Every study of money and banking begins with a few basic terms that appear again and again in later topics. Knowing their exact meaning prevents confusion, allows clear communication with customers and colleagues, and lays the base for understanding how money moves through an economy. Example: a loans officer at a SACCO who can explain the difference between money, credit and interest to a new member will be trusted more than one who uses the words loosely.
Money is anything that people in a society generally accept as payment for goods and services and as settlement of debts. It can take several forms, as long as people trust it and are willing to accept it. Example: a farmer who sells tomatoes to a hotel cook receives an M-Pesa payment and later uses the same balance to buy fertiliser at an agro-vet shop.
Barter is the direct exchange of one good or service for another without using money. It was common before money was introduced and still occurs in some rural communities. Its main weakness is the need for a double coincidence of wants, meaning each person must have exactly what the other wants at the same time. Example: a maize farmer who needs a pair of shoes must find a shoemaker who happens to want maize at that moment.
Legal tender is money that the law requires creditors to accept in settlement of a debt up to a stated amount. It gives people confidence that the money they receive will be accepted by others. Example: a stall owner at a county market cannot lawfully refuse Kenyan shilling notes offered by a customer for goods that are on sale.
Currency is the coins and notes in circulation in a country, and it is only one part of the total money in the economy. In Kenya, the Central Bank of Kenya issues the shilling, which is divided into 100 cents. Example: when a school bursar withdraws Ksh 50,000 over the counter to pay casual workers, the cash is currency, while the balance left in the school's account is deposit money.
The purchasing power of money is the quantity of goods and services that a unit of money can buy. It moves in the opposite direction to the general level of prices: when prices rise, each shilling buys less, and when they fall, each shilling buys more. Example: if a loaf of bread rises from Ksh 60 to Ksh 70, a family that spends Ksh 420 can buy 6 loaves instead of 7.
Formula: number of loaves = money available ÷ price per loaf
Substitution: before = 420 ÷ 60, after = 420 ÷ 70
Result: 7 loaves before and 6 loaves after
Credit is an arrangement in which a person receives money, goods or services now and promises to pay later, often with interest. It allows individuals and firms to spend more than the cash they hold at the moment. Example: a dairy farmer obtains animal feed on credit from a cooperative society and repays after the monthly milk payment is received.
Interest is the price paid for the use of borrowed money, or the reward received for saving it, and it is usually expressed as a percentage of the amount over a period. The amount borrowed or saved is called the principal.
Formula: simple interest = principal × rate × time
Substitution: interest = Ksh 100,000 × 0.12 × 1
Working: 100,000 × 0.12 = 12,000
Result: interest = Ksh 12,000 per year
Inflation is a sustained rise in the general level of prices over time, which reduces the purchasing power of money. It matters because savings, wages and fixed payments lose value when it is high. Example: if prices rise by 8 percent in a year, a contractor's Ksh 100,000 of savings buys goods worth only about Ksh 92,600 in the previous year's prices.
Formula: inflation rate = (new price index − old price index) ÷ old price index × 100
Substitution: inflation rate = (108 − 100) ÷ 100 × 100
Result: inflation rate = 8 percent
Deflation is a sustained fall in the general level of prices, which increases the purchasing power of money. It may look attractive to buyers, but it can discourage spending and investment, since people expect goods to be cheaper later. Example: a clothing wholesaler who sees prices fall month after month may delay restocking, and this reduces sales for suppliers.
Liquidity is the ease and speed with which an asset can be turned into cash without losing value. Cash is the most liquid asset, while land and buildings are the least liquid. Example: a bank keeps part of its funds as cash and short-term deposits so that it can pay customers who withdraw money on demand.
The financial system is the network of institutions, markets and instruments that moves money from savers to borrowers and enables payments to be made. It includes the central bank, commercial banks, non-bank financial institutions and the markets for shares and bonds. Example: a county government's pension scheme invests contributions in treasury bonds, and the government uses the proceeds to build a hospital.
The exchange rate is the price of one country's currency in terms of another currency. It determines how much a person pays when buying imported goods or sending money abroad. Example: a tour company that must pay a foreign supplier USD 500 when the rate is Ksh 130 per USD needs Ksh 65,000.
Formula: amount in shillings = amount in foreign currency × exchange rate
Substitution: amount = 500 × 130
Result: amount = Ksh 65,000
Create a free account to open more of this chapter.
Free: practical guides, quick cards, workplace scenarios and more.
Create a free account