Chapter 4

Financial system and its function 

 

A) Very Short Questions and Answers :

1. What is financial system?

Ans. A financial system is a set of institutions, such as banks,insurance companies and stock exchanges that permit the exchange of funds.

2. What is term money?

Ans. When the maturity period of a deposit is beyond 14 days is called term money.

3. What is notice money?

Ans. When a loan is granted for more than a day and for less than 14 days is called notice money

4. Give two examples of financial services.

Ans. (i) Banking services

        (ii) Insurance services.

5. Name the different forms of financial market.

Ans. (i) Capital market

(ii) Money market

(iii) Foreign exchange market

(iv) Credit market.

6. What are the different components of financial sys- tem?

Ans. The different components of financial system are -

(i) Financial institution

(ii) Financial market

(iii) Financial instruments

(iv) Payment and settlement system

(v) Regulatory authorities

(vi) Central banks

(vii) Financial infrastructure

(viii) Financial services.

7. What are the components of formal financial system?

Ans. (i) Financial institutions

         (ii) Financial markets

         (iii) Financial instruments

         (iv) Financial services.

8. Mention any two characteristics of a developed money market.

Ans. (a) A developed money market have an organized banking system.

        (b) It should have a central bank.

9. What is Bill market?

Ans. Bill market is the market in which short term papers or bills are bought and sold.


(B) Short Questions and Answers :


1. Write any five functions of financial system.

Ans. (a) Facilitating payments: The transfer of goods and services can take place smoothly only if there is a mechanism in place to ensure that the payment reach in time. It is performed smoothly by financial system.

(b) Transfer of resources from individual to individual, company to company are performed by the financial system.

(c) Risk management: Using the financial system, individuals are able to pool in their resources and cover themselves in case any unforeseen event happens in their lives.

(d) Managing information: The financial system provides important information which is important for the well-being of the economy as a whole.

(e) Efficient middleman: Financial system allows the savings to be delivered towards productive activities with the least amount of transaction costs.

2. What are the seven elements of the financial system?

Ans. The seven elements of the financial system are-

(i) Financial institution

(ii) Financial markets

(iii) Financial instruments

(iv) Payment systems

(v) Regulatory bodies

(vi) Infrastructure

(vii) Financial Services.

3. Mention the developmental functions of the financial system.

Ans. (i) To establish a bridge between the savers and the inves- tors.

(ii) To encourage savings and investment in the country.

(iii) To provide finance in anticipation of saving.

(iv) To expand financial markets in space and time.

(v) To allocate financial resources efficiently for socially desir- able purposes.

(vi) To accelerate the rate of economic development.

4. Mention the characteristics of a developed money market.

Ans. (i) A developed money market possesses a well organised banking system.

(ii) There should be a central bank which provides the ultimate liquidity as well as regulates the working of the money market.

(iii) There should be adequate availability of credit instruments.

(iv) There should be a large number of submarkets each speciDistinguish between money market

(C) Long Question and Answer  

1. Mention the various functions of financial markets.

Ans. The important functions of financial markets are-

(i) Financial markets create and allocate credit.

(ii) They serve intermediaries in the process of mobilization of savings.

(iii) They provide convenience and benefit to lenders as well as borrowers.

(iv) They enable economic units to exercise their time preference.

(v) Financial market help in separation, distribution, diversification and reduction of risk.

(vi) They provide transformation of financial claims so as to suit the preference of both savers and borrowers.

(vii) They provide efficient payment mechanism.

(viii) They increase liquidity of financial claims through security trading.

(ix) The financial markets provide better portfolio management.

(x) They promote economic development through a balanced regional and sectoral allocation of investible funds.

2. Briefly explain the functions of a financial system.

Ans. (a) Ensure liquidity: The financial institutions, markets, and service provider involved in financial system ensure a fluid flow of funds so that investors can buy and sell assets easily accessible.

(b) Create a payment system: Financial institutions create an efficient and seamless process that allows merchants and businesses to send and receive money in exchange for product and services.

(c) Manage risk: A monetary system can provide risk management by ensuring the protection of financial assets against systematic risks.

(d) Provide financing: Financial system is to develop a net- work of financial institutions that work together to provide financing through the transfer and exchange of capital across locations.

(e) Inform and implement govt. policy: Government use financial system and their components to regulate and stabilize the economy. They may set policies to control specific economic occurrences such as unemployments, inflation and interest rates.

(f) Increase individual ability to save : A primary function of financial system is to use financial institutions and services to help individual save assets. A financial institution may use a long term investment such as pension savings for an extended period to manage the effect of inflation.

3. Explain the relationship between economic growth and financial system.

Ans. Financial system of a country plays a huge role in economic growth. It promotes economic growth through capital accu- mulation and technological progress by increasing the saving rate, mobilizing and polling savings, producing information about investment, facilitating and encouraging the inflows of foreign capital as well as optimizing the allocation of capital. Countries with better developed financial systems tend to grow faster over long periods of time and a large body of evidence suggest that this effect is casual. Financial develop- ment is not simply at outcome of economic growth; it con- tributes to this growth. Again, it reduces poverty and in- equality by broadering access to finance to the poor and vulnerable groups, facilitating risk management by reducing their vulnerability to shocks and increasing investment and productivity that result in higher income generation. Finan- cial sector development can help with the growth of small and medium sized enterprises by providing them with access to finance.