CA Foundation · Business Economics · Money Market
The RBI conducts a fixed-rate reverse repo operation in a situation of excess liquidity in the banking system. Which combination correctly describes the effect on liquidity and short-term rates?
Reverse repo absorbs liquidity from banks because the RBI borrows funds from them against government securities. With less surplus cash in the system, short-term interest rates tend to firm up. Injecting liquidity is the effect of a repo operation, not a reverse repo.
- ALiquidity is absorbed from banks and short-term rates tend to firm upCorrect
- BLiquidity is injected into banks and short-term rates tend to fall
- CLiquidity is absorbed from banks and short-term rates tend to fall sharply
- DLiquidity is unaffected but the cash reserve ratio rises
Explanation
In a reverse repo the RBI borrows from banks against government securities, taking money out of the system. Reduced liquidity tends to push short-term rates up, and the reverse repo rate acts as a floor for overnight rates. Injecting liquidity is the effect of a repo, which is why the second option is wrong.
Did you get it right without looking?
One question tells you little. A timed set on Money Market shows your real accuracy, how long you take and where you lose marks.
More Money Market questions
- Which of the following is NOT a characteristic of money market instruments?
- Meera Textiles needs short-term funds for 60 days and has a well-rated, unsecured promissory note it wants to sell to investors directly, wi…
- Which of the following participants is typically EXCLUDED from participating directly in the call money market?
- Banks in an economy have a required reserve ratio of 10%, and the public holds no cash (all money is redeposited). The central bank injects …
- Which of the following is a feature of the Treasury Bill as a money market instrument in India?
- Which of the following best describes the primary function of the Liquidity Adjustment Facility (LAF) in India's monetary framework?