money supply, banking & financial institutions section 9 Practice Questions Answers Test with Solutions & More Shortcuts

Answer: (d)

Answer: (d)

An open market operation (also known as OMO) is an activity by a central bank to buy or sell government bonds on the open market.

India’s Open Market Operation is much influenced by the fact that it is a developing country and that the capital flows are much different than those in the other developed countries. Economists claim that an increase in money supply alone constitutes inflation.

In India, the Reserve Bank of India uses policy rates and reserve ratios such as Cash Reserve Ratio (CRR) in controlling the money supply. Apart from the CRR, banks are required to maintain liquid assets in the form of gold, cash and approved securities.

A higher liquidity ratio forces commercial banks to maintain a larger proportion of their resources in liquid form and thus reduces their capacity to grant loans and advances, thus it is an anti-inflationary impact.

A higher liquidity ratio diverts the bank funds from loans and advances to investment in government and approved securities.

Answer: (b)

If there is inflation in the economy it leads to a loss in the value of currency i.e. currency depreciates.

Nominal interest rate (deposit rate) = Inflation + real interest rate

When inflation increases banks increase the nominal interest rate and generally real interest rate remains the same.

Answer: (b)

Currency Swap Agreement: US India $1 = Rs. 70 In US, the US company can raise loans at 6%, but for an Indian company doing business in US, the loan rate is 8%.

So, the US company will raise a loan of $1 billion at 6% and give it to the Indian company working in US.

The Indian company will keep on paying the interest rate at 6% and after the term ends, it will give back the $1 billion amount to the US company.

In India, the Indian company can raise loans at 9%, but for a US company doing business in India, the loan rate is 11%.

So, the Indian company will raise a loan of Rs. 70 billion at 9% and give it to the US company working in India. The US company will keep on paying the interest rate 9% and after the term ends, it will give back the Rs. 70 billion amount to the Indian company.

A currency swap is an agreement in which the two parties (multinational· corporations/governments) exchange the principle amount of a loan (and the interest) in one currency for the principle and interest in another currency.

At the start of the swap, the equivalent principle amounts are exchanged at the prevailing rate. At the end of the swap period, the principle amounts are swapped back at either the· prevailing rate or at a pre-agreed rate such as the rate of the original exchange of principle amount.

Currency swaps are used to obtain foreign currency loans at a better interest rate or· as a method of hedging transaction risk on foreign currency loans. Currency swap agreements can be at the government and the company level both.

Answer: (d)