Nature and functions

of money
Terms to know:

Meaning of Barter system

Inconveniences of Barter system

Definition of money

Kinds of money

Functions of money
Meaning of Barter:
 There was a time when money did not exist, people
used to exchange goods for goods.

 Such a system for exchange of goods without the use

of money is called barter.

Or

 The direct exchange of goods for other goods is

called barter.
 Inconveniences of Barter system
Lack of common measure of values

Lack of double A C Lack of store of

coincidence of values
wants
Difficulties
In Barter
system

Difficulties in E D Payments in
tax collection the future
Inconveniences of Barter system:
 Lack of double coincidence of wants:
First difficulty was that… exchange of goods can take place b/w
two persons only if each posses the good which the other wants.

 Lack of common measure of value:

If incidentally two persons met together who wants each other
goods, they could not find a satisfactory value of their goods,
under such circumstances one party has to suffer.

 Lack of store of value:

Goods cannot be stored for a long time, because their value
decreases as time passes.
Inconveniences of Barter system
(continued):
 Payments in the future:
Under the system of barter, it is very inconvenient to lend goods to
other people. With the lapse of time, the value of the commodities
may fall.

 Difficulties in tax collection:

Under Barter system the tax cannot be collected in the form of
goods. If the commodities are collected from the tax payers, they
will not only lose value as time passes on but are difficult to store
also.
What is money
 “Money is the modern medium of exchange and the
standard unit in which prices and debts are
expressed.”
(Prof. Samuelson)
 Money is any material, which is commonly accepted
and generally used as a medium of exchange for all
types of transactions.

 Thus all kinds of currency notes and coins plus

chequing deposits etc. can be regarded as money
Legal and Functional definition of money

Legal definition: Legally money is anything proclaimed by law

as a medium of exchange .Nobody can refuse its acceptance as a medium
of exchange .

Functional definition of money: Functionally money

refers to anything that performs four basic functions :
 It serves as a medium of exchange
 It serves as a standard unit of value
 It serves as a mean for future payments
 It serves as a store of value
Money value of money and
commodity Value of Money
Money Value of Money : It refers to what is
inscribed on a coin or written on a paper note . Thus money
value of a paper note is what is written on it: One hundred
rupees , five hundred rupees etc. .Thus ,with a five hundred
rupee note you can buy goods and services worth five
hundred rupees in the market.
Commodity value of money : It refers to the value
of thing the money is made of . Thus ,if coins are made of
gold or silver (as was the practice in the old days), commodity
value of money refers to the market value of the gold or silver
contained in a coin.
Kinds of money:
Money
Currency Deposit money Near money
OR Credit money (fixed deposits)

Metallic money Paper money

(Coins) (Currency notes)

Full value Token money Convertible Inconvertible

Or Fait money
Kinds of money (cont’d):
The following is the main classification of money

1. CURRENCY: The money issued by the govt. as official

medium of exchange is called currency.
It is of two types;

I. Metallic money: Metallic money consists of various kinds of

coins.
 in AFGHANISTAN, coins of one, two and five afs. are the
example of metallic money.

II. Paper money: Paper money includes currency notes issued by

the central or state bank of a country.
 Paper money circulates in the form of notes of 10, 20, 50 etc.
Kinds of money (cont’d):
 Metallic money is of two types;

I. Full value money: when the face value of a coin is

equal to the value of a metal contained in the coin, it
is called full-bodied money.

II. Token money (Fait money): when the face value of

a coin is greater than the value of metal it contains, is
called token or fait money.
Kinds of money (cont’d):
 Paper money can be classified into two:

I. Convertible paper money: This type of money easily

converted into the metallic money or into the gold, if
demanded.

II. Inconvertible paper money: Some times after an over

issue of paper money in an emergency like war and
floods ,the authority feels unable to convert its notes into
coins. So government breaks its promise of converting
notes into standard money and thereby makes the money
inconvertible.
Kinds of money (cont’d):
2. DEPOSIT MONEY or CREDIT MONEY:

 This is the most modern form of money.

 Demand deposits (current account) in the banks are

called deposit money.

3. Near money: The deposits of the banks which are not

operated through cheques.
 For example; fixed deposits, the govt. securities,
bonds, and saving certificates.
Functions of money:
Functions
Functions of
of money
money

Primary Secondary Contingent

function function function
 Functions of money (primary functions):

The primary
functions of
Medium of exchange
1 money are;

Unit of account
2

Standard of deferred 3
payments

4
Store of values
Functions of money (primary funct.):

A. The primary functions of money are as under:

1. Money as a medium of exchange:
 Money acts as a medium of exchange and helps in
overcoming the difficulty in barter economy.
 In all market transactions, money is used to pay for
goods and services i.e. the sale or purchase of goods
is done through money.

2. Money as a unit of account:

 Money serves as a common measure of value i.e. the
value of goods and services can be expressed in terms
of unit of money.
Functions of money (cont’d):
3. Money as a standard of deferred payments:
 Money is used to make payments in the future time.
 Money is the only unit of account which is easy to
borrow and easy to lend.

4. Money as a store of value:

 Money also functions as a store of value.
 Money is the most liquid of all assets, therefore it is,
easier to store value (resources) in the form of money.
Functions of money (secondary functions):

The secondary
functions of
1 money are;
Aid to production

Money facilitates 2
to FOP

Money as a tool of 3
monetary management

Money as an instrument 4
of making loan
Functions of money (secondary functions):

B. The secondary functions of money in brief, are as;

1. Aid to production and trade:

 The market mechanism, production of commodities
and expansion of trade etc. have all been facilitated
by the use of money.

2. Money facilitates to FOP:

 All production takes place for the market and the
factors payments (rent, wages, interest and profits)
are made in money.
Functions of money (secondary function……cont’d):

3. Money as a tool of monetary management:

 All the monetary progress is done due to money.

4. Money is an instruments of making loans:

 People save money and deposit it in the banks. The
banks advance these savings to businessmen and
industrialists.
 Thus money is the instruments by which savings are
transferred into investments.
Functions of money (contingent functions):

The contingent
functions of
Distribution of 1 money are;
National income

Basis of credit
2

3
Liquidity of property
Functions of money (contingent
functions):
C. The Contingent functions of money are as follows:

1. Distribution of national income: (Money value of all

goods and services produced in a country during a
period of one year)
 Money facilitates the distribution of national income
among the various productive and non-productive
purpose.

2. Basis of credit system:

 Banks create credit on the basis of their cash reserves.
Functions of money (contingent function):

3. Liquidity of property:
 Money gives a liquid form to wealth. A property can
be converted into liquid form with the use of money.
Essential attributes of a good money
The essential attributes of a good money material
are as follows:
1. General acceptability: The essential quality of a
good money material is that it would be
acceptable to all without any hesitation in
exchange for goods and services.
2. Stability of value: Another very important
attribute of good money is that it should be fairly
stable in value .If the commodity chosen as
money is subject to violent fluctuations, then that
Qualities of a good money material
cont…..
is a useless money. Money is the standard by which we
measure the value of all other commodities and if the
standard itself is influenced by changes in its demand
and supply ,then how does it serve as a perfect money.
3. Transportability: The commodity chosen should be
easily transportable without any depreciation. It should
have a large value in small bulk.
4. Storability: Another requisite of a good money
material is that it should be storable without
depreciation .If the commodity chosen as money is
perishable ,then that cannot serve as a good money.
Qualities of a good money material
cont…..
5. Divisibility: The commodity chosen as
money should be capable of being re
United without losing its value.
6. Homogenity: The commodity as money
should be of uniform quality and capable
of standardization.
7. Cognizability . One very essential
condition of perfect money is that it
should be easily recognized by the eye ,
ear or touch.
Origin
Origin and
and Growth
Growth of
of
Commercial
Commercial Banking
Banking
Terms to know:

3
1 Evolution of Banking

Functions of commercial
2 Bank
Role of commercial Banks
in the economic
3
3 development

4 Classification of Banks
 Evolution of Banking
 There are various views about the origin of the ‘bank’.
 One view is that it is derived from an Italian word
‘banque’ which means a ‘bench’.

 The other point of view is that it has originated from the

German word, ‘banc’ which means a joint stock firm.

 G. Crowther in his famous book, “An outline of money”

defined that present day banker has three ancestors;
1) The merchants
2) The goldsmiths and
3) The money lenders.
Evolution of Banking:

According to Crowther, the

present day banker has three
ancestors;

The money lenders

The goldsmiths

The merchants
 Evolution of Banking (cont’d):
 The merchants:
 The earliest stage in the growth of banking can be traced
to the working of merchants.
 These merchants were traders in commodities and those
activities were carried on by them from one place to
another.
 The traders faced many difficulties to carry metallic
money with themselves for payment.
 The traders with high reputation began to issue receipts
which were accepted as titles of money.
 These receipts or letters of transfer also called hundi in
indo sub continent were first mode of payment .The
merchant banking thus forms the earliest stage in the
evolution of banking.
Evolution of Banking (cont’d):

 The goldsmiths:
 The second stage in the growth of banking is normally
traced to earlier goldsmiths.

 These goldsmiths received gold and silver for safe

custody and issue receipts for the metallic money kept
with them.

 In this way these receipts became a medium of

exchange and a mean of payment.
Evolution of Banking (cont’d):
The money lenders:
 The third stage in the development of banking
arose when the goldsmiths became the money
lenders.

 The goldsmiths kept a small proportion of the

total deposits for meeting the demands of
customers for cash and the rest they could easily
lend.

The modern commercial banking system actually

developed in the nineteenth century.
What is a commercial bank
A bank is a financial institution which deals with money
and credit. It is organized on a joint stock company system
primarily for the earning of profit. Commercial bank
accepts deposits from individuals , firms and companies
at a lower rate of interest and gives at a higher rate to
those who need it. The difference between the terms at
which it borrows and those at which it lends forms the
source of its profit.
According to Crowther “a bank is a firm which collects
money from those who have it spare and it lends money
to those who require it.”
According to Mr. .Parking .” a bank is a firm that takes
deposits from households and firms and makes loans to
other households and firms”.
Functions of commercial banks:

Functions of commercial
Banks

The basic The secondary

functions of Functions of
commercial Commercial banks
bank
Functions of commercial banks:

1) Basic functions:
The basic functions of commercial banks are
(A) Accepting of deposits and (B) Advancing of loans

A. Accept of deposits:
In order to attract the savings from different persons
and institutions, the banks maintain the following
three types of accounts:

(i) Current account (ii) Saving account (iii) Fixed

deposit account.
Functions of commercial banks
i. Current account.
 On demand deposits, the banks pay no interest. The
deposits can be withdrawn at any time in full or in
part.
Current account holders receive a check book and
regular statements containing details of money paid
in and paid out.

 Saving account:
 The banks pay interest on this types of deposits and
advance the facility to withdraw the amount, subject
to certain restrictions.
Functions of commercial banks
iii. Fixed deposit account:
 Fixed deposit (term deposit) are kept with the banks
for a specified period of time.
 The rate of interest on fixed deposits are fairly high.
 The longer the period of deposit, the higher is the
rate of interest.

B. Making loans:
the lending of money may be in any of the following
forms;

(i) Loans (ii) Cash Credit (iii) Overdraft

(iv) Discounting of Bills.
Functions of commercial banks
i. Loans:
 The commercial banks grant short term loans and
long term loans to individuals, firms, and companies
mostly against some securities.

ii. Cash credit:

 The banks advance long term loans to the different
sectors against the security of goods.
 The borrower is permitted to draw within the cash
credit limit sanctioned by the bank.
 The interest is charged only on the amount of money
withdrawn by the borrower.
Functions of commercial banks
iii. Overdraft ( O/D):
 It is a convenient form of short term financing by a bank.
 The customer is allowed to draw certain amount of money
over and above his own deposited money.
 Interest is charged on daily balance on the overdrawn
amount.

iv. Discounting of bills:

 A bill of exchange is a peace of paper representing a
promise by the buyers of goods on credit, to pay the seller
at a specified time.
 The discount charged is the earning of the bank.
 Functions of commercial banks
2) Secondary functions:
The secondary function of a commercial bank are as
follows:
i. Special financial services:
 commercial banks are now offering international
services in the form of currency exchange, issue of letters of
credit, ATMs (Automatic Teller Machine), banker’s
acceptances and Electronic Fund Transfer (EFT).
ii. Purchase or sell of securities:
 The bank, if authorized by the customer, purchases or sells
securities on behalf of the customer.
Functions of commercial banks
iii. Execution of standing Instructions:
 The customer may order in writing to his bank to make
payments of regular installment to an individual or firm by
loaning them to his account.
 Against such payments the bank charge a small
commission.
iv. Acting as Trustee:
 If a client directs his bank to act as a trusty in the
administration of a business, the bank performs this
responsibility for the benefit of its customer.
 The bank charge a small fee for providing this services.
Role of Commercial Banks in the Economic
Development of a Country:

 The significance of commercial banks in the

economic development of a country are as given in
brief:
1. Banks promote capital formation:
 The commercial banks encourage savings.
 These savings are then available in the businesses
which make use of them for productive purposes.

2. Promotion of trade and industry:

 with the growth of commercial banks in the 19th and
20th centuries, the trade and industrial sector
expanded.
 The use of cheques, bill of exchange, credit card etc.
has increased both national and international trade.
Role of Commercial Banks in the Economic
Development of a Country (cont’d):

3. Development of Agriculture sector:

 The commercial banks advance credit to the agricultural
sector which greatly support in rising agricultural
productivity and income of the formers.

4. Investment in new enterprises:

 Businessmen normally hesitate to invest in new
enterprises. The commercial banks generally provide short
and medium term loans to the firms to invest in new
enterprises.
5. Influencing economic activity:
 The banks can also influence the economic activity of a
country by increasing and decreasing the rate of interest.

6. Implementation of Monetary policy:

The central bank of a country controls and regulates the
volume of credit through the active cooperation of the
commercial banking system in the country.

7. Export promotion cell:

 In order to increase the export of a country, the commercial
banks provide information about trade and conditions both
inside and outside the country to its customers.
Classification of Banks:

 The main types of banks are as under:

1. Central Bank:
 The central bank is the head, the leader, and the
supervisor of the banking and monetary system of a
country.
 Almost every country of the world has its own central
bank.

2. Commercial Banks:
 Commercial banks are the financial institutions, which
perform general banking functions.
 They receive deposits, advance loans and create
credit.
Classification of Banks:
3. Industrial Banks:
 The industrial banks mainly provide, medium and long-
term credit to the industries.
 These banks are established for industrial development.

4. Agriculture Banks:
 Agricultural banks are set up to provide financial assistance
to the agriculturists.
 They advances short-term and long-term credit to the
formers for purchasing seeds, tractors and introducing
modern techniques in forming.
 Classification of Banks:
5. Mortgage Banks:
 Such banks mortgage land, houses and other property and
advance loans. Some commercial banks perform such
activates.

6. Exchange Banks:
 Exchange banks mainly deal with international trade. These
banks take the responsibility of settlement of foreign
exchange and arrange the foreign business.

7. Investment Banks:
 These banks provide funds for long-term projects. They can
raise their funds by getting deposits or selling share/stocks,
issuing bonds or commercial paper.
Instruments of Credit
Terms to know:

1. Definition of Credit

2. Instruments of Credit
3. Documentary/Negotiable
Credit Instruments
 Definition of Credit:
 The word ‘Credit’ is derived from the Latin word ‘Credo’ which
means “I trust you”.

 It is define as, “An exchange which is complete after the expiry

of a certain period of time after payment”. i.e.

 The promise usually based on the confidence and on the belief

that the debtor whether a person, a business firm or a government
unit will be able and willing to pay on demand or at some future
time.

 The creditor is to exchange present goods for the right to receive

payments in the future.
 Instruments of Credit:
 The main instruments of Credit are:
1. Pay roll credit:
 Pay roll credit is also called oral agreement.
 In development countries as well underdevelop countries some
credit is extended to individuals, friends, businesses associations
without keeping any record.
 The agreement to pay back the money is purely oral.

2. Book Credits or Open book accounts:

 Open book account merely consists of entries on the books of
business concerns.
Instruments of Credit
(cont’d):
 These entries appear as an account receivable on the books
of lender and as an account payable on the books of the
borrower.

3. Documentary Credit instruments:

 Most of the credit is evidenced by a written contract.
 Such instruments exhibit the existence and terms of debt, the
identity of lender, the amount to be lend, the rate of interest,
the time of maturity etc.
 These are also represents Negotiable instruments (written
document which entitles a person to receive a sum of money).
What is negotiable instrument
The term negotiable instrument means a
written document which entitles a person to
receive a sum of money. A negotiable
instrument is transferable by delivery or
endorsement and delivery. A person who
takes the negotiable instrument in good faith
becomes the true owner even if he has not
received it from the true owner. The
negotiable instrument is thus a document
which is legally recognized by custom of
trade or law, transferable by delivery or
by endorsement.
Characteristics of Negotiability
An instrument is negotiable by virtue of the following
features.
1. Transferable by delivery: It is transferable from one
person to another person by delivery or by endorsement
and delivery.
2. Entitled to receive money. The legal holder of the
instrument is entitled to receive money mentioned in it.
3. Filling a suit: The holder of a negotiable instrument has
the right to file a suit in his name for payment from all
or any of the concerned parties.
Instruments of Credit
(cont’d):
 The main negotiable instruments are:

(1) Promissory Note (2) Bill of Exchange (3) Cheque

1) Promissory Note:
It is an unconditional written promise by one person to
another in which the maker (Payer) promises to pay on
demand or at a fixed or determinable date in the future,
a stated sum of money to or to the order of a specified
person or to the bearer of the instrument .
 Instruments of Credit (cont’d):

 Maker: He is the person who draws and signs the promissory note
and promises to pay the amount.
 Payee: He is the person to whom the amount of the promissory
note is payable.

Specimen of a Promissory Note

Afs. 20,000 Kabul
June 1,2008
Stamp
Sixty days after for value received, I promise to pay,
Mr. Qais or order the sum of Afs. Twenty thousand
Mr. Qais only.
Fahim Ahmad
Payee Parwan-e-2, signature
Kabul
Maker
Instruments of Credit (cont’d):

 Conditions for Promissory note:

The following are the essential features of a promissory
note:
 There are two parties to a promissory note.
 The promise to pay must be in written.
 The promise to pay must be signed by the Maker or Payer.
 The promise to pay must be unconditional.
 The amount to be paid must be definite in terms of money.
 The promissory note must be payable to a definite person.
 The promissory note must be payable on demand or at a fixed or
determinable future date .
Instruments of Credit (cont’d):

2) Bill of Exchange:
 A bill of exchange is a peace of paper representing a
promise by the buyers of goods on credit, to pay the
seller at a specified time.

 Parties to the bill:

There are three parties involved to a bill of exchange.
i. Drawer: The drawer is the person who draws the bill.
He is the person who orders to pay a certain sum of
money.
Instruments of Credit (cont’d):

ii. Drawee: Drawee is the person on whom

the bill is drawn. He is the person who is
ordered to make the payment of the bill.

iii. Payee: Payee is the person to whom the

money is directed to be paid. He gets the
payment of the bill.
 Instruments of Credit (cont’d):

 Bill of Exchange:

Specimen of a Bill of Exchange

Afs. 30,000 Kabul
March 1,2009

Payee

Two months after date pay to a Financial Institute.

To
Drawee Mr. Amir Khan Wahedullah
Parwan-e-2, signature
Kabul Drawer
Classifications of bills
Bills of exchange are classified on several bases . The main
classifications in brief are as under.
1. Classifications of bills by parties: If one bank orders the
other bank to pay , it is called a bank draft or bank bill. If the order
to pay in drawn on any other type of drawee (individual or firm) it
is named as trade draft or trade bill. A trade bill is drawn either by a
seller on a buyer or by a creditor on debtor. When we talk of a bill
of exchange, we mean by it a trade bill.
2. Classification on the basis of maturity: A bill of
exchange is also classified on the bases of period of time required
for payment . A bill ordering payment on demand or at sight is
called sight bill. A bill ordering payment after a period of time
specified on it is called time bill.
continued
3. Classification of bill on the basis of
security: If a bill is fully supported by documents
for payments, it is called documentary bill. In case no
security or document is provided , that bill is called
clean bill.
4. Classification on the bases of place: A
bill of exchange is either inland or foreign bill of
exchange. Inland bills are those which are drawn and
payable inside a country. Foreign bills are those which
arise out of trade transactions between on a persons or
firms in a foreign country.
Advantages of bill of exchange
Following are the advantages of bill of exchange.
1. Written verification of bill: The accepted bill of exchange shows
the amount owned by a person and the exact date of payment. In
case of delay or non payment , the payment can be enforced on him
in the court of law.
2. Negotiable instrument: The bill of exchange is a negotiable
instrument , being transferable , it enables increase in commercial
transactions.
3. Discounting facility: The bill of exchange being a negotiable
instrument enables the payee or holder to obtain prompt cash by
discounting it with bank . The banks consider the discounting of
bills of exchange as a very useful investment.
continued
4. Easy transfer of money: With the help
of bill of exchange , the money can be
easily transferred merely by signing and
delivery of the bill. The risk involved in
the actual transfer of money is thus
avoided.
continued
5. Self liquidating credit: A businessman can easily
purchase goods by promising to pay a specified sum at
a determined future time to the seller. Before the
maturity of the bill, he can arrange to sell the goods in
the market and the proceeds can be used for meeting
the obligation . A bill of exchange is thus a self
liquidating credit.
6. Facilitates foreign trade: The bill of exchange
facilitates settlement of international obligations . It
thus helps in promoting trade between nations.
Instruments of Credit (cont’d):

3. Cheque:
A written order of a depositor upon a bank to pay to or
to the order of a designated party or to bearer, a
specified sum of money on demand.

 The person who draws the ceque is called Drawer.

 The bank on which the cheque is drawn is called
Drawer.
 The person to whom payment is to be made is called
Payee.
 Instruments of Credit (cont’d):

Cheque:

Payee Drawee Cheque

Number
CHEQUE
ABC Bank (pvt.) Ltd. 34634528
Paroshgah Branch Kabul
Date 30 May, 2008
Pay Shafiullah Sahak

Afs. Ten Thousand Only Afs. 10,000 Amount in

Figures
A/C No. 000268003 Signature

***************************************
Counter
Amount in
work Account Number Code Number
Words
Features or Characteristics
of the Cheque:

The main characteristics or features of

a Cheque are as follow:
◦ It is an order of the customer without
condition.
◦ It is drawn upon a certain bank in writing.
◦ The bank has always to pay it on demand.
◦ It is payable to a certain person or to his
nominee or to the bearer of the instrument.
Types of Cheque:
How many types of cheques we have?

 We have two types of cheques:

1) Open Cheque and 2) Crossed cheque

Types of Cheque (cont’d):
1. Open cheque:
Open cheques are those cheques which are paid across
the counter of the bank.

Open cheques has further two types:

◦ Bearer cheque and
◦ Order cheque
Types of Cheque (cont’d):
 Bearer cheque:
◦ If a drawer orders the bank to pay a stated sum of
money to the bearer, it is called a bearer cheque.
◦ Any person who lawfully possesses a bearer cheque is
entitled to receive payment of that cheque.
 Order cheque:
◦ If the cheque is to the order of a person in whose
favor the cheque is drawn, it is called order cheque.
◦ The order cheque is paid by the bank only when the
bank is satisfied about the identity of the payee.
Types of Cheque (cont’d):
2. Crossed cheque:
 If a cheque is crossed by drawing two parallel lines
across the face of the cheque, with or without the
words & Co or A/c payee only, it is called a Crossed
cheque.

 The crossed cheque cannot be paid on the counter of

the drawee bank.
 It will be deposited in the account of a person in whose
order or favor it is drawn.
Types of Cheque (cont’d):
How many kinds of cross cheque we
have?

 There are two kinds of cross cheque;

◦ General crossing and
◦ Special crossing
Types of Cheque (cont’d):
 General crossing:
 The drawing up of two parallel lines on the face of the
cheque at the top left hand corner with or without the
words & Co not negotiable or Account payee only is
known as a General Crossing.

 The effect of general crossing is that the crossed check

cannot be paid at the counter of the bank.

 Itspayment can only be deposited into the payee’s

account only.
Types of Cheque (cont’d):
 Special crossing:
A cheque is deemed to be crossed specially when it
bears across its face the name of the banker either with
or without the words not negotiable.
 In case of special crossing the payment can only be
made to the bank named therein the cheque.
Endorsement
The word endorsement is derived from the
Latin word ‘indorsum’ which means the back
. According to the negotiable instrument act ,
1881, the writing of a person’s name either
on the back or the face of instrument
followed by one’s signature for the purpose
of negotiation is called endorsement. There
may be endorsement on a separate piece of
paper attached to the instruction called
‘allonge’.
Kinds of endorsement
The main types of endorsement are as under:
1. Blank or general endorsement: If the holder of the instrument
signs his name only and delivers it to the endorsee, it is called
general or blank endorsement.
2. Full endorsement: it contains not only the signature of the
endorser but specifies the endorsee or to his order also.
3. Restrictive endorsement: Here the endorser uses such words in
endorsement which restricts further negotiation and transfer of bills.
4. Sans recourse endorsement: In this type of endorsement , the
endorser refuses to accept any liability on the instrument to any
subsequent party in case of dishonor of instrument.
5. Conditional endorsement: it contains an order to pay only when a
condition expressly laid down by the endorser is met with.
Kinds of endorsement continued
6. Partial endorsement: it contains an order
to pay only a part of the amount
mentioned in the instrument . This type
of endorsement is not valid in law.
 Main Modes of inland remittances by
commercial banks
The main modes of inland remittances by commercial banks are as under:
1. Bank draft: A bank draft is an order by one branch of a bank to another
branch of the same bank to pay a certain sum of money on demand to the
person named therein.
Features of bank draft
1. it is drawn by one branch of a bank to another branch of the
same bank.
2. Drawer and drawee bank is the same but branches are
different.
3. The amount payable is specified in the draft.
4. The person to whom amount is payable is also specified
therein.
Features of bank draft continued
5. It is payable on demand.
6. It is unconditional order for payment.
7. It bears no stamp.
8. Draft can be negotiated by endorsement
and delivery.
9. The purchaser of the draft may or may
not be customer of the bank.
2. Pay order
A pay order is an unconditional which is
drawn by the bank and is payable on the
issuing branch only. We can say that one
and the same branch is both the issuing
and the paying branch. A pay order is paid
only to the person named there-in. It is
thus non transferable.
3. Inland traveler cheque
inland traveler cheque is also named Rupee traveler
cheque. The cheque is drawn by the bank for
round amount and is payable at all the branches of
the issuing bank in the country.
The purchaser signs on the face of the cheque at
the time of purchase . He is also required to sign
once again on the face of cheque when he
presents it for encashment . The bank releases the
payment if the two signatures tally. In case the
two signatures are not identical , the paying
branch will insist on identification of the payee
through some independent source.
4. Telegraphic transfer(T.T)
Telegraphic transfer is an instrument that is
cabled or telexed for the transfer of money to
a third party by one branch of a bank to its
another branch located in some other town.
The remitter branch instructs the paying
branch in coded language to pay cash or
credit the specified sum of money into the
account of the named payee.
All local remittances through T.T are
payable in local currency. Bank remittances
through T.T are cheap and convenient to use.
5. Mail transfer
Mail transfer is another method of remitting
money by one branch of a commercial bank
to another branch of the same bank
functioning in some other town. Here the
remitting branch instructs the paying branch
by mail to pay cash to or credit into the
account of the named payee the specified
sum of money . ( This method of transferring
money is outdated and is replaced by
electronic funds transfer system)
Electronic funds credit system ( EFTS)
As the telecommunication system is
advancing , the payments both inland and
foreign are increasingly being made by
electronic fund credit system. We are now
gradually moving towards a payment
system in which the use of paper is
diminishing with the introduction of tele-
banking services , The ATM and credit
card facilities, a cashless and chequeless
society is emerging.
 Difference between three negotiable
Basis
instruments
Promissory note Bill of exchange cheque
1. Parties Two Three Three
1)maker 1)Maker 1) Drawer
2) payee 2)Drawee 2) Drawee
3)payee 3) Payee
2.Acceptance Not required A legal necessity Not required
3. Period Payable on demand Payable on demand only payable on
also only demand
4. Promise or order Promise order order
5. Stamp A legal necessity A legal necessity Not required
6. Crossing Cannot be crossed Cannot be crossed Can be crossed
7. Grace days Allowed Allowed No grace days .
8. Liability The maker is not The maker and others The maker is not free
free from liability free from liability from liability

9. Area Generally inland Inland and foreign Only on the bank of

the depositor
End of CH #3
Chapter # 4

Financial markets
and their
functions
Terms to know:

1 What are Financial Markets?

2 Classification of Financial Markets:

3 What is Money Market?

4 Instruments of money market

5 What is capital market?

 Financial markets:
 Financial markets are markets in which funds are transferred
from people who have surplus funds to people who have a
shortage of funds.

 Its allow the movement of surplus funds from savers to

investors.
 By facilitating transfer of funds , the financial markets
contribute to higher production and efficiency in the overall
economy.
 These markets also improve the well being of consumers by
providing them timely funds to purchase goods and improve
their standard of living.

 Financial sectors in developing countries comprises of

commercial banks, development financial institution, micro
finance companies, investment banks, mutual funds, stock
exchange and insurance companies.
Classification of Financial
Markets:
Financial
Financial Markets
Markets

Financial markets basically

divided into two:

MONEY CAPITAL
MARKET MARKET
 Money Market:
1. Money market: is a financial market for short term
loans. It basically meets the short term requirements of
the borrowers for money and provides liquidity of cash
to the lenders. Technically money markets refers to the
collection of institutions engaged in the employment of
short term funds.
 In the money market, commercial banks are the most
important lenders.

MONEY MARKET

Financial institutions Financial intermediaries

 Instruments of money market:
 The main short term credit instruments traded in the money market are
as follows:
I. Call loans:
 These loans are also called ‘loans at call and short notice'. The call
loans are generally granted maximum for seven days.
 It is granted to bill brokers, discount houses and stock exchange
dealers.

 The commercial banks also lend their surplus funds on call to other
banks as they need them.

 Call loans are usually made without any security.

Instruments of money market:

II. Treasury bills:

 Treasury bills are short term govt. securities.

 These are sold by the central bank on behalf of the government.

 The period of maturity generally ranges from 3 to 12 months.

 Treasury bills are usually issued for meeting the temporary deficit
which a government faces due to excess of its expenditure over revenue
at some point of time. Thy should not be made a permanent source of
funds for the central government.
Instruments of money market:

III. Bankers acceptance:

 These are bills of exchange accepted by commercial banks on

behalf of their customers.

A bill of exchange is a peace of paper

representing a promise by the buyers
of goods on credit, to pay the seller at
a specified time.
 Banker’s acceptances are used mostly in financing the
commercial transactions both within and outside the country.
Instruments of money market:
IV. Collateral loans:

 The commercial banks usually grant short term loans against

collateral securities to stock exchange dealers and brokers.

V. Sales / purchase operations (Repo):

 Under a Repo transaction, the treasury bills and securities are sold
by their holder to an investor with an agreement to repurchase
them at a predetermined rate and date. Under reverse Repo
transactions , securities are purchased at with a simultaneous
commitment to resell at a predetermined rate and date .
Importance of money market
If the money market is well developed and broad based in a country ,
it greatly helps in the economic development of a country. The
importance of money market in brief is given as under.
1. Financing industry: A well developed money market helps the
industries to secure short term loans for meeting their working
capital requirements . It thus saves a number of industrial units
from becoming sick.
2. Financing trade: An outward and a well knit money market
system plays an important role in financing the domestic as well as
international trade. The traders can get short term finance from
banks by discounting bills of exchange. The acceptance houses and
discount market help in financing foreign trade.
continue
3. Profitable investment: The money market helps the commercial
banks to earn profit by investing their surplus funds in the
purchase of treasury bills and bills of exchange . These short term
credit instruments are not only safe but also highly liquid. The
banks can easily convert them into cash at a short notice.
4. Self sufficiency of banks: The money markets is useful for the
commercial banks themselves . If the commercial banks are at any
time in need of funds , they can meet their requirements by
recalling their old short term loans from the money market.
5. Effective implementation of monetary policy: The well
developed money market helps the central bank in shaping and
controlling the flow of money in the country. The central bank
mops up excess short term liquidity through the sale of treasury
bills and injects liquidity by purchase of treasury bills.
continue
6. Encourage economic growth: if the money
market is well organized , it safeguards the liquidity and safety of
financial asset. This encourage the twin functions of economic
growth , savings and investment.
7. Proper allocation of resources: In the money market , the
demand for and supply of loan able funds are brought at
equilibrium . The savings of the community are converted into
investment which leads to proper allocation of resources in the
country.
What is capital market?

2. Capital Market:

 Capital market deals with the grant of medium and

long term loans.

 The capital market refer to the institutional

arrangements which facilitate the lending and
borrowing of medium and long term loans.
 Instruments of capital market:

Capital Market

Issue of Debt instruments Issue of shares

Issue of debt instruments such Rising funds by issuing of

as a bonds or securities having Equities (shares) by public
a maturity of more than one year. Limited companies.
 Instruments of capital market:

BONDS

Debt
GOVERNMENT SECURITIES
instruments

Mortgages
Instruments of capital market:

A. Issue of debt instruments:

I. Bonds:

 Bond is a debt security that promises to make payments

periodically for specified period of time.

 Companies issue long term bonds for raising of funds.

II. Mortgages:

 Mortgages are long term loans to individuals or firms.

 Instruments of capital market:
III. Government securities:

 The long term debt instruments are issued by the govt. of a country to finance the
deficit of the budget.

B. Issue of shares:

 The second method of raising funds is by issuing of shares by the public limited
companies.

 The market where the shares of public companies are traded is called the equity
market.

 Equity market is of two types

(a) Primary market (b) Secondary market
Primary and secondary markets
Primary market: A primary market is a
financial market which deals with the
issuance of and purchase of new shares
of a public company.
Secondary market: A secondary market is
a market which deals with the purchase
and sale of old shares of public
companies.
Role of capital market
Capital market plays an important role in the mobilization of long
term funds for the economic development of the country.
1. Mobilization of equity market: The security market both primary
and secondary help the companies to raise long term capital. If
there were no such organized market it would then be very difficult
to exchange their shares for cash.
2. Savers and borrowers: The capital market provides a link between
savers of money and borrowers of funds. There are a numbers of
organizations like commercial banks , insurance companies and
saving organizations which collect the savings from people and
then advance these savings to the people and institutions who are in
need of money.
Continue….
3. saving incentives : If in a country the capital market is
organized , it encourages people to save money. If there had been
no banking and non banking financial institutions to collect
savings of the people , it would have been diverted to
unproductive channels such as purchase of Jewellery , land , gold
etc.
4. Balanced economic growth: The capital market provides an
opportunity to mobilize savings from the areas where people are
economically quite well of . The financial resources are then
transferred to backward areas of the county for expansion of trade
and industry. The capital market , thus, helps in promoting
balanced growth in the county.
Continue…..
5. Attraction to foreign investors: An
efficient capital market attracts the
foreign companies to invest funds in the
shares of companies, build up factories
etc. The foreign investment thus helps in
increasing the productivity and
prosperity of the country.
What is a mutual fund
Mutual fund is a company which pools the savings of individual ,
organizations for investment in capital market instruments. Mutual
fund is an ideal tool or instrument for individuals who want to
invest in stocks , debentures and other securities which otherwise is
difficult for them to invest.
The working of mutual fund is very simple. The money pooled by
a number of investors is entrusted to a fund Manger who is hired by
the trust . The fund manager invests money directly in primary
market or through brokers in secondary market on behalf of the
investors . The fund manager is paid a management fee . If there is
a profit on investment , it belongs to the investors. In case there is a
loss , it is also shared by the investors.
Types of mutual fund
There are two types of mutual funds
1. Open end mutual fund: are those where
subscription and redemptions of shares
are allowed on a continuous basis.
2. Closed end mutual funds: are those
where the shares are initially offered to
the public and then traded in the securities
market.
Advantages of mutual funds
The advantages of mutual funds are that the money
pooled for investment is managed by expert
professional fund managers . The Funds are
invested in different instruments which reduces
the risk of losses. In addition to this, they are well
regulated . A mutual fund generates profit from
three different sources.
1. Dividend
2. Capital gains
3. Appreciation of shares prices
Chapter Completed
Foreign Exchange
There is not a single country in the world
which is self sufficient. There is constant
inflow and outflow of goods and services
from one country to another country . When
goods and services are exported , the money
is to be received from the foreigners, and
when they and imported , the money is to be
paid to them. The receiving or making of
payments to a person, firm or government in
foreign countries involves many problems.
Definition of foreign exchange
The term foreign exchange is used in narrow as well as in broad
sense.
In the narrow sense , foreign exchange simply means the
money of a foreign country. For example the Japanese's Yen
is a foreign exchange to a Afghani and a Afghani AFS is a
foreign exchange for Japanese.
In the broader sense , the word ‘foreign exchange’ is
related to the exchange methods and mechanism through
which the payments in connection with international trade are
made. It covers the methods by which:
1. The currency of one country is exchanged for that of another.
2. The forms in which exchanges are conducted.
3. The ration at which they are effected.
continue
In the words of H.E. Evitt , “the means and
methods by w3hcih rights to wealth
expressed in terms of the currency of one
country are converted into rights to
wealth in terms of the currency of
another country are known as foreign
exchange”.
Hartley whither defines foreign exchange “
as a mechanism by which international
indebtedness is settled between one
country and another”.
Importance of foreign exchange
1. Strength of economy: The financial reserves indicate the
financial strength and the stage of development of the
economy. If a nation possesses large reserves of foreign
exchange , it indicates the stability, soundness and the
development of the economy.
2. Balance of payments: If a country is facing shortage of
foreign exchange and is having persistent adverse balance of
payments , it indicates that the economy is in a bad shape.
3. Makes international trade easy: The international
payments are made in the currency of credito0r’s country on
the mutually acceptable rates . This makes the international
trade easy.
4. Rate of exchange: The rate of exchange at which the
different monetary units are exchanged shows a direct
relationship between the prices of the commodities in
national and international market.
Continue….
5. Hard currency nations: The foreign
exchange balances of a country directly
affect the rates of exchange . A country
having large foreign exchange i.e., a sound
nation for the other country. A hard
currency nation has stability in foreign
currency rate.
6. Credit worthiness: The rising foreign
exchange balances of a nation increases its
credit worthiness in the international capital
market.
What is Foreign exchange market
Foreign exchange market is a place in
which foreign exchange transactions take
place. In the words of Kindleberger, “
Foreign exchange market is a place
where foreign moneys are bought and
sold.” It is the part of money market in
the financial centers.
Functions of foreign exchange market
There are three main functions of foreign exchange market.
1. Transfer functions: The basic function of foreign exchange
market is to transfer foreign moneys between countries. The
main credit instruments used for payments in foreign
currencies are letter of credit , bill of exchange ,banker’s
draft, telegraphic transfer.
2. Credit functions: Another function of the foreign exchange
market is to provide credit to the importer who is a debtor .
The credit facility is provided through the bill of exchange.
3. Hedging functions: Foreign exchange market provides the
facility to the importer to pay for the goods at the foreign
exchange rate prevailing in the market called spot rate or at
the future date called future rate called hedging. Forward
exchange rate protects the importer from all risks of
fluctuations in the foreign exchange market.
Factors influencing rate of exchange
Following are the factors influencing rate of exchange.
1. Trade movements: change in the volume of exports and imports of
goods between two countries in foreign exchange market may lead
to fluctuations in the rates of exchange. For example , if the imports
of a country exceed its exports , it will be obligated to pay more in
terms of foreign exchange and therefore, the rate of native currency
will fall . Conversely , if the exports of a country exceeds its
imports, the demand for foreign exchange decreases and as a result
the rate of exchange rises and moves in favor of the native country.
2. Capital flow : Movements of capital from one country to another
also influences the rate of exchange. For example, if there is a flow
of capital form America to Pakistan for investments in shares , or in
the shape of loans , the demand for Pakistani currency will go up in
the foreign exchange market. As a result , the rate of exchange of
Pakistani rupees in terms of American $ can rise.
Continue…..
3. Banking influences: Banking operations also influence the
rate of exchange . For example if the central bank of a
country increases its bank rate . Its market rate of interest
will rise . The higher interest rate will attract the foreign
capital in the country. As a result of increase in demand of
Pakistani currency , Its rate of exchange in terms of foreign
currency will rise . If the bank rate is reduced , the effect
will be in favor of foreign currency and against home
currency.
4. Speculations: Rate of exchange is also affected by
speculation in the foreign exchange market. If the
speculators expect that value of foreign currency to rise,
they begin to buy foreign currency in order to sell it in
future to earn profit. By doing so , they tend to increase the
demand for foreign currency . The rate of exchange will be
in favor of foreign currency and against home currency.
Continue…..
5. Policy of protection: If the government of a country
follows the policy of protection of the domestic industries, it
discourages imports and encourages exports. As a result of
discouraging imports form other countries , the demand for
foreign currency will decrease . The rate of exchange will
move in favor of home currency and against the foreign
currency.
6. Exchange control: the rate of exchange is also affected by
the exchange control measures taken by the government of a
country. If the government of a country imposes restrictions
to curtail imports, It would lead to a fall in the demand for
foreign currency . As a result the rate of exchange moves in
favor of home currency and against the foreign currency.
continue
7. Monetary policy: if the monetary policy perused
by the central bank fails to achieve its objectives
and creates inflationary conditions in the country,
it will lead to the flight of capital form the
country. The supply of foreign currency will fall
and the rate of exchange will turn in favor of
foreign currency and against home currency.
8. Political conditions: political situation has a direct impact over the
rate of exchange in a country. If there is stable government and the
various institutions function smoothly, it will encourage inflow in
the country . As a result the supply of foreign currency increases
and their value in terms of home currency falls.
continue
9. Peace and security: if there is strict
maintenance of law and order and peace in a
country , it will encourage the supply of
foreign capital in the country . Such a situation
leads to favorable rate of exchange for the
home currency.
10. Industrial conditions: if there is industrial
discipline in the country it will attract foreign
capita and in turn the foreign currency fall .
Exchange control
Under the system of free market in foreign exchange, the citizens of a country
are at full liberty to buy and sell foreign currencies to any extent . Under a
controlled economy the free movements in foreign exchange are restricted
and control is imposed on the purchase and sale of foreign exchange by the
state or the central bank of the country .Foreign exchange control thus
means interference by the state or control bank in the free play of market
forces that determine foreign exchange rate. the government or central
bank monopolizes the foreign exchange business and exercises full control
over the foreign exchange market in the country.
The exchange control usually take the following three forms.
1. The monetary authority or the government of a country manages the
foreign exchange rate and buys and sells foreign currency at the rate fixed
by it.
2. All foreign exchange earned by the exporters are surrendered to the central
bank which pays the money in local currency.
3. The importers of goods are allocated foreign exchange at the official rate or
enabling them to make payments for the imported goods.
Objectives of exchange control
1. To correct an adverse balance of payments: One of the main
objectives of the exchange control to be followed by a county is to
correct its adverse balance of payments. This objective is achieved
by restricting the volume of imports to essential items and
according to availability of its reserves.
2. To conserve foreign exchange: A country may introduce
exchange control for conserving its hard earned foreign exchange.
These reserves are restricted for
a. Payments of external debt
b. Imports of essential goods
c. Purchase of defense material
3. To protect home industry: Exchange control is also employed
with the object of protecting home industry . If certain domestic
industries are facing stiff competition from abroad and the
government desires to protect them from foreign competition , it
will not sanction foreign exchange for the import of these
commodities.
Objectives of foreign exchange
Conti….
4. To stabilize exchange rate: A government may
introduce exchange control for keeping exchange
rate stable . The fluctuations in exchange rate cause
disequilibrium in the economy . In order to create
confidence and stability in the economic life of the
country , the government officially fixes the
exchange rate at a predetermined level.

5. To prevent the flight of capital abroad: if the

capital of a country is moving abroad due to
depreciation of currency at home, or in response to
higher rate of interest in other countries , then the
large scale movement of the capital can be checked
by the introduction of exchange control.