Assignment No. 2
Download Button Is Given At The End Of Page
Q1. What is trade cycle? Discuss Keynesian’s theory of trade cycle.
A trade cycle refers to fluctuations in economic activities especially in employment, output and income, prices, profits etc. It has been defined differently by different economists. According to Mitchell, “Business cycles are of fluctuations in the economic activities of organized communities. The adjective ‘business’ restricts the concept of fluctuations in activities which are systematically conducted on commercial basis.
The noun ‘cycle’ bars out fluctuations which do not occur with a measure of regularity”. According to Keynes, “A trade cycle is composed of periods of good trade characterised by rising prices and low unemployment percentages altering with periods of bad trade characterised by falling prices and high unemployment percentages”.
Features of a Trade Cycle:
- A business cycle is synchronic. When cyclical fluctuations start in one sector it spreads to other sectors.
- In a trade cycle, a period of prosperity is followed by a period of depression. Hence trade cycle is a wave like movement.
- Business cycle is recurrent and rhythmic; prosperity is followed by depression and vice versa.
- A trade cycle is cumulative and self-reinforcing. Each phase feeds on itself and creates further movement in the same direction.
- A trade cycle is asymmetrical. The prosperity phase is slow and gradual and the phase of depression is rapid.
- The business cycle is not periodical. Some trade cycles last for three or four years, while others last for six or eight or even more years.
- The impact of a trade cycle is differential. It affects different industries in different ways.
- A trade cycle is international in character. Through international trade, booms and depressions in one country are passed to other countries.
John Maynard Keynes, one of the most influential economists of the 20th century, never worked out a pure theory of trade cycles, though he made significant contributions to the trade cycle theory. Keynes states, “The trade cycle can be described and analyzed in terms of the fluctuations of the marginal efficiency of capital relatively to the rate of interest.” According to Keynes, the level of income and employment in a capitalist economy depends upon effective demand, comprising of total consumption and investment expenditure. Changes in total expenditure will imply changes in effective demand and will lead to changes in income and employment in the country. Therefore, in the Keynesian system fluctuations in total expenditure are responsible for fluctuations in business activity. Now, according to Keynes, consumption expenditure is relatively stable, and consequently it is the fluctuations in the volume of investment that are responsible for changes in the level of employment, income and output.
Investment depends upon two factors: (a) marginal efficiency of capital, and (b) the rate of interest. Investment is carried on up to the point where the marginal efficiency of capital (the profitability of capital) is equal to the rate of interest (i.e., the cost of borrowing capital). Keynes argues that the rate of interest will depend upon the liquidity preference of the people in the country and the quantity of money available. In the short period, the rate of interest will be stable and hence it is not responsible for causing cyclical fluctuations in trade cycles. According to Keynes the fluctuations in the marginal efficiency of capital are the fundamental cause of fluctuation in trade cycles.
The substance of Keynesian Theory of Trade Cycles is that an initial investment outlay will generate multiple amount of income and employment under the influence of the multiplier and acceleration effects. On the other hand, contraction of investment will similarly lead to multiple contractions of income and employment. But whether a fresh investment will be undertaken will depend upon the marginal efficiency of capital. We can explain these points a little more elaborately.
Let us start at the bottom of a depression. At this point, the marginal efficiency of capital will be high due to exhaustion of accumulated stocks and necessity to replace capital goods. At the same time, the rate of interest may be low because of large cash balances with commercial banks or due to fall in the public liquidity preference. As a result, the entrepreneurs may borrow funds from banks and make fresh investments. Under the impact of the multiplier and acceleration effects, the process of increased investment and employment gets an upward trend. There is heavy economic activity everywhere in the primary, secondary and tertiary sectors of the economic system. This sudden shoot in investment activity gives rise to boom and as long as it lasts, the economic situation appears very easy and bright. The boom conditions themselves contain the very seeds of their own destruction. Very soon goods are accumulated beyond the expectations of entrepreneurs and competition among them to dispose their accumulated stocks bring crash in prices. While the prices of finished goods are declining, their costs of production continuously rise because factors of production are becoming scarce and hence are commanding higher prices. The marginal efficiency of capital is sandwiched between rising costs of production on the one side and falling prices of finished goods in the other hand. The marginal efficiency of capital, therefore, collapses and brings about a crash in the investment market.
Keynes believes that the rate of interest could have prevented the collapse of the marginal efficiency of the capital and revives the confidence among the entrepreneurs, by exerting its pressure to reduce cost. But then, the rate of interest is very high, like all other prices and wages. The rate of interest goes up due to a rise in the liquidity preference of the people. The marginal efficiency of capital falls below the current rate of interest and thus, the decline of investment is aggravated. Keynes believes that at this stage a reduction in the rate of interest is neither easy nor adequate to restore confidence and revive investment. In Keynesian Theory of Trade Cycles, the marginal efficiency of capital has great significance than the rate of interest. In fact, it disturbs the equilibrium of the economy and thereby causes fluctuations in the economy. The other factor that occupies an equally important place in Keynes theory is the “investment multiplier“. However, for the active operation of investment multiplier, the cycle needs to be milder in magnitude than what it actually is.
Weaknesses of the Keynesian Analysis
Keynes’ theory of the trade cycle has been regarded as quite convincing since it explains exactly the cumulative processes, both in the upswing as well as in the downswing. Besides, Keynes’ advocacy of fiscal policy to bring about business stability has been widely used. However, critics have found some weaknesses in the Keynesian Theory of Trade Cycles. First, according to Keynes, marginal efficiency of capital is the most important factor that guides the investment decisions of the entrepreneurs. However, this important factor depends on entrepreneurs’ anticipation of future prospects that further depend upon the psychology of investors. If such a case, Keynes’ theory of trade cycles approaches close to Pigou’s psychological theory, which assumes that the changing assumptions of entrepreneurs regarding future market conditions play a key role in the cyclical fluctuations of capitalist reproduction. Secondly, in Keynes’ theory, the rate of interest plays a minor role. Keynes expresses the opinion that sizable fall in the rate of interest can do something to revive the confidence among the entrepreneurs by exerting pressure on the cost of production. However, Keynes himself has pointed out that this has been sufficiently proved to be correct that the rate of interest does not have any influence on investment. Thirdly, his theory does not throw light on the periodicity aspect of the trade cycle.
Q2. Define credit. How is credit and debit merely the same thing looked at from two different points of view?
A credit card is a thin rectangular piece of plastic or metal issued by a bank or financial services company that allows cardholders to borrow funds with which to pay for goods and services with merchants that accept cards for payment. Credit cards impose the condition that cardholders pay back the borrowed money, plus any applicable interest, as well as any additional agreed-upon charges, either in full by the billing date or over time. An example of a credit card is the Chase Sapphire Reserve.
Credit cards typically charge a higher annual percentage rate (APR) versus other forms of consumer loans. Interest charges on any unpaid balances charged to the card are typically imposed approximately one month after a purchase is made (except in cases where there is a 0% APR introductory offer in place for an initial period of time after account opening), unless previous unpaid balances had been carried forward from a previous month—in which case there is no grace period granted for new charges.
ost major credit cards—which include Visa, MasterCard, Discover and American Express—are issued by banks, credit unions or other financial institutions. Many credit cards attract customers by offering incentives such as airline miles, hotel room rentals, gift certificates to major retailers and cash back on purchases. These types of credit cards are generally referred to as rewards credit cards.
To generate customer loyalty, many national retailers issue branded versions of credit cards, with the store’s name emblazoned on the face of the cards. Although it’s typically easier for consumers to qualify for a store credit card than for a major credit card, store cards may only be used to make purchases from the issuing retailers, which may offer cardholders perks such as special discounts, promotional notices, or special sales. Some large retailers also offer co-branded major Visa or MasterCard credit cards that can be used anywhere, not just in retailer stores.
Secured credit cards are a type of credit card where the cardholder secures the card with a security deposit. Such cards offer limited lines of credit that are equal in value to the security deposits, which are often refunded after cardholders demonstrate repeated and responsible card usage over time. These cards are frequently sought by individuals with limited or poor credit histories.
Similar to a secured credit card, a prepaid debit card is a type of secured payment card, where the available funds match the money someone already has parked in a linked bank account. By contrast, unsecured credit cards do not require security deposits or collateral. These cards tend to offer higher lines of credit and lower interest rates vs. secured cards. Many credit cards attract customers by offering incentives such as airline miles, hotel room rentals, gift certificates to major retailers and cash back on purchases. These types of credit cards are generally referred to as rewards credit cards.
When you use a debit card, the funds for the amount of your purchase are taken from your checking account in almost real time. When you use a credit card, the amount will be charged to your line of credit, meaning you will pay the bill at a later date, which also gives you more time to pay.
It can often be complicated to decide when it is best to use each card. For everyday purchases, consider using your debit card because you will see the money taken out of your checking account right away. For bigger items, such as a rental car or hotel room, you could use your credit card so that you can save up money by the time you have to pay.
Advantages of a debit card
In addition to the convenience if you don’t have cash readily available, debit cards have several advantages for users.
- Avoid increasing your debt. Using a debit card instead of a credit card is a good way to decrease your chances of getting into debt. This payment method should keep you within your budget and from spending all of the money in your checking account. If you ever do spend more than your checking account allows, you may be charged an Overdraft or Return Fee from your bank.
- Debit cards give you easy access to your cash. You can use your debit card to withdraw cash from ATM machines. Some retail stores will also allow you to get “cash back,” charging more than your initial transaction to your checking account and giving the cash to you with your receipt.
- Pay now to avoid a bill later. Since the money from a purchase you make with your debit card is taken directly out of your checking account, you don’t have to worry about a bill coming your way at the end of the month. This also means that you don’t have to worry about interest accumulating on that bill.
Advantages of a credit card
There are several benefits of having and using a credit card.
- Credit cards give you extra time to pay for purchases. At the end of your monthly credit card cycle, you will receive a bill stating how much you owe for purchases made in the last 30 days. Depending on when you made the purchase, you have up to a few weeks to pay your credit card bill. Technically, you are only required to pay the minimum fee each month but this could lead to future debt.For example, if you spend $1,000 in a month but only pay your monthly minimum payment of $15 and you spend again next month, you are likely to fall into a debt trap. Each month that you don’t pay off the entire bill, there will be a certain amount charged for interest by the credit card company. A helpful tip is to pay off as much as you can each month to earn better credit and avoid building up debt.
- Credit card use builds your credit history. Each time you purchase something with your credit card and then pay it off on time, your credit history will build up. Building good credit is important when you are taking out a loan, buying a car or house, etc. Paying off your credit card bill each month will show that you are capable of paying off debt and can help increase your credit score.
- Convenient for emergencies. Having a credit card is very useful and convenient when there is an emergency. If you suddenly need to pay for a repair in your house, you can put the charge on your credit card. In this case, you probably did not plan for this expense, so your credit card company will extend you credit until you pay the bill at the end of the month. Again, this gives you a little extra time to pay for something you weren’t expecting to pay.
Q3. Define commercial Banks and describe its major and minor function in detail.
The term commercial bank refers to a financial institution that accepts deposits, offers checking account services, makes various loans, and offers basic financial products like certificates of deposit (CDs) and savings accounts to individuals and small businesses. A commercial bank is where most people do their banking.
Commercial banks make money by providing and earning interest from loans such as mortgages, auto loans, business loans, and personal loans. Customer deposits provide banks with the capital to make these loans.
Commercial banks provide basic banking services and products to the general public, both individual consumers and small to mid-sized businesses. These services include checking and savings accounts, loans and mortgages, basic investment services such as CDs, as well as other services such as safe deposit boxes.
Significance of Commercial Banks
They ensure liquidity by taking the funds that their customers deposit in their accounts and lending them out to others. Commercial banks play a role in the creation of credit, which leads to an increase in production, employment, and consumer spending, thereby boosting the economy.
Customers find commercial bank investments, such as savings accounts and CDs, attractive because they are insured by the Federal Deposit Insurance Corporation (FDIC), and money can be easily withdrawn. Customers have the option to withdraw money upon demand and the balances are fully insured up to $250,000. Therefore, banks do not have to pay much for this money.
Banks attract the idle savings of people in the form of deposits.
Demand deposits, also known as current accounts:
These are repayable on demand without any notice. Usually no interest is paid on them, because the bank cannot utilize short-term deposits, and must, therefore, keep almost cent per cent reserve against them. On the other hand, a little commission is charged for the services rendered. Occasionally, however, a small interest is paid to people who keep large balances.
Fixed Deposits or Time Deposits:
These deposits can be withdrawn only after the expiry of the period for which these deposits have been made. Higher interest is paid on them—the rate rising with the length of the period and the amount of deposit. The usual rate in India today varies between 6 per cent and 110 per cent, depending upon the time-period for which deposits are made.
Savings Bank Deposits:
These deposits stand midway between current and fixed accounts. These deposits are not as freely withdraw-able as current accounts. One or two withdrawals up to a limit of one-fourth of the deposit but not more than Rs. 1,000 are generally allowed in a week. The rate of interest is less than that on the Fixed Deposits.
But receiving of deposits is not the whole story about a bank’s functions. If that were so, how could a bank pay interest? Hence, after collecting money by way of deposits, a bank invests it or lends it out. Money is lent to businessmen and traders usually for short periods only. This is so because the bank must keep itself ready to meet the demands of the depositors, who have deposited money for short periods.
By allowing an Overdraft:
Customers of standing are given the right to overdraw their accounts. In other words, they can get more than they have deposited, but they have to pay interest on the extra amount which has to repaid within a short period. The amount of permissible over-draft varies with the financial position of the borrower.
By Creating a Deposit:
Cash credit is another way of lending by the banks. When a person wants a loan from a bank, he has to satisfy the .manager about his ability to repay, the soundness of the venture and his honesty of purpose. In addition, the bank may require a tangible security, or it may be satisfied with the borrower’s personal security.
The discounting of bills by a bank is another way of lending money. The banks purchase these bills through bill-brokers and discount; companies of discount them directly for the merchants. These bills provide a very liquid asset (i.e., an asset which can be easily turned into cash). The investment in bills is considered quite safe, because a bill beats the security of two businessmen, the drawer as well as the drawer, so that if one proves dishonest or fails, the bank can claim the money from the other. This is regarded as the best investment by the banks. It is liquid, lucrative and safe. That is why it is said that a good bank manager knows the difference between a bill and a mortgage.
Banks remit funds-for their customers through bank draft to any place where they have branches or agencies. This is the cheapest way of sending money. It is also quite safe. Funds can also be remitted to foreign countries.
Ornaments and valuable documents can be kept in safe deposit with a bank, in its strong room fitted with lockers, on payment of a small sum per year. Thus the risk of theft is avoided.
The bank works as an agent of their constituents. They receive payments on their behalf. They collect rents, dividends on shares, etc. They pay insurance premia and make other payments as instructed by their depositors. They accept bills of exchange on behalf of their customers. They pass bills of lading or railway receipts to the purchasers of goods when they pay for them. This amount is passed on to the suppliers of goods.
They provide references about the financial position of their customers when required. They supply this information confidentially. This is done when their customers want to establish business connections with some new firms within or outside the country.
Letters of Credit:
In order to help the travelers, the banks issue letters of credit travelers’ cheques. A man going on a tour takes with him a letter of credit from his bank. It is mentioned there that he can be paid sums up to a certain limit. He shows this letter to banks in other places which make the payment to him and debit the bank which has issued the letter of credit.
Q4. Explain the short term and long term credit instrument of a bank.
Debt instruments are the instruments that are used by the companies to provide finance (short term as well as long term) for their growth, investments and future planning and comes with an agreement to repay the same within the stipulated time period. Long-term instruments include debentures, bonds, long-term loans from the financial institutions, GDRs from foreign investors. Short-term instruments include working capital loans, short-term loans from financial instruments.
Types of Debt Instruments
There are two types of debts instruments, which are as follows:
- Medium & Short-term
Long-Term Debt Instruments
The company uses these instruments for its growth, heavy investments, future planning. These are those instrument which generally has a period of financing of more than 5 years. These instruments have a charge on the companies assets and also bears an interest paid regularly.
A debenture is the most used and most accepted source of long-term financing by a company. These carry a fixed Interest Rate on the finance raised by the company through this mode of the debt instrument. These are raised for a minimum period of 5 years. Debenture forms part of the capital structure of the company but is not clubbed with calculating share capital in the balance sheet.
Bonds are just like debentures, but the main difference is that bonds are used by the government, central bank & large companies, and also these are backed by securities, which means these have a charge over the company’s assets. These also have a fixed interest rate, and the minimum period is also at least 5 years.
It is another method that is used by companies to get loans from banks, financial institutions. It is not as much a favourable option method of financing as the companies have to mortgage their assets to banks or financial institutions. And also, the Interest rates are too high as compared to Debentures.
Under this option, the company can raise funds by mortgaging their assets with anyone either from other companies, individuals, banks, financial institutions. These have a higher rate of interest in funding the companies. The interest of the party providing funds is secured as they have a charge over the asset being mortgaged.
Medium & Short-Term Debt Instruments
These are those instruments which generally used by the companies for their day to day activities and working capital requirements of the companies. The period of financing in this case of Instruments are generally less than 2-5 years. They don’t have any charge over the companies assets and also don’t have a high-interest liability on the companies. Examples are as follows:-
Working Capital Loans
Working capital loans are the loans that are used by the companies for their day to day activities like clearing of creditors outstanding, payment for the rent of the premises, purchase of raw material, repairs of machinery. These have interest charges on the monthly limit used by the company during the month from the limit allowed by financial institutions.
Banks and financial institutions also finance these, but they do not charge interest monthly; they have a fixed rate of interest, but the period for funds transferred is for less than 5 years.
Treasury Bills are short-term debt instruments that mature within 12 months. They are redeemed at the maturity in full, and if sold before maturity, then they can be sold at a discounted price. The interest on these T-bills is covered in the issue price as they issued at a premium and redeemed at par value.
· Tax Benefit for Interest Paid:- In debt financing, the companies get the benefit of interest deduction from the profit before calculation of tax liability.
· Ownership of Company:- One of the major advantages of debt financing is that the company does not lose its ownership to the new shareholders as the debenture does not form part of the share capital.
· Flexibility in Raising Funds:- Funds can be raised from debts instruments more easily as compared to equity funding as there is a fixed rate of interest payment to the debt holder at regular intervals
· Easier Planning for Cashflows:- The companies know the payment schedule of the funds raised from debt instruments such as there is an annual payment of interest and a fixed time period for redemption of these instruments, which helps companies to plan well in advance regarding their cashflow/funds flow status.
· Periodic Meetings of Companies:- The companies raising funds from such instruments are not required to sent notices, mails to debt holders for the regular meetings, as in the case of equity holders. Only those meeting which affects the interest of the debt holders would be sent to them.
· Repayment:- They come with a repayment tag on them. Once funds are raised from debt instruments, these are to be repaid on their maturity.
· Interest Burden:- This instrument carries an interest payment at a regular interval, which needs to be met for which the company needs to maintain sufficient cash flow. Interest payment reduces the company profit by a significant amount.
· Cashflow Requirement:- The company needs to pay interest as well as the principal amount for the company has kept the cashflows for making these payments well in time.
· Debt-Equity Ratio:- The companies having a larger debt-equity Ratio are considered risky by the lenders and investors. It should be used up to such an amount, which does not fall below that risky debt financing.
· Charge Over the Assets:- It has a charge over the companies assets, many of which require the company to pledge/mortgage their assets in order to keep their interest/funds safe for redemption
Q5. Define cheque and discuss its characteristics.
A cheque is a bill of exchange, drawn on a specified banker and it includes ‘the electronic image of truncated cheque’ and ‘a cheque in electronic form’.
The cheque is always payable on demand. A cheque must contain all the characteristics of a bill of exchange.
Characteristics of a Cheque
Cheque is one of the important negotiable instruments. It is frequently used by the people and business community in the course of their personal and business transactions. The definition of cheque has been given in Section 6 of Negotiable Instrument Act in these words,” A cheque is a bill of exchange drawn on a specified banker and is expressed to the payable, otherwise than on demand.” The essential requisites of cheque are as:
- Must be in Writing: The cheque may be written in hand by using ink or ballpoint pen, typed or even it may be printed. But the customer should not use pencil to fill up the cheque form. Even though other columns may be permitted to be written in hand or printed or typed, the signatures should be made by ink pen or ballpoint pen by the maker.
- Must be Unconditional: The order to pay the amount must be unconditional. If there is any condition imposed to pay the amount to the holder of the cheque then it will not be considered as a cheque. A cheque made payable on the happening of a contingent event is void ab-initio.
- Must be drawn on a Specified Banker: For the validity of a Cheque it must be drawn on a specified banker. If there is not mentioned in the cheque about the banker it would not be a valid cheque. In addition to it, it must contain all the three parties i.e. Drawer, Drawee and Payee.
- Certain Sum of Money: It is one of the essential requirement of the Cheque that it must be payable in money and money only. If is not in term of money then it will be a valid one. The sum mentioned in it must be certain.
- Certain Payee: The parties of the Cheque must be certain. There are three parties of the cheque i.e. Drawer, Drawer and Payee. In a valid Cheque the name of the must contain in other words they must be certain. It must contain an order, which must be unconditional. If any condition were imposed then it would not be a valid cheque.
- Date: In a valid cheque it must be signed by the drawer with date otherwise it would not be a valid cheque. It must be written in hand by using ink or ball point pen, typed or even it may be printed as it becomes conclusive proof i.e. presumption under Section 118(b) unless contrary is proved.
Parties to the Cheque
The maker of a cheque is called the ‘Drawer’, the person thereby directed to pay is called ‘Drawee’ and the person named in the instruments, to whom or to whose order the money is by the instrument direct to be paid, is called the “Payee.”
The person entitled in his own name to the possession of the cheque and to receive or recover the amount due is called the “Holder of the cheque.”
The person who for consideration becomes the possessor of the cheque if payable to bearer, or the payee or endorsee thereof, if payable to order, before the amount mentioned in it became payable and without having sufficient cause to believe that any defect existed in the title of the person from whom he derived his title is called the “Holder in due course.”
he maker or the holder of the cheque signs his name (endorse) on the back of the cheque for the purpose of negotiable and he is said to be the ‘Endorser.’ The endorser who signs his name and directs to pay the amount mentioned in the cheque to, or the order of, a specified person, and the person so specified is called the “Endorsee” of the cheque.
be paid or a person receiving payment.
Types of Cheque
Cheques are of four types.
- a) Open cheque:
A cheque is called ‘Open’ when it is possible to get cash over the counter at the bank. The holder of an open cheque can do the following:
- Receive its payment over the counter at the bank,
- Deposit the cheque in his own account
- Pass it to someone else by signing on the back of a cheque.
- b) Crossed cheque:
Since open cheque is subject to risk of theft, it is dangerous to issue such cheques. This risk can be avoided by issuing other types of cheque called ‘Crossed cheque’. The payment of such cheque is not made over the counter at the bank. It is only credited to the bank account of the payee. A cheque can be crossed by drawing two transverse parallel lines across the cheque, with or without the writing ‘Account payee’ or ‘Not Negotiable’.
- c) Bearer cheque:
A cheque which is payable to any person who presents it for payment at the bank counter is called ‘Bearer cheque’. A bearer cheque can be transferred by mere delivery and requires no endorsement.
- d) Order cheque:
An order cheque is one which is payable to a particular person. In such a cheque the word ‘bearer’ may be cut out or cancelled and the word ‘order’ may be written. The payee can transfer an order cheque to someone else by signing his or her name on the back of it.
There is another categorization of cheques which is discussed below:
Ante-dated cheques: Cheque in which the drawer mentions the date earlier to the date of presenting if for payment. For example, a cheque issued on 24th March 2011 may bear a date 4th March 2011.
Stale Cheque: A cheque which is issued today must be presented before at bank for payment within a stipulated period. After expiry of that period, no payment will be made and it is then called ‘stale cheque’
Mutilated Cheque: In case a cheque is torn into two or more pieces and presented for payment, such a cheque is called a mutilated cheque. The bank will not make payment against such a cheque without getting confirmation of the drawer. But if a cheque is torn at the corners and no material fact is erased or canceled, the bank may make payment against such a cheque.
Post-dated Cheque: Cheque on which drawer mentions a date which is subsequent to the date on which it is presented, is called post-dated cheque. For example, if a cheque presented on 8th May 2003 bears a date of 27th March 2011, it is a post-dated cheque. The bank will make payment only on or after 27th March 2011.
To open a checking account, a person deposits a sum of money in a bank. The bank gives him a check-book with blank check forms, and provides him with a means of keeping a record of the checks he writes and the amount of money he still has on deposit. The bank gives him a receipt for each new deposit and sends him a statement (usually monthly) showing a complete record of all transactions. All concealed checks (checks that have been cashed by the bank) are returned with the statement, providing the depositor with proof that payment was received. The bank usually makes a small service charge on every account, and perhaps also a charge for each check written. Ordinarily, no interest is paid on checking accounts.
To make out a check, the depositor writes the date, the name of the payee (the person or firm who is to receive the money), and the amount. He then signs his name. Before cashing the check the payee must endorse it by signing his name on the back. He then either deposits it in a bank or exchanges it for cash by giving the check to a bank, currency exchange, business firm, or individual. The new owner can endorse the check to someone else or can deposit it in a bank. When a check reaches a bank, it is forwarded through a clearing-house back to the bank on which it was drawn. After making sure the depositor’s signature is genuine, this bank in turn pays the cashing bank through the clearing- house. The biggest danger in accepting a check is that the person writing it may not have enough money (or any money) in the bank to cover it. Forgery is another danger. The best defense against “bad checks” is to refuse to accept checks from strangers.