Class 12 Money and Banking Mock Test (CBSE)

Topics in Money and Banking

• Functions of money
• Demand for money and supply of money
• Legal definitions: narrow and broad money
• Money creation by the banking system
• Balance sheet of a fictional bank
• Limits to credit creation and money multiplier
• Policy tools to control money supply
• The Reserve Bank of India

Money and Banking practice questions with answers

1. Q1Multiple choice·1 mark
   Which of the following components constitute Broad Money ($M_3$) in the Indian monetary system?

   1. (a)$M_1$ plus total deposits with post office savings organisations
   2. (b)Currency with the public plus demand deposits with the banks
   3. (c)$M_1$ plus net time deposits held with the banking system
   4. (d)$M_1$ plus savings deposits with post office savings banks
   Show answer and step marks

   1. Correct option: (c) $M_1$ plus net time deposits held with the banking system. $M_1$ is currency with the public plus net demand deposits with banks (the RBI also counts 'other' deposits with the RBI); adding post office savings deposits to $M_1$ gives $M_2$, and adding total post office deposits to $M_3$ gives $M_4$.+1

   Answer: (c)
2. Q2Multiple choice·1 mark
   In the context of the money creation process by commercial banks, which of the following statements is true regarding secondary deposits?

   1. (a)They are kept entirely as cash reserves by the commercial banks to meet daily withdrawal demands.
   2. (b)They arise due to the loans given by commercial banks to the borrowers, which are subsequently redeposited into the banking system.
   3. (c)They are directly issued by the central bank to control money supply.
   4. (d)They refer to the initial cash deposits made by the public with the commercial banks.
   Show answer and step marks

   1. Correct option: (b) Secondary deposits are generated through loans given by commercial banks, which are paid out and subsequently redeposited into the banking system, driving the credit and money creation process.+1

   Answer: (b)
3. Q3Short answer·2 marks
   State two main items that constitute the 'Assets' side of a commercial bank's balance sheet and briefly explain any one of them.
   Show answer and step marks

   1. First asset item, any one of: reserves (cash in hand and deposits with the RBI); loans and advances; investments in government securities; or any other valid asset item.+0.5
   2. Second asset item, a different one from the same list.+0.5
   3. Brief explanation of one item stated, e.g. loans and advances are credit given to the public on which the bank earns interest, its main source of income; reserves are cash and RBI deposits kept to meet withdrawals and the reserve requirement.+1

   Answer: Any two of: reserves (cash and deposits with the RBI), loans and advances, investments. E.g. loans and advances are credit given to the public on which the bank earns interest.
4. Q4Short answer·2 marks
   Suppose a commercial bank receives a fresh initial deposit of ₹ 5,000 and the Legal Reserve Ratio (LRR) is set at $10\%$. The bank keeps only the legally required reserves and lends out the rest, and the borrowers withdraw the loan amount in cash. Present the balance sheet of the commercial bank at this stage, showing its total assets and liabilities.
   Show answer and step marks

   1. Liabilities side: Demand Deposits = ₹ 5,000.+0.5
   2. Assets side: Reserves ($10\%$ of ₹ 5,000) = ₹ 500.+0.5
   3. Assets side: Loans = ₹ 5,000 − ₹ 500 = ₹ 4,500.+0.5
   4. Total assets (₹ 500 + ₹ 4,500) = Total liabilities = ₹ 5,000.+0.5

   Answer: Liabilities: Demand Deposits ₹ 5,000; Assets: Reserves ₹ 500, Loans ₹ 4,500; totals ₹ 5,000 each.
5. Q5Long answer·5 marks
   Meena, a weaver in a village, faces three situations in one year. (1) She wants to exchange 4 sarees for wheat and milk, but the grain merchant who needs sarees has no milk to offer, and the milk seller does not want sarees. (2) After the village starts using currency notes, she sells her sarees for ₹ 8,000 and keeps ₹ 3,000 safely aside to buy seeds after the harvest. (3) She borrows ₹ 5,000 from a moneylender, who agrees that she will repay ₹ 5,500 after six months, with the agreement written in rupees. (a) Explain why the exchange in situation (1) is difficult under the barter system and how the use of money removes this difficulty. (2 marks) (b) Distinguish between the function of money as a 'store of value' in situation (2) and as a 'standard of deferred payment' in situation (3). (3 marks)
   Show answer and step marks

   1. (a) Under barter, the exchange fails for lack of double coincidence of wants: Meena's sarees must be matched directly with a person who both wants them and offers the wheat and milk she needs.+1
   2. (a) Money acts as a medium of exchange: Meena sells sarees for money to one buyer and uses that money to buy wheat and milk from different sellers, so she does not need a direct match.+1
   3. (b) In situation (2), money acts as a store of value because the ₹ 3,000 keeps its purchasing power and can be used to buy seeds after the harvest.+1
   4. (b) In situation (3), money acts as a standard of deferred payment because the debt of ₹ 5,500 is fixed in rupees and payable after six months.+1
   5. (b) Distinction: store of value means holding purchasing power for use at a time chosen by the holder, whereas deferred payment means money used as the unit in which a debt is fixed and settled on a future date agreed in a contract.+1

   Answer: (a) Barter fails because of lack of double coincidence of wants; money as a medium of exchange removes this by separating the sale of sarees from the purchase of wheat and milk. (b) Store of value means holding purchasing power for future use at the holder's choice (situation 2), whereas standard of deferred payment means money is the unit in which a future debt is fixed and paid (situation 3).

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