Banking

INTRODUCTION TO BANKING
Q.1. Define and explain the term Banking?
The term bank or banking is one of those terms that are increasingly being used in business language. With growing
importance of the financial sector of a country. Bank are considered to be the major role players.
DEFINITION
A bank is an institution that deals in money. But this definition does not cover all the aspects of banking business as it
includes all persons dealing in money, which is not true to be more perfect we can say that
A bank is an organized house which borrows money from the people for the sake of providing loan or services of
monetory nature to businessmen or need person.
EXPLANATION
An institution that accepts money of the people or organizations in the form of deposits and does its business is called a
bank. Banking system of a country refers to teh working process followed by the banking institutions. It is identify through
the relationship between the apex bank.

Origin of Banking
Q.2. Trace out the origin of banking.
OR
Merchants, money lenders and gold smiths are considered to be the ansectors of banks.
Discuss.
ORIGIN OF BANKING
It is very difficult to trace out the exact origin of banks. It is said that the evolution of
banking business is as old as the concept of money. Crowther in his book AN OUTLINE OF
MONEY says that the present day banker has three ancestors merchants, money lenders
and gold smiths. A modern bank is something of these. It is believed that goldsmiths and
grocers of primitive days started keeping deposits of valuables and jewelleries people on
the basis of their sound financial position in the community. They charged a certain
amount from the depositors for the services rendered in keeping and preserving the
valuables in safe custody. But they soon realized that only a small portion of metal and
valuable deposited were taken bark by the people even at the expiry of the stipulated
period. They therefore began to make profit by lending a part of these deposits. In case of
lending, it was not always gold or silver, but issued their receipts which would pass among
the people as if they were gold just like cheques in modern banks. The present day banks
are performing the same functions as performed by the money lenders and goldsmiths of
older days. Therefore it is believed that goldsmiths and moneylenders are the ancestors of
banks.

Word BANK

Q.3. Briefly state the history of the word BANK.

THE WORD BANK
The derivation of the world Bank has been differently given by different authors. Same
authors think that the word BANK has been derived from the Italian word BANCHI
or BANCHERII. The payable used in Italian Business Houses. Some believe that it is
derived from the German word BANCK meaning heap or mounds. The first public bank
of Venice established on 1157 is considered as the first ever Public Bank.

Kinds of Bank
Q.4. Explain some of the kinds of banks?
OR
How many types of banks are there? Briefly explain each of them.
OR
Write a short note on kinds of banks.
KINDS OF BANKS
Some important types of banks are as follows
i. Central Banks.
This bank is of great significance in the banking system of a country. Central Bank is
considered as the Bank of government and directly or indirectly control the activities of all
the banks operating in the country. State Bank of Pakistan is the central bank of Pakistan.
ii. Commercial Bank
This is another most important type of the banking system. It is main function is to receive
deposits, advance loans and discounting of bills.
iii. Industrial Bank
These type of banks provide loans to industries. Generally these banks advance loans for
long periods.
iv. Agricultural Bank
The main functions of these banks is to provide loans for long and short periods to the
agriculturists. Long period loans are used for acquisition of and improvement of land while
short period loans is used for purchasing seeds manures and for current expenditure.
v. Exchange Bank
These banks deal in foreign currencies in the form of bill of exchange, drafts, telegraphic
transfers etc. They buy and sell foreign currencies.

vi. Saving Bank

Saving Banks provide incentives to people of small means to save money. These banks
provide monetary facilities to the people.
vii. Land Mortgage Banks
These banks are meant to provide loans to agricultural by mortgaging their lands. An
agricultural has to mortgage his his land if he wants to take loan from this particular type
of a bank.
viii. Co-Operative Bank
Such type of banks are usually run by co-operative societies through its members. These
are non-scheduled banks. They are meant for the benefits of the society and its members.

IMPORTANCE OF A BANK
Q.5. Discuss the importance of a bank for a country.
IMPORTANCE OF A BANK
The importance of the banking system to an economy no emphasis. A well organized
banking system provide liquidity and mobility to the financial resources available in the
economy. It helps the economy in the following regards.
1. BRING ECONOMIC STABILITY IN THE COUNTRY
The banks play a prominent role in providing stability to a country economically. It helps
in getting out of depression or inflation. During depression the banks follow a cheap money
policy and generate money income which pushes up the consumption level and the
economy gets price support to reactivate production units and the produced level is
enhanced which raises the employment level. The investment rises to stimulate saving and
to expand which further increases employment opportunities. Similarly the banks specially
the central banks take certain measures to control inflation in the economy. The central
bank through it is well adjusted monetory policy stablises the internal price level and thus
facilitates economic & development in the country.
2. CO-ORDINATION AMONG ALL THE UNITS
The banking system maintains a coordination among all the units which are engaged in
banking functions. It consists of collecting of surplus money from the people and lending
them to the entrepreneurs who utilize it for productive purposes.
Creating a country wide circulation of money through remittance facilities.
Activating idle money to make them productive
Provide finance by credit accommodation to different sectors of the economy.
3. ENCOURAGE SAVING
The banks encourage saving by providing safe custody and making it a source of income to
the persons who save. The people having surplus money arising out of saving, deposit it
with the banks. The banks pay them interest and get them relief from burden of safety and
other risks.
4. ACCERATE INVESTMENT
The banks constitute constitute a source of accelerating investment in the economy . The
funds collected from the depositors are used for financing development projects in the
public and private sectors and for granting loans and advance for raising the production
level of the country.
5. CAPITAL FORMATION
In any plan of economic development capital occupies a place of pivotal importance.

Without capital nothing can be achieved effectively. Banks obimulate capital formation in
the country. Savings of the people is capitalized through lending by banks.
6. CREATION OF MONEY
Banks create money in the sense that through credit granted to entrepreneurs, whether to
the private or government agents they increase supply of money which they manage
because of inflow of fund through deposits. The development agencies manage to bridge the
gap between the income and expenditure and thus the development work continues
undisturbed
7. FACILITATE TRADE
The banks facilitate trade by furnish information regarding financial stability and dealings
of the parties in the market to customers. They provide remittance facility to the
entrepreneurs and help them in the settlement of transactions even at far places.
ACCEPTANCE OF DEPOSITS
Acceptance of deposits is perhaps the major functions that a commercial bank performs. It
accumulates the scattered savings of the individuals and offer them attractive incentives to
make deposits in the form of profit. The bank accepts three types of deposits from the
public.
Fixed Deposit Account
Money in this account is accepted for a fixed period of time and cannot be withdrawn
before the expiry of that period.
Current Account
The deposits can withdraw money from this account whenever he wants to. The banks
generally grant no interest

CENTRAL BANK
Q.6. Define a Central Bank.

CENTRAL BANK
A banking system of a country without a central bank at the top in like a human body
without a head. In the words of R.P. Kene
central bank is an institution charged with the responsibility of managing the entire
monetory and banking affairs of the country in the nations interest.

The Central bank is generally recognized as a bank which constitutes the apex of its
monetory structure, controls, directs and equalates the activities of other banks operating
in the economy. A central bank has direct dealings with the governments and other banks.
It is a separate branch of banking having distinct functions quite different from other
banks. It operates not for profit sake. But with an objective of bring in economic prosperity
to the people and ensuring economic stability in the country.

Functions of a Central Bank

Q.7 Indicate the different functions of a Central Bank.
A Central bank performs many important and essential functions which are described as
follows:
MONOPOLY OF NOTE ISSUE
Formerly in certain countries, many banks issued their own notes. This resulted in
uncontrolled confusion. Hence, gradually the right of note issue was withdrawn from
ordinary banks. Note issue became the sole privilege of the central bank. Today the central
bank in every country enjoys the exclusive privilege of bank note issue.
BANK TO THE GOVERNMENT
This functions of a central bank may be studied under the following two heads.
As Banker To The Government
As governments banker, the central bank keep the deposits or banking accounts of
government departments boards and enterprises. It advances short term loans to the
government in anticipation of collection of taxes or the raising of loans from the public. It
also makes extra-ordinary advances during depression, war or other national emergencies.
As An Agent Of The Government
As an agent of the government the central bank is often entrusted with the management of
the public debt and issue of new loans and treasury bills on behalf of the government.
Moreover the central bank is the fiscal agent to the government and receives taxes and
other payments into its account.
on this account. On the other hand it levies certain charges on the customer for the services
rendered by it.
Saving / Profit & Loss Sharing Account
All the banks in Pakistan nearly have started accepting deposits only under Profit and Loss
Sharing Accounts where the depositors share in profit and loss instead of getting interest
(Commonly known as Profit).
ADVANCING LOANS
The second important function of a commercial bank is to advance loans. The banks
advance certain types of loans to their customers such as:
Ordinary Loans
Here the banks give a specified sum of money to a person or firm against some collateral
security. The loan money is credited to the account of the customer and he can withdraw
the money according to his requirements.
NON-COMMERCIAL FUNCTIONS
The non-commercial functions of the commercial banks are as follows.
i. Agency Functions
Commercial banks act as the agents of their customers and perform agency functions as
transfer of funds from one place to another. Collecting customers funds and crediting the

same to their accounts. Purchase and Sale of shares and securities, collecting dividends on
the shares of the customers and payments of insurance premium on policies of the
customers.
ii. Purchase and Sale of Foreign Exchange
The bank also carries on the business of buying and selling of foreign currencies Ordinarily
their functions is performed by specialized banks known as Foreign Exchange Banks.
iii. Financing Internal & Foreign Trade
The bank finances internal and foreign trade through discounting of exchange of bills. This
discounting business greatly finances the movement of internal and foreign trade.
iv. Creation of Credit
When the bank grants loan to its customers it opens an account in the borrowers name and
credits the amount of the loan. Since the deposits of the bank circulate as money the
creation of such deposits lead to a net increase in the money stock of the economy. This is
known as Creation of Credit
v. Miscellaneous Functions
Bank performs different kinds of various services other than described above such as
collect utility of bills on behalf of Government and other authorities. Provide valuable
advice to customers about trade and business provide information about sale and purchase
of shares and act according to Government policy like deduction of Zakat and Islamic
blessing System etc.

Central Bank Credit

Q.8. Show how the Central Bank of a country controls CREDIT?
The modern economy is a credit economy. Credit is the life-blood of modern business.
Accordingly control of credit is essential for stability and orderly growth of an economy.
There are two types of controls used by the central banks in modern time for regulating
bank advances.
i.Quantitive or General Control
ii.Quantitive or Selective Credit Controls
These are discussed below
i. Quantitive or General Control.
The aim of Quantitive Controls is to regulate the amount of bank advances i.e. to make the
banks lend more or lend less. Some of the controls are
a. Manipulation of Bank Rate
The bank rate is the rate at which the central bank of a country is willing discount the first
class bills. It is thus the rate of discount of the central bank. If the central bank wants to
control credit, it will raise the bank rate. As a result the market rate will go up. Borrowing
will consequently be discouraged. Those who hold stocks of commodities with borrowed
money will unload their stocks, since as a result of the rise in the interest. They will repay
their loans thus the raising of bank rate will lead to a contraction of credit.
b. Open Market Operations
The term open market operations in the wider sense means purchase or sale of any kind of
papers in which it deals like government securities or any other trade securities etc. In
practice this term is used to identify the purchase and sale of government securities by the
central bank. When the central bank sells securities in the open market it receives
payments in the form of a cheque on one of the commercial banks. If the purchaser is a

bank the cheque is drawn against the purchasing bank. In both cases the result is the same.
The cash balance of the bank in question which it keeps with the central bank is to that
extent reduced with the reduction of its cash the commercial bank has to reduce its louding.
Thus credit contracts.
c. Varying Reserve Ratio
The varying reserve ratio method is comparative a new method of credit control used by
central banks in recent times. The minimum balance to be maintained by the member
banks with the central banks are fixed by law and the central bank is given statutory power
to change these minimum reserves. Variations of reserve requirements affect the liquidity
position of the banks and hence their ability to lend. It reduces the excess reserves of
member banks for potential credit expansions.
d. Credit Rationing
Credit rationing means restrictions placed by the central bank on demands for
accommodation made upon it during times of monetary stringency and declining gold
reserves. The credit is rationed by limiting the amount available to each applicant. Further
the central bank restrict its discount to bills maturing after short periods.
ii. Quantitive or Selective Controls
In this regard the following methods are used.
a. Varying Margin Requirement
The central bank controls credit by varying margin requirements. While lending money
against securities the bank keeps a certain margin. They do not advance money to the full
value of the security pledges for the loan. If it is desired to curtail bank advances the
central bank may issue directions that a higher margin be kept. The raising of margin
requirements is designed to check speculative in the stock market.
b. Regulation of Consumer Credit
A part from credit for trade and industry a great deal of credit in development countries at
any time may be for durable consumer goods like houses, motor cars, refrigerator etc on
purchase or installment credit system. Central seek to control such credit in several ways.
E.g.
by regulating the minimum down payments in specified goods.
by fixing the coverage of selective consumer goods
by regulating the maximum maturities on all installments credits.
c. Direct Action
Direct action implies measures like refusal on the part of the central bank to rediscount for
the banks whose credit policy is not in accordance with the wishes of the central bank or
whose borrowings are excessive in relation to their capital and reserves.
d. Moral Sausion
The central bank may request and persuade member banks to refrain from increasing their
loans for speculative or non-essential activities.
e. Publicity
The method of publicity is used by issuing of weekly statistics, periodical review of the
money market conditions, public finances, trade & industry the issue of weekly statements
of assets & liabilities in the form of balance sheets.
BANKERS BANK
Broadly speaking the central bank acts as a bankers bank in three capacities.

i. As the Custodian of Cash Reserves

In every country its commercial bank keep a certain percentage of their cash reserves with
the central bank. Infact the establishment of central bank makes it possible for the banking
system to secure the advantages of centralized cash reserves.
ii. As Lender of the Last Resort
As a lender of the last resort in times of emergencies the central bank gives financial
accommodation to commercial banks by rediscounting by bills. The monopoly of note issue
and centralization of cash reserves with the central bank increase its capacity of growing
credit and thus to rediscount the bills as the lender of last resort.
iii. As a Bank of Central Clearance
The central bank act as a clearing house for member banks. As the central becomes the
custodian of cash reserves of commerce was banks it is an easy and logical step for it to act
as a settlement bank or clearing house for other banks as the claims of banks against one
another are settle by simple transfers from and to other accounts.
CONTROL OF CREDIT
By far the most important of all central banks in modern times is that of controlling credit
operations of commercial banks i.e. regulating the volume and direction of bank loan. On
the level or volume of credit depends largely the level employment and the level of prices in
a country.
Maintenance of Exchange Rates
Another important function of a central bank is to keep stable the foreign value of the
home currency. A stable exchange rate is necessary to encourage foreign trade and inflow
of foreign investment which is so essential for accelerating the pace of economic growth
particularly underdeveloped countries.
Custodian of Cash Reserves
It is the central bank which serves as the custodian of a nations reserves of gold and
foreign exchange. It is the duty to take appropriate measures to safeguard these reserves.

Credit Instruments
Q.9(A). Define Credit Instruments.
Q.9(B). Define the different kinds of Credit Instruments.
CREDIT INSTRUMENTS
Credit Instruments are the documents describing details of credit and debit. Credit
Instruments provide a written means fro future reference describing terms and conditions
of any debt and loan. Credit Instruments may be an order for payment of money to a
specified person or it may be a promise to pay the loan. Credit Instruments generally in use
are cheques, bills of exchanges, bank overdraft etc.
KINDS OF CREDIT INSTRUMENTS
There are two broad kinds of Credit Instruments.
1. Negotiable Instruments
According to the negotiable instruments Act under Section 13-A, A negotiable instrument
means a cheque promissory note and a bill of exchange which are payable to the bearer of
the instrument or the person to be ordered.
Features of Negotiable Instruments
i. It must be unconditional

ii. It must be in writing

iii. It is payable on demand or the period for the payment which is determined.
2. Non-Negotiable Instruments
Non-Negotiable Instruments can not be transferred or the documents which are restricted
to transfer by the issuer e.g. Money Order, Postal Order, Shares Certificate etc. Such
documents appears at the name of the beneficiary and the payments are made only to those
persons to whom the instruments are made payable.

Cheque
Q.10 (A). Define a Cheque?
Q.10 (B). Name the parties to a cheque.
Q.10 (C). What are the essentials of a cheque?
Q.10 (D). Draw a specimen of a cheque.

CHEQUE
A bill of exchange drawn on a specified banker and not expressed to be payable
otherwise than on demand. A cheque is a bill of exchange but a bill of exchange often is
not a cheque. A cheque is always payable on demand. The person drawing or making the
cheque must be a customer of the bank and must be having the required find as deposit
with the bank.
PARTIES TO A CHEQUE
Drawer
He is the maker of the cheque. He must be the holder of the account at the bank and must
sign the cheque as per specimen signature.
Drawee
He is the banker with whom the A/C is maintained by the drawer of the cheque.
Payee
He is a person named in the cheque to whom or to whose order the payment is to be made.
ESSENTIALS OF A CHEQUE
A cheque must have the following features / essentials.
i. It must be in writing but should not be written by a pencil.
ii. It must be an unconditional order to pay. The drawer must not pay any condition for the

payment of cheque.
iii. It must be signed by the person giving it.
iv. Cheque must be drawn upon a banker not else.
v. It must be for the payment of a certain sum of money only.
vi. Amount of money must be written in figures and words.
vii. The cheque must be payable on demand.

Kinds of Cheque
Q.11. Define the different types / kinds of a cheque.
Cheque may be of different types. Some of them are
Order Cheque
Order Cheque is which is expressed to be so payable or which is expressed to be payable to
a particular person without containing words prohibiting transfer or indicating that it will
not be transferable.
Open Cheque
They are payable in cash at the counter of the banks to the bearer of the cheque.
Crossed Cheque
These type of cheques are not encashed at the counter but which can be collected only by a
bank from the drawer bank. But these days an individual can also draw a crossed cheque
for the purpose of safety and security in certain cases.
Bearer Cheque
A bearer cheque is that which can be cashed for the bank by the bearer of the cheque. Any
person who is in possession of a bearer cheque can cash it without any difficulty.

DISHONOUR OF A CHEQUE
Q.12 what do you mean by Dishonor of a cheque? Under what circumstances a cheque is said
to be dishonored.
DISHONOUR OF A CHEQUE
The relation between a banker and his customer is that of a debtor and a creditor. Money
deposited will always belong to the customer and the bank will be bound to return its
equivalent to the customer or to any person to his order. But in certain cases a banker
refuses to honor his customers cheque. When the payment of the cheque is refused by the
bank, it is said to be dishonored.
REASONS FOR DISHONOUR
i. When balance to the credit of the customer is insufficient to meet the cheque.
ii. When money deposited cannot be withdrawn on demand in the case of fixed deposit.
iii. When the customer closes the account before the cheque is presented for encashment.
iv. When the cheque is not properly drawn.
v. If the cheque is crossed but presented on counter for the payment.

vi. When the cheque is post dated.

vii. If death information of the A/C holder is received.
viii. If the A/C holder is declared insolvent by the law.
ix. If the A/C holder has stopped the payment.
x. If the signature on the cheque is different with the specimen signature.
xi. If the amount written in figures is different from the amount written in words.
xii. If the cheque is presented for payment at a branch other than the one where the
customer has the account.

ENDORSEMENT
Q.13 (A). Define Endorsement.
Q.13 (B). What are the different kinds of Endorsement?
ENDORSEMENT
The word Endorsement has been derive from the latin word Indorsum which means
On the back. Anything written or printed on the back of a deed or instruments is called
endorsement. When the member or holder signs his name on the negotiable instrument for
the purpose of negotiation i.e. direction to pay the amount to another person is called
Endorsement. Section 15 of the Negotiable Instrument Act 1881 defines Endorsement as
When the maker or holder of a negotiable instrument sign the same, otherwise than as such
maker for the purpose of negotiation on the back or face therefore on a slip of paper or so
signs for the same purpose a stamp paper intended to be completed as a negotiable
instrument he is said to endorse the same and he is called the endorse.
KINDS OF ENDORSEMENT
Different kinds of Endorsement are as follows.
i. Blank or General Endorsement
When the endorser simply put his signature on the back of the instrument without
specifying the name of the endorsee, it is said to be general endorsement. The holder can
convert it in full endorsement by writing the name of the payee above the signature of the
endorsee.
ii. Special or Full Endorsement
It specifies in addition to the signature of the endorser the person to whom or to whose
order the instrument is payable.
iii. Restrictive Endorsement
An endorsement which prohibited further negotiation of the instrument is called restrictive
endorsement. For instance if a cheque is endorsed saying Pay A only or Pay A for A/C of
B the endorsed has no power to transfer his right further.
iv. Partial Endorsement
An endorsement which makes the transfer of the instrument from the endorser to the
endorsee after the fulfillment of stated conditions is called Partial Endorsement.
Sans Recourse
When a person wants to exclude his liability to the endorse or any subsequent holder in
case of dishonour of the instrument. The Endorser fees himself from his liability on a
negotiable instrument by writing the words SANS RECOURSE after the name of the
endorsee. He should make it clean that he endorsee or the holder should not look to him for
payment in case of the dishonour of the instrument. The endorsee may refuse to take an
instrument with such an endorsement.

CROSSING OF A CHEQUE
Q.14. What do you understand by the term Crossing of a Cheque?
CROSSING OF A CHEQUE
A Crossing is a direction to the paying banker that the cheque should be paid only is a
specified banker named in crossing. A cheque is said to be crossed when it bears across it is
face the transfers lines without any words on them.
Crossing prevents the cheque from being cashed by anyone except the payee. This ensures
safety of payment by means of cheques. It affords security and protection to the true
corner. Cheques are crossed in order to avoid losses arising from open cheques. However it
does not affect the negotiability of a cheque.

BILL OF EXCHANGE
Q.16. Define a bill of exchange and its different kinds.
BILL OF EXCHANGE
A bill of exchange is a written acknowledgment of a debt. It is written by the credit and
accepted by the debtor. Section 5 of the Act define a bill of exchange as An instrument in
writing containing an unconditional order, signed by the makers directing a certain person
to pay a certain sum of money only to, or to the order of a certain person or to the bearer of
the instrument.
Kinds of Bill of Exchange
A bill of exchange is of the following types.
i. Inland Bill
A bill of exchange which is drawn in a country and is payable anywhere in the same is
called an Inland Bill. For example if a bill is drawn in Pakistan and is payable in any city of
the country it will be considered as an Inland Bill.
ii. Foreign Bill
If a bill is drawn in one country but is payable in any other country, this type of bill of
exchange is called a foreign bill. For example it has been drawn by a businessman in
Pakistan in the name of other businessman living in Japan, the payment of the bill of
exchange will be among the two businessman of different nations therefore this kind of bill
of exchange is called Foreign Bill.
iii. Commercial Bill
A bill which is drawn for business purposes is called a Commercial bill. Sometimes a
businessman does not pay in cash but issues a bill which is payable in some future date
such type of a bill is called a Commercial Bill.
iv. Accomodation Bill
An accommodation bill is a bill whereof the acceptor according to the terms of the
instrument stands as a surety for some other person who may or may not be a party
thereto.
v. Time Bill
These are such type of bills which are payable on demand on some specified dates. These
specified dates may be of present or future.

vi. Demand Bill

The bills which are payable on demand are called demand bills. Such type of bills are
generally used for specific purposes.

Parties to a Bill of Exchange

Q.17. Who are the parties to a Bill of Exchange?
The parties to a bill of exchange are
i. The Drawer who prepares the bill.
ii. The Drawee in whose name the bill has been drawn.
iii. The Payee to whom the bill has to be paid.
iv. The Endorsee to whom the bill has been transferred by way of endorsement by the
payee.

Essentials of a Bill of Exchange

Q.18. What are the essentials of a bill of exchange?
ESSENTIALS OF A BILL OF EXCHANGE
The following are the essentials of a bill of exchange.
i. It must be in writing.
ii. It must be an unconditional order to pay.
iii. It must be signed by the maker.
iv. It must be addressed by one person to another.
v. It must be written for some certain sum of money.
vi. It must be payable on demand.

NOTING OF THE BILL

Q.21. What do you mean by Noting of the Bill?
NOTING OF THE BILL
When the bill of exchange is dishonoured by the party, the holder of the bill has a legal
right to take action against them. In this regard he prepares a type of Public Notice. It is
known as Notery Public which is attached along with the bill and is again presented for
repayment. Usually this entry of the bill is made on a separate attached with the bill. If the
payment is not made i.e. refused again then the date of the presentation the reference of the
register with his signature is entered in the notice. This is called Notice of the Bill.
PROTESTING OF THE BILL
Sometimes due to refusal of payment a certificate or document is issued by the notary
public containing all the information about the dishonour. This document is known as
protest of the bill. It contains
i. Attested copy of the bill.
ii. Signature of Notery Public.
iii. The name of the person whose bill was protested.
iv. The date and amount of the protest.
v. The cause of the protest.
vi. The reply of the drawee.
vii. The reason of absence of the drawee and the accepted.

viii. The reason for the non-payment of the bill.

ix. The certificate stamp of the notery public.

Renewal and Retirement of a Bill of

Exchange
Q.22. What is Renewal and Retirement of a bill of exchange?
RENEWAL OF THE BILL
Sometimes the drawee of the bill is unable to pay the bill on its agreed date or time. In such
a situation the drawee can apply to issue a new bill subject to certain conditions after the
agreement of the drawer. This issuance of a new bill for some new time is known as renewal
of the bill. After the issuance of the bill the former is considered to be cancelled. But if the
drawee again unables to pay the newly issued bill, the first bill with all its farmer
conditions becomes payable and valid.
RETIREMENT OF THE BILL
Sometimes the drawee pays the bill before the agreed date enjoying the rebate which is
provided to him for prepayment of the bill. This is known as retirement of the bill. The
amount of the rebate depends upon the time left for payment and the amount for which the
bill is drawn.

Rate of Exchange
Q.23(A). Define the term rate of exchange.
Q.23(B). Explain how the rate of exchange is determined?
RATE OF EXCHANGE
The rate at which the currency or monetary unit of one country can be exchanged with the
monetary unit of other country is called the rate of exchange. In other words, the rate at
which a unit of one country exchanges for the currency of another is the rate of exchange
between them. It may be used to denote the system whereby the trading nations pay off
their debts.
Determination of Rate of Exchange
The rate of exchange is determined under the following under the following money systems
as:
Under Gold Standard
If two currencies are on gold standard and if their currencies are expressed in terms of gold
i.e. a certain weight of gold then the rate of exchange is determined by reference to the gold
contents of the two currencies. Suppose Pakistan and United States are on gold standard
the rupee being equal to 10 grams of gold and dollar consisting of 50 grams of gold. The
rate of exchange between the two countries will be
1 Rupee = 10/50 = 1/5 $ or 0.20 cents
1 Dollar = 50/10 = 5 Rupees.
Thus the rate of exchange is determined in a direct manner by comparison between the
gold contents of the two countries. This rate of exchange is also known as Mint Par of
Exchange. The actual rate in the foreign exchange market will be slightly different from the
mint par to allow for certain expenses. However the actual rate of exchange between

currencies will not depart much from the mint par and will move between the two points of
export and import of gold. These points are called Gold Points.
Under Paper Currency Method
This phenomenon of exchange rates determination is also called Purchasing Power Parity
Theory. No country in the world is rich enough to have a free gold standard. All countries
nowadays have paper currencies. According to this theory the rate of exchange between
two countries depend upon the relative purchasing powers of their respective currencies.
Such will be the rate which will equate the two purchasing powers.
For example if a certain assortment of goods can be purchased for 1 in Britain and a
Similar assortment of goods with Rs. 16 in Pakistan then the purchasing power of 1 is
equal to the purchasing power of Rs. 16. Thus the rate of exchange according to purchasing
power parity theory will be
1 = Rs.16

Fluctuation in Rate of Exchange

Q.24. What are the causes of fluctuation in the rate of exchange of a country?
The rate of exchange fluctuates in the market due to interplay of demand and supply of
currency of a particular country. This is the result of some of the following transactions.
BALANCE OF TRADE
The main reason for fluctuations in the rate of exchange of the currency is the value of
imports and exports of a country. If the value of imports exceeds the value of exports the
rate of exchange will lend downwards and vice versa.
FOREIGN INVESTMENT
Foreign capital investment in a country necessities the payment of dividends or interest to
the investing countries. If the capital absorbing country is not in a position to pay such
claims in foreign currency, the rate of exchange of that country will definitely fall down.
SERVICE CHARGES
Freight and Insurance expenses also fluctuates the rate of exchange of a country. If the
importing country does not have her own shipping companies the transportation charges
are to be paid to foreign ships. So the insurance premium in case is to be paid to foreign
companies. This creates a demand of foreign currency and if the supply is limited the rate
of exchange will fall.

OBJECTIVES OF EXCHANGE
CONTROL
Q.25. Identify the objectives of exchanges control?
OBJECTIVES OF EXCHANGE CONTROL
The following are some of the objectives of exchange control.
To restore Equilibrium
The chief objective of exchange control is to restore equilibrium in its balance of payments.
If a country finds that its balance of trade has been persistently unfavourable then it must
do something set it right. The balance of payment must ultimately be made to balance.
To Protest Home Industries
Another objective of exchange control is to protect the home industry from unfettered

competition from abroad if the people at home are more interested in purchasing foreign
goods it will ultimately discourage the local producers to produce more. It will directly
affect the National Income and the domestic Gross Product of the country.
To Conserve Foreign Reserves
To conserve foreign reserve is another major objective of exchange control. Every Country
needs foreign exchange in order to maintain its stability monetarily in the present age. Also
the countries need foreign exchange to make payments for their imports and to pay back
their debts obligation. For this a country must have foreign currencies on their hand. If
there is a deficiency of the foreign exchange it is going to affect its liquidity position
internationally and its credit rating.

Foreign Exchange
Q.26. How does a country controls its foreign exchange?
METHODS OF EXCHANGE CONTROL
Paul Einzig is his book exchange controls has mentioned as many as 41 different methods
of exchange control. They can be categorized as
1. Direct Method
2. Indirect Method
They are discussed here as under.
1. DIRECT METHOD
The direct method are further classified as:
Intervention
For an effective control of foreign exchange rates and the foreign exchange market the
government usually have a central authority i.e. the Central Bank that has the complete
power to control and regulate the foreign exchange market. Under this method any body
who either wants to purchase or sell foreign exchange he has to deal with the central bank.
All the selling and purchasing transactions of foreign exchange is controlled by the central
bank which helps it to adjust demand and supply of foreign exchange according to the need
of the country.
Restriction
Exchange restriction is another powerful weapon of exchange control. It refers to the policy
by which the government restricts the supply of its currencies coming into the exchange
market. It is achieved either by one of the following methods.
i. By centralizing all trading in foreign exchange with central bank of the country.
ii. To prevent the exchange of national currency against foreign currency with the
permission of the government.
iii. By making all foreign exchange transactions through the agency of the government.
Exchange Clearing Agreement
Under this method the countries engaged in trade pay to their respective central bank the
amounts payable to their respective foreign creditors. The central banks they use the
money in off setting the corresponding claims after fixing the value of the foreign
currencies by common agreement. The basic principle is to offset international payments so
that they have not to be settled through the medium of the foreign exchange market.
2. INDIRECT METHODS
The most commonly used direct method or tool of exchange control is the use of tariff
duties and quotes and other quantative restrictions on the volume of international trade.

By imposing tariff and quotes the demand for the foreign currency falls down in the case of
restricting the imports.
Rate of Interest
Another method of indirect exchange is the rate interest. The rate of exchange is the result
of demand and supply of each other currencies arising out of trade and capital movement.
A high rate of interest in a country attracts short term capital from other countries that
leads to a exchange rate for the currency in terms of other currencies goes up.

Direct and Indirect Methods

Adopted of Exchange Control
Q.27. Compare the direct and Indirect methods adopted of exchange control.
COMPARISON OF DIRECT & INDIRECT METHODS
These methods of exchange control are known as indirect methods because they do not
control the exchange rate but only influence it. On the others hands the direct methods of
intervention, restriction and exchange clearing agreements have the effect of directly
controlling the exchange rate or the foreign exchange market.

Balance of Trade
Q.28. Define Balance of Trade
BALANCE OF TRADE
Balance of trade refers to the difference in the value of imports and exports of commodities
only i.e. visible items only. Movements of goods between countries is known as visible trade
because the movement is open and can be verified by the custom officials with respect to
balance of trade the following terminologies are important.
Balanced Balance of Trade
If during a given years exports and imports of the country are equal the balance of trade is
said to be Balanced.
Favourable Balance of Trade
If the value of exports exceeds the value of imports the country is said to experience an
export surplus or favourable balance of trade.
Un-Favourable Balance of Trade
If the value of imports exceeds the value of its exports the country is said to have a deficit
or an adverse balance of trade.

Balance of Payment
Q.29. Write a detailed note on Balance of Payments.
BALANCE OF PAYMENTS
Each nation periodically publishes a set of statistics that summarize for a given period all
economic transactions between its residents and the outside world. This statistical
statement is referred to as balance of payments. The accounts show how a nation has
financed its internation activities during the reporting period. They also show that what
changes have taken place in the nations financial claims and obligations with the rest of the
world.

STANDARD PRESENTATION
The IMF has significantly worked with success to standardize the system and the form of
presentation.
B.O.P DOUBLE ENTRY ACCOUNT
The B.O.P used double entry accounting. Transactions are recorded as credits of the yield
receipts from or claims against foreign owners. Credits are received for example by exports
of merchandise, sale of securities overseas and rendering services to foreigners. Similarly,
debits are recorded of transactions cause payments to foreigners e.g. importing goods,
tourist expenses abroad, purchase of foreign bonds.
B.O.P CURRENT ACCOUNT
The Current Account uncludes merchandise trade in good and International Services are
termed as Invisible trade. There are four basic service components. Tourism, Investment,
Private Sector, Services such as royalties, rent, consulting and engineering fees etc and
Government services such as diplomatic and buildings and membership fees in
international organizations.
B.O.P CAPITAL ACCOUNT
The capital account has a long term and a short term sector. The long term amount shows
the inflow and outflow of capital commitments which have a maturity longer than a year.
Short term capital movement frequently have a maturity date from 30-90 days. Long term
capital items generally include loans to and from other governments, financial support for
development. Projects abroad and export financing. Short term capital include paying for
international services, selling accounts etc.

Adverse Balance of Payments

Q.30. Explain in detail that how are adverse balance of payments can be corrected?
METHODS OF CORRECTING AN ADVERSE BALANCE OF PAYMENTS
Following are same of the methods adopted for correcting and adverse balance of
payments.
Improving the balance of trade through import restrictions & measures of export promotions
Since balance of payments becomes adverse because of excess imports over exports, so a
country having such a problem must try to check imports either by total prohibition or by
levying import duties so by a quota system. Another method may be import substitution i.e.
trying to produce in the country what it currently imports. Exports can be stimulated by
measures of export promotion granting subsidies or other concessions to industrialists and
exports.
Depreciation of the currency
If a country depreciates its currency it proves very helpful in increasing the exports of
goods. The value of the home currency fall relatively to foreign currency hence the
foreigners are able to buy move goods with the same amount of their own currency or for
the same amount of goods they have to pay less in terms of their own currency than before.
Devaluation
A country can turn the balance of payments in its favour by devaluating her currency. In
this case also the devalued currency will become cheaper in terms of the foreign currency
and the foreigners will be able to buy move goods by paying the same amount of their own
currency. The effect is the same as in the case of depreciation.

Deflation
Deflation means construction of currency. If currency is contracted then according to the
quantity theory of money the value of the currency will rise or the prices will fall. When
prices fall the country becomes a good country to buy in and not a good country to sell into
Exports will also thus increase and imports will be checked and hence the balance of trade
will become favourable.
Exchange Control
Under a system of exchange control, all exporters are asked to surrender their claims or
foreign currencies to the central bank which pays in return the home currency, which the
exporters really want. This available foreign exchange is rationed by the central bank
among the licenced importers. Thus imports are restricted to the foreign exchange
available. There is no danger of more goods being imported than exported.

International Trade
Q.32. Why do International trade take place?
OR
What are the bases for international trade?
Some of the reasons that why do trade between different countries occur are discussed
under the following heads.
NATURAL ENDOWMENTS
Differences in advantages of trade to different countries may arise because of natural
reasons like geographical and climatic conditions. This lead to territorial division of labour
and localization of industry. This different countries specialize in the production of
different things.
HUMAN CAPABILITIES
People in some countries are physically more sturdy where as in others they are
intellectually superior. Some have greater skill and dexterity thus the countries. Which do
not possess these qualities try to share with them.
STOCK OF CAPITAL
Some countries have large stock of capital goods like U.K, U.S.A, etc. These gives an
opportunity to the underdeveloped countries or those which lack these capital goods to
exchange or trade them through the channel of distribution internationally.
SPECIALIZATION IN PRODUCTION
A country may have a comparative cost advantage in production in more than one
commodity over other countries but produces only one commodity for the sake of
specialization. It helps in improving the quality of production to a great extent.

Advantages and Disadvantages of

International Trade
Q.33. What are the advantages of International trade? Also discuss its disadvantages.
ADVANTAGES OF INTERNATIONAL TRADE
Various advantages are named for the countries entering into trade relations on a
international scale such as:

A country may import things which it cannot produce

International trade enables a country to consume things which either cannot be produced
within its borders or production may cost very high. Therefore it becomes cost cheaper to
import from other countries through foreign trade.
Maximum utilization of resources
International trade helps a country to utilize its resources to the maximum limit. If a
country does not takes up imports and exports then its resources remain unexplorted. Thus
it helps to eliminate the wastage of resources.
Benefit to consumer
Imports and exports of different countries provide opportunities to the consumer to buy
and consume those goods which cannot be produced in their own country. They therefore
get a diversity in choices.
Reduces trade fluctuations
By making the size of the market large with large supplies and extensive demand
international trade reduces trade fluctuations. The prices of goods tend to remain more
stable.
Utilization of Surplus produce
International trade enables different countries to sell their surplus products to other
countries and earn foreign exchange.
Fosters International trade
International trade fosters peace, goodwill and mutual understanding among nations.
Economic interdependence of countries often leads to close cultural relationship and thus
avoid war between them.
DISADVANTAGES OF INTERNATIONAL TRADE
International trade does not always amount to blessings. It has certain drawbacks also such
as:
Import of harmful goods
Foreign trade may lead to import of harmful goods like cigarettes, drugs etc. Which may
run the health of the residents of the country. E.g. the people of China suffered greatly
through opium imports.
It may exhaust resources
Internation trade leads to intensive cultivation of land. Thus it has the operations of law of
diminishing returns in agricultural countries. It also makes a nation poor by giving too
much burden over the resources.
Over Specialization
Over Specialization may be disasterous for a country. A substitute may appear and ruin the
economic lives of millions.
Danger of Starvation
A country might depend for her food mainly on foreign countries. In times of war there is a
serious danger of starvation for such countries.
One country may gain at the expensive of Another
One of the serious drawbacks of foreign trade is that one country may gain at the expense
of other due to certain accidental advantages. The Industrial revolution is Great Britain
ruined Indian handicrafts during the nineteenth century.
It may lead to war
Foreign trade may lead to war different countries compete with each other in finding out

new markets and sources of raw material for their industries and frequently come into
clash. This was one of the causes of first and second world war.

Theory of Comparative Costs

Q.34. Explain in detail the theory of Comparative Costs.
INTRODUCTION
The classical theory of International trade commonly known as the principle of
comparative cost was first enunciated by David Ricardo. The theory went through many
additions improvements and refinements at the hands of economists like Mill, Cairns &
Bastable.
An individual is able to perform many tasks but he does not perform them all. He selects
that work which pays him the most. A doctor can also do the work of a dispenser but he
does not do it. The same principle works in international trade. Considering the climatic
conditions, distribution of material resources, geographical concern etc. Every country
seems to be better suited for the production of certain articles rather than for others to
employ its resources more remuneratively it will be to the advantages of each country as
well as to the world.
THEORY
In its simplest form the theory may be stated as, It pays countries to specialize in the
production of those goods in which they possess the greatest comparitve disadvantage.
EXPLANATION
Ricardo argued that two countries can gain very well by trading even if one the countries is
having an absolute advantage in the production of both the commodities over the country.
The condition is Provided the extent of absolute advantage is different in the two
commodities in question i.e. the comparative advantage is greater or comparative is lesses
in respect of one good than in that of the other. In this connection we compare not the cost
of production of one commodity with the other rather we compare the ratio between the
cost of production of the two commodities concerned in one country with the ratio of their
cost of production in the other country.
EXAMPLE
Suppose there are two countries A and B and there are two commodities wheat and rice.
Suppose a unit of labour produces 10 tons of wheat or 20 tons of rice in country A. The
same unit can produce 6 tons of wheat and 18 tons of rice in country B. According to this
situation country A is having an absolute advantage in the production of both commodities
over B. But she is at a greater comparative advantage in the production of wheat country B
is at a disadvantage in both. Commodities the comparative disadvantage is less than case of
rice. Hence the ratio would be
In A it is 10 : 20 i.e. 1 : 2
In B it is 06 : 18 i.e. 1 : 3
Therefore, A will specialize in wheat and B in rice and international trade will become
possible and profitable. This is the law of comparative advantage or costs.

Theory of Comparative Advantage

Q.35. What are the assumptions and criticism relating to the theory of comparative
advantage?

ASSUMPTIONS OF THE THEORY

The comparative cost theory is based on the following assumptions:
i. labour is regarded as the sole factor of production and the cost of production only
consists of labour cost.
ii. Production is subject to the law of constant returns.
iii. Factors of production are assumed to the perfectly modile within a country but
immobile between countries.
CRITICISM
The theory of comparative cost is criticized on the following grounds.
Assumption of Constant Cost
The classical economists were of the opinion that additional quantities & a commodity
could be obtained with the same expenditure of cost per unit us previously But this is not
valid assumptions lost ratios are subject to change where specialization between the two
countries has gone a pace.
Some Static Assumptions
The comparative cost theory in a number of static assumptions of fixed costs industrial
production functions between trading countries and fixed supply of land, labour, capital
etc. It cannot be applied 100% to the real world.
Assumption of perfect mobility inside and immobility outside a country
This assumptions seems to be un-applicable to todays modern world of communication and
technology the development of cheap quick and safe means of transport and
communication has broken down this immobility to a great extent.

Short Notes
Q.31. Define the following terms
INTERNATIONAL TRADE
International trade refers to that trade that take place between a country and a number of
countries of the world. In other words we can say that all the trading activities that take
place across the national boundaries is called International or Foreign trade. It is effect is
called balance of payments.
INTERNAL TRADE
Internal or Domestic or inter-regional trade is the trade between different regions in the
same country. We can also say that all the trading activities that take place within a
country is called Internal trade.
ABSOLUTE ADVANTAGE
A country due to its most favourable geographical conditions may have an advantage in the
production of a particular commodity over other countries. This advantage is known as
absolute advantage for that country over rest of the world. The absolute advantage results
in a regular inflow and outflow of goods which gives rise to International Trade.
COMPARATIVE ADVANTAGE
When a country has an advantage of production and move than one commodity it prefers
to produce only one commodity that is more advantageous for other. This advantage is
calculated by comparing the different commodities that how much they paying commodity
is selected and the country goes for specializing. This is known as comparative
advantage.Q.15. Write Short Notes.
PROMISSORY NOTE

The promissory note is one of the simplest forms of the credit instrument. Section 4 of the
Act defines a Promissory Note as an instrument in writing not being bank note or a
currency note containing an unconditional undertaking signed by the maker to pay a
certain sum of money only to or to the orders of a certain person to the bearer of the
instrument.
Characteristics of a Promissory Note
The essential characteristics of a promissory note are as follows
i. It is a written document signed as follows.
ii. It contains an unconditional promise to pay.
iii. Besides an acknowledgement a promissory note is an express promise to pay.
iv. Promissory note must always relate to a definite and certain amount of legal money of
the country and not to foreign money.
v. It should not be a bank note or currency note.
vi. No particular from is prescribed for it.
vii. A promissory note is not payable to the bearer on demand.
viii. The person to whom the promise is made must be definite person.
DRAFT
A draft is a cheque drawn by one branch of a bank upon another situated at any other
place required to pay a fixed / certain amount of money to a specified person or by his
order. A bank draft may either by inland or foreign. Drafts are issued by banders after
receiving written and signed applications. The person is required to remit the required
amount of money along with its commission. The banker hands over the draft to the
depositors and sends a credit advice to the branch upon which the draft is drawn.
Draft are a common media of transferring money from one place to another. They are of
great importance for financing trade, specially foreign trade. The draft are also known as
demand draft.
LETTER OF CREDIT
The letter of credit is a request made by the issuing bank to its correspondent or agent
making the request on demand on any draft on the issuing bank up to the amount
mentioned in the letter of credit. A letter of credit remain enforced for a fixed date only.
They are issued only to the persons who furnish guarantee or securities or make payment
of the full amount there in. The L.Cs are of great significance in international trade.
Specially the importers and exporters frequently use them. It saves from the trouble of
carrying money from place to place with the risk of loss or theft