of volatility: the more a stock's returns vary from the stock's average return, the more volatile the stock.

Question: Define yield to maturity in simple terms?
Answer: A rate of return measuring the total performance of a bond (coupon payments as well as capital gain or loss) from the time of purchase until maturity is called yield to maturity. OR This is the yield or return that bondholders receive if they hold the bond to its maturity when the final principle payment is made. It can be calculated by the present value formula. OR The rate of return anticipated on a bond if it is held until the maturity date. YTM is considered a long-term bond yield expressed as an annual rate.

Question: Discuss the positive and negative inflation.
Answer: Positive Inflation is the name of persistent rise in the prices of goods and services. In simple words, if prices are raising then it is positive inflation. Negative Inflation is the name of persistent decrease in the prices of goods and services. In simple words, if prices are falling then it is called negative inflation or deflation.

Question: What is elastic and inelastic demand?
Answer: Responsiveness of one variable due to change in another variable is called elasticity of that variable. And the responsiveness of Quantity demanded due to change in the price level is called Elasticity of demand. This elasticity of demand can be elastic or inelastic. If there occur more change in the quantity demanded due to small change in the price level then it is known as elastic demand or the demand is more elastic. If there is less change in the Quantity demanded due to high change in the prices then it is known as inelastic demand or demand is inelastic or less elastic.

Question: Explain securities firms in detail.
Answer: Securities Firms: The securities firms are another type of non-depository institutions. These include brokerage firms, investment banks and mutual fund companies. They serve as financial intermediaries. They stand in between the lender and borrowers. Brokerage firms: These firms help the people and provide them information about the financial market. They sit in the secondary markets. For example, if you want to purchase the stock or shares of any company then you can not directly go to the stock market. You need the services of the brokers. Brokers involves in the trade. They perform the role of intermediary. Intermediaries collect the resources, pool them and they can also lend you the money. If the balance in your account is less then you can ask for the loans. In this case, brokers help you out and lend you money. They also help to purchase the securities on margin. They also provide the sources of funds and liquidity to the account holder. Investment banks: Investment banks advise on certain issues of capital stock and debt instruments. A group of investment banks go for underwriting. They collect the information about the company and sale the shares of that company in the market at higher prices and earn profit. In some cases, they write an agreement that they will sell bonds and stocks of that company at certain price to the general public and for this they will charge fees. And if some stock goes unsold then that will be purchased by the underwriters. This involves risk that’s why they do a very care full analysis of the issuing company. Mutual funds companies: These companies sell their shares to the general public, collect funds, and invest those funds in different investments.

Question: Explain; "Adjustments to equilibrium.
Answer: Equilibrium is the point where there is no tendency to change. Short run equilibrium exists at the intersection point of Aggregate demand curve and short run aggregate supply curve while Long run equilibrium exists at the intersection point of Aggregate demand curve and long run aggregate supply curve. If there is any inflation shock (or if actual output increase or decrease than the potential output) then this equilibrium disturbs and economy is out of equilibrium or in other words economy is in disequilibrium. So, to adjust the economy again towards equilibrium the forces of demand and supply works according to the shock and move the economy towards equilibrium.


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