Question

1.Why does the central bank of a nation hold official reserve assets? What are its major components?

Answer 1

Answer 1 : What are Official Reserve assets? : Reserve assets are financial assets denominated in foreign currencies, held by central banks, that are primarily used to balance payments. A reserve asset must be readily available to monetary authorities, must be an external physical asset that is, in some measure, controlled by policymakers, and must be easily transferable.

Reserve assets are external assets that are readily available to and controlled by monetary authorities for meeting balance of payments financing needs, Official Reserve Assets intervention in exchange markets to affect the currency exchange rate, and for other related purposes

• Reserve assets are currencies or other assets, like gold, that can be readily transferable and are used to balance international transactions and payments.
• A reserve asset must be readily available, must be a physical asset, must be controlled by policymakers, and must be easily transferable.
• The U.S. dollar is a reserve currency, meaning it is widely held as a reserve asset around the world.

Due to following Reasons Central Bank of Nation holds official Reserves :

1) Control the Exchange rate fluctuations : Official Reserve assets are part of Balance of payment hence when deficient arises in BOP the central bank takes certain measures through official reserve asset i,e restricting goods imports which causes higher deficit in BOP.

2) Controlling of Precious Metal Prices : Every central banks holds gold as reserve requirement due to its a precious metal having so much demand in the market. if country's central banks are having more gold in official reserves means they are having positive surplus in their official reserve.

3) Its Holds US$ in official Reserves : Every nation wants to keep more US$ as much as possible because every nations exchange rates are converted in dollar for export and import purpose, if nation is having so much $US it reflects that it has strong official reserves.

Components of Official Reserve Assets ?

1) Monetary gold consists of gold bullion and unallocated gold accounts, presented in volume (fine troy ounces) and value (at market price).

2) Reserve position in the International Monetary Fund (IMF) consists of the reserves the country has given to the IMF, such as the reserve tranche and/or any loan to the IMF that is readily available to the member country.

3) The special drawing right (SDR) is an international reserve asset created by the IMF to supplement existing reserve assets that are periodically allocated to IMF members in proportion to their respective quotas. SDR holdings represent unconditional rights to obtain foreign exchange or other reserve assets from other IMF members. SDRs are not claims on the IMF. Rather, the membership of the SDR Department of the IMF incurs the asset or liability position.

4) Financial derivatives included under official reserve assets are financial instruments linked to another specific financial instrument, indicator or commodity through which specific financial risks (such as interest rate risk, foreign exchange risk, equity and commodity price risks, and credit risk) can be traded in financial markets in their own right and that pertain to the management of reserve assets.

5) Other claims include loans to non-resident non-banks, long-term loans to an IMF Trust account.