money supply, banking & financial institutions section 2 Practice Questions Answers Test with Solutions & More Shortcuts

Answer: (b)

Operation Twist is when the central bank uses the proceeds from the sale of short-term securities to buy long-term government debt papers, leading to the easing of interest rates on the long-term papers.

When RBI's objective is to decrease the interest on long term lending, so that the companies are able to borrow at a cheaper rate for the long term to promote economic growth then RBI purchases debt papers of long-term maturity of government.

So, when RBI is purchasing the debt paper, that means RBI is giving loan/money for the long term, which results in easy availability of money for the long term, hence decrease in long term interest rate.

Operation Twist will resolve the problem of long-term liquidity. So now enough long-term liquidity/money is available in the market. This helps in reducing the interest rates on long term borrowing.

As the long-term interest rate comes down in the financial market, banks cannot keep the lending rate higher for the long term due to competition in the market for lending among banks. This will then help in reducing the interest rates on long term lending by banks also.

Earlier RBI had reduced the repo rate several times but banks have not passed/transmitted this into the lending rate. But since in the financial markets interest rate has come down due to Operation Twist, banks will be pressurized to reduce lending rate, which means better monetary transmission.

If RBI will purchase long term bonds, then the price of long-term bonds will go up and the yield/return will be low/soften. (If Rs. 100 bond paper (face value) with an interest rate of 8% is available in Rs. 110 in the market then the yield will be (Rs.8/Rs. 110)*100 = 7.27% Operation Twist is "Open Market Operation" and it is a part of RBIs Monetary Policy.

Monetary Transmission is the pass-through of RBI's policy actions to the economy at large in terms of asset prices and general economic conditions.

Answer: (a)

• Creditor means the person who has given money to someone
• Debtor means who has taken money from someone
• Depositors mean those who have deposited money in banks or financial institutions
• Bondholders mean a person who is holding bonds

When a person holds a physical asset whose price is denoted in Rupees then he benefits from price increase or inflation.

But a person who holds financial assets (like Rs. 100 note) or any financial instrument which guarantees fix return of cash payments in future then he loses from the price rise. This is because the purchasing power of the rupee (the fixed money which he is supposed to get) decreases due to inflation.

Hence, in case of inflation, depositors, creditors and bondholders will lose. So, only (ii) statement is true

Answer: (b)

Devaluation makes import expensive and discourages it, while the export of a country that devalues becomes cheaper and thereby induces trade partners to import more goods from her.

Nations that produce industrial goods on a large scale stand to benefit from devaluation.

Answer: (b)

Answer: (c)