FM & ECO Marathon Revision by CA Rahul Garg Sir PDF

CA RAHUL GARG’s
FM & ECO
MARATHON
2019
CA IPC
CA INTER
RAHUL SHIKHA ACADEMY

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CHAPTER 1 COST OF CAPITAL

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CA IPC
CA INTER
CONCEPT FINANCING DECISION & COST OF CAPITAL
CONCEPT COMPONENTS OF CAPITAL
CONCEPT COMPONENTS OF COST OF CAPITAL
CA Rahul Garg Gold Medalist All India Rankholder in CA, CS, CMA (incl Rank 1)
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CONCEPT COST OF DEBT
Cost of Irredeemable Debt
Cost of Redeemable Debt
CONCEPT COST OF PREFERENCE SHARE CAPITAL
Cost of Irredeemable Preference Share
Cost of Redeemable Preference Share
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CONCEPT COST OF EQUITY SHARE CAPITAL
Dividend Yield Model
Earnings Yield Model
Dividend Growth Model
Earnings Growth Model
Realised Yield Approach
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Capital Asset Pricing Model
CONCEPT COST OF RETAINED EARNINGS
In absence of Personal Taxes
In presence of Personal Taxes
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CONCEPT WEIGHTED AVERAGE COST OF CAPITAL
S.No. Source of Finance Amount Weight Cost W × C

1 Equity Share Capital
2 Preference Share Capital
3 Reserves & Surplus
4 Debt
CONCEPT BOOK VALUE WEIGHTS VS. MARKET VALUE WEIGHTS
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CHAPTER 2 LEVERAGE
CA IPC
CA INTER
CONCEPT OPERATING RISK
Meaning and Basic Condition
It is measured by Degree of Operating Leverage (DOL).

Higher the DOL, higher is the operating risk.
Condition to apply DOL is the existence of Fixed Operating Cost.
Formula
Interpretation
DOL measures the effect of change in Sales on EBIT.

1% change in sales shall cause >1% change in EBIT.
Question
Consider the following information for RSA Ltd:

Contribution 1,40,000
Fixed Cost 1,00,000
EBIT 40,000
Calculate percentage change in EBIT, if sales increase by 10%.
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CONCEPT FINANCING RISK
It is measured by Degree of Financial Leverage (DFL).

Higher the DFL, higher is the financing risk.
Condition to apply DFL is the existence of Fixed Financing Cost.
Formula
Interpretation
DFL measures the effect of change in EBIT on EPS.

1% change in EBIT shall cause >1% change in EPS.
Question
Consider the following information for RSA Ltd:

EBIT (Earnings before Interest and Tax) 40,000
Interest 5,000
EBT 35,000
Calculate percentage change in earnings per share, if EBIT increase by 6%.
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CONCEPT COMBINED RISK
It takes into account operating as well as financing risk.

It is measured by Degree of Combined Leverage (DCL).
Higher the DCL, higher is the combined risk.
Condition to apply DCL is the existence of Fixed Cost.
Formula
Interpretation
DCL measures the effect of change in sales on EPS.

1% change in sales shall cause >1% change in EPS.
Question
Consider the following information for Omega Ltd:

EBIT (Earnings before Interest and Tax) Rs. 15,750 Lakh
Earnings before Tax (EBT) Rs. 7,000 Lakh
Fixed Operating costs Rs. 1,575 Lakh
Calculate percentage change in earnings per share, if sales increase by 5%.
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CHAPTER 3 CAPITAL STRUCTURE

CA IPC
CA INTER
CONCEPT CHOOSING OPTIMUM CAPITAL STRUCTURE
Particulars Option 1 Option 2 Option 3
EBIT
‘ - Interest
= EBT
‘ - Tax
= EAT
‘ - Preference Dividend
= Earnings for Equity

Shareholders
No. of Equity Shares
= EPS
× P/E Ratio
= MPS
That option shall be chosen which provides maximum MPS.
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CONCEPT FINDING OLD RATE OF RETURN
CONCEPT FINDING NEW RATE OF RETURN
CONCEPT FINDING NEW EBIT
CONCEPT INDIFFERENCE POINT
It is that level of EBIT, at which the firm has 2 such financial plans, which result in
same level of EPS.
CONCEPT CHOICE OF PLAN
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CHAPTER 4 THEORIES OF CAPITAL STRUCTURE

CA IPC
CA INTER
CONCEPT IMPORTANT FORMULAS
CONCEPT NET INCOME THEORY
Diagram
Question
Expected EBIT is Rs. 2 lacs. The company has Rs. 8 lacs in 10% debentures. The cost of equity or
capitalisation rate is 12.5%. Calculate the value of firm and the overall cost of capital.
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CONCEPT NET OPERATING INCOME THEORY
Diagram
Question
EBIT is Rs. 9,00,000. The firm’s cost of debt is 10 % and currently firm employs Rs. 30,00,000 of
debt. The overall cost of capital of firm is 12 %. Calculate cost of equity.
CONCEPT TRADITIONAL APPROACH
Diagram
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Question
In considering the most desirable capital structure of a company, the following estimates of the cost
of debt and equity capital (after tax) have been made at various levels of debt-equity mix :
Debt as a percentage of total Kd (%) Ke (%)
capital employed
0 5 12
10 5 12
20 5 12.5
30 5.5 13
40 6 14
50 6.5 16
60 7 20
Determine the optimal debt-equity mix for the company by calculating composite cost of capital.
CONCEPT M-M THEORY
Formula
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Question
'A' Ltd. and 'B' Ltd. are identical in every respect except capital structure. 'A' Ltd. does not employ
debts in its capital structure whereas 'B' Ltd. employs 12% Debentures amounting to Rs. 10 lakhs.
Assuming that :
a. All assumptions of M-M model are met;
b. Income-tax rate is 30%;
c. EBIT is Rs. 2,50,000 and
d. The Equity capitalization rate of ‘A' Ltd. is 20%.
Calculate the value of both the companies.
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CHAPTER 5 CAPITAL BUDGETING

CA IPC
CA INTER
CONCEPT IMPORTANCE OF CAPITAL BUDGETING DECISION
Huge sum of money

Long term implication
Irreversible in short run
CONCEPT CAPITAL BUDGETING TECHNIQUES
Traditional Techniques Modern Techniques

Accounting Rate of Return Discounted Pay Back Period
Pay Back Period Net Present Value
Variants of Pay Back Period Profitability Index
Internal Rate of Return
CONCEPT ACCOUNTING RATE OF RETURN
Meaning
It is the rate of return generated by the project during its life.
Formula
Decision Rule
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Computation of PAT
Particulars Year 1 Year 2 Year n
Sales
‘ - Variable Cost
= Contribution
‘ - Fixed Cost
= EBIT
‘ - Interest
= EBT
‘ - Tax
= EAT
CONCEPT COMPUTATION OF CASH FLOWS
METHOD 1 METHOD 2
EBDIT EBDIT
‘ - Depreciation ‘ - Interest
= EBIT = Balance
‘ - Interest ‘ - Tax
= =
= EBT = Balance
‘ - Tax ‘ + Tax Saving on Depreciation
= EAT (Depreciation × Tax Rate)
+ Depreciation = Cash Flow
= Cash Flow
Question
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METHOD 1 METHOD 2
EBDIT EBDIT
‘ - Depreciation ‘ - Interest
= EBIT = Balance
‘ - Interest ‘ - Tax
= =
= EBT = Balance
‘ - Tax + Tax Saving on

‘
Depreciation
= EAT (Depreciation × Tax Rate)
+ Depreciation = Cash Flow
= Cash Flow
CONCEPT PAY BACK PERIOD
Meaning
It is the period within which cost of the project will be recovered.
Formula
If Cash Flows are equal p.a. If Cash Flows are not equal p.a.
Statement showing computation of Payback period

Year End Cash Inflow Cumulative Cash Inflow
Decision Rule
Question
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CONCEPT TIME VALUE OF MONEY
CONCEPT DISCOUNTED PAY BACK PERIOD
Decision Rule
Computation of Discounted Pay back Period
Statement showing computation of Discounted Payback period

Year End Cash Inflow PVF @ __ % PVCF Cumulative PVCF
CONCEPT NET PRESENT VALUE
Meaning
It denotes the net value of cash flows from the project, either positive or negative.
Formula
Total PVCI – Total PVCO
Decision Rule
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Computation of NPV
Statement showing computation of NPV

Year End Particulars Cash Inflow PVF @ __ % PVCF
Question
CONCEPT PROFITABILITY INDEX
Formula
Decision Rule
CONCEPT NET PROFITABILITY INDEX
Formula
Decision Rule
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CONCEPT INTERNAL RATE OF RETURN
Meaning
It is the actual rate of return being generated by the project.
Formula
It is such rate at which Total PVCI = Total PVCO i.e. NPV is 0.
Methodology
Find out 1 Positive NPV.

Find out 1 Negative NPV.
The maximum difference between the 2 rates should be maximum 4 - 5%.
Apply this formula after that :
Decision Rule
CONCEPT PROJECTS HAVING UNEQUAL LIFE
CONCEPT WORKING CAPITAL
Release of Working Capital
Recovery of Working Capital
CONCEPT SCRAP VALUE
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CHAPTER 6 WORKING CAPITAL MANAGEMENT

CA IPC
CA INTER
CONCEPT BASICS OF WORKING CAPITAL
Meaning
It refers to the funds required for day to day business operations.
Types of Working Capital
Gross Working Capital Net Working Capital
CONCEPT ESTIMATION OF WORKING CAPITAL
To have the better management of working capital, its estimation in advance is essential and
important.
Estimated Current Assets

‘ - Estimated Current Liabilities
= Estimated Working Capital
Statement Showing Estimation of Working Capital
S.No. Particulars Computation Amount
A Current Assets
1 Raw Material
Inventory
2 WIP Inventory
a Material
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b Labour
c Overheads
3 FG Inventory
4 Debtors
5 Prepaid Expenses
6 Cash
Total (A)
B Current Liabilities
1 Raw Material
Creditors
2 Outstanding
Expenses
Total (B)
C Working Capital (A) - (B) ‘
D Safety Margin
E Total Working (C) + (D)

‘
Capital
CONCEPT SOME SPECIAL POINTS
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MAXIMUM PERMISSIBLE BANK FINANCE (MPBF)

CONCEPT
AS PER TANDON COMMITTEE
NORM I NORM II NORM III
Current Assets Current Assets Current Assets
‘ - Current Liabilities ‘ - 25 % ‘ - Core Current Assets
= Working Capital = 75% Current Assets = Non Core Current Assets
‘ - 25 % ‘ - Current Liabilities ‘ - 25 %
= MPBF = MPBF = 75% Non Core Current

Assets
- Current Liabilities
‘
= MPBF
CONCEPT EFFECT OF DOUBLE SHIFT ON WORKING CAPITAL
Impact on Total Units
Impact on WIP Units
Impact on Variable Expenses
Impact on Fixed Overheads
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CONCEPT OPERATING CYCLE PERIOD
Computation of Operating Cycle Period
Particulars Days
Raw Material Holding Period
+ WIP Conversion Period
+ FG Holding Period
+ Average Collection Period
‘ - Average Payment Period
Computation of No. of Operating Cycles in a Year
Computation of Amount of Working Capital Required
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CHAPTER 7 DEBTOR’S MANAGEMENT

CA IPC
CA INTER
CONCEPT BASICS OF DEBTOR MANAGEMENT
We are concerned with evaluating the impact of change in credit period.
CONCEPT COMPUTATION OF INCREMENTAL GAIN
Statement Showing Incremental Gain or Loss
S.No. Particulars Current Option 2 Option 3

Policy
1 Sales
2 Contribution
3 Incremental Contribution
4 Bad Debts
5 Incremental Bad Debts
6 Administration Cost
7 Incremental Administration Cost
8 Collection Cost
9 Incremental Collection Cost
10 Discount
11 Incremental Discount
12 Opportunity Cost
13 Incremental Opportunity Cost
14 Net Incremental Gain

(3 – 5 – 7 – 9 – 11 - 13)
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CONCEPT COMPUTATION OF OPPORTUNITY COST
CONCEPT COMPUTATION OF DISCOUNT
CONCEPT IMPACT OF FIXED COST
CONCEPT IMPACT OF TAXATION
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CONCEPT FACTORING
Computation of Net Amount Given by Factor in Advance
Particulars Computation Amount
Average Debtors
‘ - Commission
‘ - Reserve
= Eligible Advance
‘ - Interest on Advance
= Net Amount given by Factor
Annual Analysis of Factoring
Savings Due to Factoring Cost Due to Factoring

Administration Cost Commission
Collection Cost Interest on Advance
Bad Debts
Effective Cost or Saving Due to Factoring
Effective Cost or Saving %
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CHAPTER 8 CASH MANAGEMENT

CA IPC
CA INTER
CONCEPT OPTIMUM CASH BALANCE
CONCEPT AVERAGE CASH BALANCE
CONCEPT CASH BUDGET
S.No. Particulars 1 2 3
A Opening Balance
B Receipts
1 Cash Sales
2 Receipt from Debtors
3 Sale of Asset
4 Tax Refund
Total (B)
C Payments
1 Cash Purchases
2 Payment to Creditors
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3 Payment for Wages
4 Payment for Overheadds
5 Payment for Tax
6 Purchase of Asset
7 Dividend Paid
Total (C)
D Balance (A + B - C)
E Investment
F Sale of Investment
G Borrowings
H Closing Balance (D – E + F + G)
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CHAPTER 9 RATIO ANALYSIS

CA IPC
CA INTER
CONCEPT PROFITABILITY RATIOS
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CONCEPT ACTIVITY RATIOS
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CONCEPT COVERAGE RATIOS
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CONCEPT MARKET TEST RATIOS
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CONCEPT SOLVENCY/ FINANCIAL RATIOS
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CHAPTER 10 TIME VALUE OF MONEY

CA IPC
CA INTER
CONCEPT BASIC OF TVM
CONCEPT SIMPLE INTEREST
CONCEPT COMPOUND INTEREST
CONCEPT EFFECTIVE RATE OF INTEREST
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CONCEPT FUTURE VALUE OF ANNUITY
CONCEPT PRESENT VALUE OF ANNUITY
CONCEPT PERPETUITY
CONCEPT SINKING FUND
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CHAPTER 11 FUND FLOW STATEMENT

CA IPC
CA INTER
CONCEPT MEANING
It’s a statement of change in assets and liabilities of an enterprise.

It is prepared to indicate how the financial position has changed over a period.
CONCEPT SCHEDULE OF CHANGE IN WORKING CAPITAL
S.No. Particulars Opening Closing Increase in Decrease

WC in WC
A Current Assets
1 Debtors
2 Cash
3 Stock
4 Prepaid Expenses
Total (A)
B Current Liabilities
1 Creditors
2 Bills Payable
3 Outstanding Expenses
Total (B)
C Working Capital (A) – (B)
D Increase/ Decrease in WC
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CONCEPT ADJUSTED PROFIT & LOSS A/C
Particulars Amount Particulars Amount
To Non Cash Expenses By Balance b/d
To Non Operating Expenses By Non Cash Income
To Funds Lost in Operations By Non Operating Income
To Balance c/d By Funds From Operations
CONCEPT FUNDS FLOW STATEMENT
Sources Amount Applications Amount
Decrease in WC Increase in WC
Funds From Operations Funds Lost in Operations
Sale of Assets Purchase of Assets
Issue of Share Capital Redemption of Preference

Share Capital
Refund of Tax Redemption of Debentures
Tax Paid
Dividend Paid
CONCEPT TRANSACTIONS AFFECTING FFS
We are concerned with those transactions from where the flow of working capital arises.
Source Application
Any transaction which increases the Any transaction which decreases the
amount of working capital is a Source. amount of working capital is Application.
WC increases if the transaction WC decreases if the transaction
- Increases CA - Decreases CA
- Decreases CL - Increases CL
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CHAPTER 12 CASH FLOW STATEMENT

CA IPC
CA INTER
CONCEPT BASICS
Meaning of CFS It’s a statement of change in cash and cash equivalents of an enterprise.
Cash It comprises Cash in Hand and Demand Deposits with the bank.
Cash Equivalents These are short term highly liquid investments which are readily
convertible into known amounts of cash and which are subject to
insignificant risk of change in value.
Any investment will qualify as cash equivalent only if it has short
maturity of 3 months or less from the date of acquisition.
AS : 3 As per AS 3, these are
Cash in Hand
Cash at Bank
Marketable Securities
Bank Overdraft
Cash Credit
Cash Flows These are inflows and outflows of cash & cash equivalents.
Cash flow arises when the net effect of transaction is to either
increase or decrease the amount of cash and cash equivalents.
CONCEPT DIVISION INTO ACTIVITIES
Operating These are the principle revenue producing activities of enterprise

Activity and other activities which are not investing or financing.
Investing These are acquisition and disposal of long term assets and other
Activity investments.
Financing These are the activities which result in change in size and
Activity composition of owner’s capital and borrowings of enterprise.
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CONCEPT CASH FLOW STATEMENT (INDIRECT METHOD)
S.No. Particulars Amount

A Cash Flow from Operating Activity
Surplus during the year
+ Non cash expenses
+ Non operating expenses
‘ - Non cash income
‘ - Non operating income
= Cash from Operations (Before Working Capital Changes)
+ Decrease in Current Assets
‘ - Increase in Current Assets
‘ - Decrease in Current Liabilities
+ Increase in Current Liabilities
= Cash from Operations (Before Tax)
‘ - Tax Paid
+/- Extraordinary items
Total (A)
B Cash Flow from Investing Activity
+ Sale of Fixed Assets/ Investment
‘ - Purchase of Fixed Assets/ Investment
+ Interest/ Dividend Received
Total (B)
C Cash Flow from Financing Activity
+ Issue of Share Capital/ Debenture
‘ - Redemption of Share Capital/ Debenture
‘ - Interest/ Dividend Paid
Total (C)
D Net Cash and Cash Equivalents Generated during the year
E Opening balance of Cash and Cash Equivalents
F Closing balance of Cash and Cash Equivalents
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CONCEPT CASH FLOW STATEMENT (DIRECT METHOD)
S.No. Particulars Amount

A Cash Flow from Operating Activity
Cash Sales
+ Payment received from Debtors
‘ - Cash Purchases
‘ - Payment made to creditors
‘ - Payment made for operating expenses
= Cash Generated from Operations
‘ - Tax Paid
+/- Extraordinary items
Total (A)
CONCEPT LEDGER ACCOUNTS TO BE PREPARED
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CHAPTER 13 RISK ANALYSIS IN CAPITAL BUDGETING

CA IPC
CA INTER
CONCEPT STATISTICAL TECHNIQUE
CONCEPT RISK ADJUSTED DISCOUNT RATE
CONCEPT CERTAINTY EQUIVALENT APPROACH
CONCEPT SENSITIVITY ANALYSIS
To find the impact of change in a variable on the outcome of project i.e. NPV.
More sensitive is the NPV, more critical is the variable.
Find Percentage change in NPV :
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CONCEPT SCENARIO ANALYSIS
CONCEPT SIMULATION
Determining the range of Random Numbers : For each variable, find the cumulative probability on the
base of probability given and specify the range of random numbers.
Fit the random numbers given in question for each trial run for each variable.
Find NPV for each run.
CONCEPT DECISION TREE
It’s a graphical presentation of relationship between future decisions and their consequences.
Computation of NPV
Path PVCF (Y 1) PVCF (Y 2) Total PVCI PVCO NPV
Computation of Expected NPV

Path NPV Joint Probability Expected NPV
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CHAPTER 14 LEASING
CA IPC
CA INTER
CONCEPT TYPE OF DECISIONS
CONCEPT COMPUTATION OF NET ADVANTAGE OF LEASING
CONCEPT COMPUTATION OF PVCO : LEASE
Lease Rent (1 - t) Annuity Factor (r %, n years)
CONCEPT COMPUTATION OF PVCO : BUY (OWN FUNDS)
Year End Particulars Cash Flow PVF @___% PVCF
0 Cost of Asset
1 – n Tax Saving on Depreciation
n Scrap Value
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CONCEPT COMPUTATION OF PVCO : BUY (BORROWED FUNDS)
Year End Particulars Cash Flow PVF @___% PVCF
0 Down Payment
(Cost of Asset – Borrowings)
1 – n Tax Saving on Depreciation
1 – n Principal
1 – n Interest (1 - t)
n Scrap Value
CONCEPT DISCOUNT RATE ABSENT
CONCEPT AMOUNT OF INSTALLMENT NOT GIVEN
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CHAPTER 15 DIVIDEND DECISONS

CA IPC
CA INTER
CONCEPT GORDON MODEL
CONCEPT WALTER MODEL
CONCEPT TRADITIONAL MODEL
CONCEPT LINTNER MODEL
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CONCEPT M-M HYPOTHESIS
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CHAPTER 1 DETERMINATION OF NATIONAL INCOME

UNIT – 1 : NATIONAL INCOME ACCOUNTING
National Income
Meaning National Income is the money value of all the final goods and services produced by
an economy in a specific period of time.
Since in an economy, different types of goods and services are produced, it is not
possible to physically add them. Therefore, all these goods and services are
measured in terms of money and added together to find the value of national
income or national output.
Uses Analyzing and evaluating the short-run performance

Enables businesses to forecast the future demand
Evaluation of governments’ economic policies
International comparisons in respect of incomes and living standards
Governments can fix various sector-specific development targets for different
sectors of the economy
Key Only Economic Activities

points Final goods
Productive Activities
Excludes transfer payments
Some Gross vs. Net

Important The difference between Gross and Net Product is due to Depreciation.
Concepts Gross is inclusive of depreciation whereas Net is not.
Domestic vs. National

The difference between ‘national’ and ‘domestic’ is due to net factor income from
abroad (NFIA).
National is inclusive of NFIA whereas Domestic is not.
Market Price vs. Factor Cost

The difference between Market Price and Factor Cost is due to Net Indirect
Taxes.
Market Price is inclusive of Net Indirect Taxes whereas Factor Cost is not.
Net Indirect Taxes means Indirect Taxes less Subsidies.
Aggregates Related to National Income

GDPMP It stands for Gross Domestic Product at Market Prices.
It is a measure of the market value of all final economic goods and services, gross
of depreciation, produced within the domestic territory of a country during a given
time period.
‘Gross’ implies that GDP is measured including depreciation.
‘Domestic’ means domestic territory.
‘Market Price’ means including Net Indirect Taxes.
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NDPFC It stands for Net Domestic Product at Factor Cost.

It is defined as the total factor incomes earned by the factors of production.
In other words, it is sum of domestic factor incomes or domestic income net of
depreciation.
‘Net’ implies that NDP is measured excluding depreciation.
‘Domestic’ means domestic territory.
‘Factor Cost’ means excluding Net Indirect Taxes.
NNPFC / It stands for Net National Product at Factor Cost.

National National Income is defined as the factor income accruing to the normal residents
Income of the country during a year.
In other words, national income is the value of factor income generated within the
country plus factor income from abroad in an accounting year.
Value Added Method Or Product Method Or Industrial Origin Method Or Net

Output Method
Focus The value added method measures the contribution of each producing enterprise
in the domestic territory of the country in an accounting year and entails
consolidation of production of each industry less intermediate purchases from all
other industries.
Steps Identifying the producing enterprises and classifying them into different
sectors according to the nature of their activities i.e. Primary, Secondary &
Tertiary Sector.
Estimating the gross value added (GVAMP) by each producing enterprise
Gross value added (GVAMP)
= Value of output – Intermediate consumption
Estimation of National income
Σ (GVAMP) – Depreciation = Net value added (NVAMP)
Net value added (NVAMP) – Net Indirect taxes = Net Domestic Product
(NVAFC)
Net Domestic Product (NVAFC) + (NFIA) = National Income (NNPFC)
Income Method Or Factor Payment Method Or Distributed Share Method

Focus National income is calculated by summation of factor incomes paid out by all
production units within the domestic territory of a country as wages and
salaries, rent, interest, and profit.
Formula NNPFC or National Income = Compensation of employees

+ Operating Surplus (rent + interest+ profit)
+ Mixed Income of Self-employed
+ Net Factor Income from Abroad
Expenditure Method Or Income Disposal Approach

Focus National income is the aggregate final expenditure in an economy during an
accounting year.
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Components Private Final Consumption Expenditure (PFCE)

Government Final Consumption Expenditure (GFCE)
Gross Domestic Capital formation
Net Exports
Formula Adding above 3, we get GDPMP.

GNPMP = GDPMP + NFIA
GNPFC = GNPMP – NIT
NNPFC = GNPFC – Depreciation
Limitations Of National Income Computation

Ignores quality improvements
Production hidden from government (drugs etc.)
Non economic contributors (education level etc.)
Ignores volunteer work (w/o remuneration)
Accurate distinction between final goods and intermediate goods
Issue of transfer payments
Absence of recording of incomes due to illiteracy and ignorance
Lack of reliability of available data
UNIT – 2 : THE KEYNESIAN THEORY OF DETERMINATION OF NATIONAL INCOME
Aggregate Demand
Meaning Aggregate demand broadly refers to the total demand for final goods and services
in the economy.
Components Aggregate demand for consumer goods (C), and

Aggregate demand for investment goods (I)
Diagram
Aggregate Supply
Meaning Aggregate supply refers to the total output of goods and services produced for
sale by all the entrepreneurs in an economy.
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Components A major portion of income is spent on consumption of goods and services and the
balance is saved.
Thus, national income (Y) or aggregate supply (AS) is sum of
❖ consumption expenditure (C) and
❖ savings (S)
Diagram
Consumption Function
Meaning Consumption function shows the mathematical relation between income and
consumption i.e. how much of income is spent on consumption goods. Consumption is
related to income.
Features At zero or very low level of income, consumption expenditure is higher than income
because minimum consumption is necessary for survival, and
As income increases, consumption expenditure also increases but increase in
consumption is less than the increase in income.
Marginal Propensity To Consume (Mpc)

Meaning MPC is ratio of change in consumption (C) due to change in income (Y).
It is the ratio of additional consumption (C) to additional income (Y).
Insights MPC falls with increase in income.

As a person becomes richer, he tends to consume a smaller portion of increase in
income.
Formula
Average Propensity To Consume (Apc)

Meaning APC is the ratio of total consumption expenditure to total income.
It is the percentage (or ratio) of income which is spent on consumption.
Formula
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Savings Function
Meaning Saving function shows the mathematical relation between income and saving i.e.
how much of income is saved.
Features At zero or very low level of income, Savings can be negative and
As income increases, savings also increases but increase in savings is more than the
increase in income.
Marginal Propensity To Save (Mps)

Meaning MPS is ratio of change in savings (S) due to change in income (Y).
It is the ratio of additional savings (S) to additional income (Y).
Formula
Average Propensity To Save (Aps)

Meaning APS is the ratio of total savings to total income.
It is the percentage (or ratio) of income which is saved.
Formula
Two-Sector Model Of National Income Determination
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Investment Multiplier
Meaning Investment Multiplier (K), is the ratio of increase in national income (Y) due to an
increase in investment (l).
Relationship There exists a direct relationship between MPC and the value of multiplier.
with MPC & Higher the MPC, more will be the value of the multiplier, and vice-versa.
MPS On the contrary, higher the MPS, lower will be the value of multiplier and vice-
versa.
Formula
Diagram
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CHAPTER 2 PUBLIC FINANCE

UNIT – 1 : FISCAL FUNCTIONS : AN OVERVIEW
Economic System
Basic Due to qualitative as well as quantitative constraints, the resources available to
Economic any society cannot produce all economic goods and services that its members
Problem desire to have.
Types of Market
Economic Government
System Mixed System
Allocation Function
Meaning Resource allocation refers to the way in which the available factors of production
are allocated among the various uses to which they might be put.
Importance Optimal or efficient allocation of scarce resources is one of the most important
function of an economic system so that the available resources are put to their
best use and no wastages are there.
Private vs. Private sector resource allocation is characterized by market supply and demand
Govt. forces and producer profit motives.
Sector Govt. sector resource allocation is accomplished through the revenue and
Allocation expenditure activities of governmental budgeting.
Market While private goods will be sufficiently provided by the market, public goods will
Failure not be produced in sufficient quantities by the market.
Market failure occurs when the free market leads to misallocation of resources
i.e. the resources are not allocated efficiently.
Government Market failures provide the rationale for government’s allocative function.
Intervention Government may directly produce the economic good.
Government may influence allocation through its competition policies, merger
policies etc. which will affect the structure of industry and commerce.
Redistribution Function
Meaning It is concerned with the adjustment of the distribution of income and wealth so
as to ensure distributive justice namely, equity and fairness.
Government If left to the market, the distribution of income and wealth among individuals in
Intervention the society is likely to be skewed and therefore the government has to
intervene to ensure a more desirable and just distribution.
Instruments Provision of subsidy to the poor households.

Proceeds from progressive taxes used for financing public services
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Employment reservations
Special schemes for backward regions
Stabilisation Function
Meaning It aims at eliminating macroeconomic fluctuations arising from suboptimal
allocation.
Government In the absence of appropriate corrective intervention by the government, the

Intervention instabilities that occur in the economy in the form of recessions, inflation etc.
may be prolonged for longer periods causing enormous hardships to people
especially the poorer sections of society.
Instruments Expansionary fiscal policy

Contractionary fiscal policy
UNIT – 2 : MARKET FAILURE
Market Power
Meaning Market power can cause markets to be inefficient because it keeps price higher
and output lower than the outcome of equilibrium of supply and demand which
causes market failure.
Externalities
Meaning When the actions of either consumers or producers result in costs or benefits
that do not reflect as part of the market price, such costs or benefits which are
not accounted for by the market price are called externalities.
Insights These can be negative or positive.

These may be unidirectional or reciprocal.
These can be initiated in production or consumption.
Private vs. Private cost is the cost faced by the producer or consumer directly involved in a
Social Cost transaction.
Social costs refer to the total costs to the society on account of a production or
consumption activity.
Social Cost = Private Cost + External Cost
Public Goods
Meaning A public good (also referred to as collective consumption good or social good) is
defined as one which all enjoy in common in the sense that each individual’s
consumption of such a good leads to no subtraction from any other individuals’
consumption of that good.
Features of Public goods yield utility to people and are products (goods or services) whose
Public consumption is essentially collective in nature.
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Goods No direct payment by the consumer is involved in the case of pure public goods.
Public good is non-rival in consumption.
Public goods are non-excludable.
Public goods are generally more vulnerable to issues such as externalities and free
rider problem.
Features of Consumption of private goods is ‘rivalrous’.

Private Private goods are ‘excludable’.
Goods Consumers will get different amounts of goods and services based on their desires
and ability and willingness to pay.
There is no market failure as the market will efficiently allocate resources for the
production of private goods.
Impure These are hybrid goods that possess some features of both public and private
Public goods. Such goods are called impure public goods and are partially rivalrous or
Goods congestible.
For Example, Open access Wi-Fi networks become crowded when more people
access it.
Quasi These are the goods which possess nearly all of the qualities of the private goods
Public and some of the benefits of public good.
Goods These are also called near public goods.
(Mixed It is easy to keep people away from them by charging a price or fee.
Goods) However, it is undesirable to keep people away from such goods because the
society would be better off if more people consume them like education.
Common Common access resources or common pool resources are a special class of impure
Access public goods which are non-excludable as people cannot be excluded from using
Resources them.
These are rival in nature and their consumption lessens the benefits available for
others.
These are generally available free of charge.
Free Rider Free riding is ‘benefiting from the actions of others without paying’. A free rider
Problem is consumer or producer who does not pay for a nonexclusive good in the
expectation that others will pay.
There is no incentive for people to pay for the public good because they can
consume it without paying for it.
Incomplete Information
Impact Due to information failure, misallocation of scarce resources takes place and
equilibrium price and quantity is not established through price mechanism, which
results in market failure.
Types Asymmetric Information - Asymmetric information occurs when there is an

imbalance in information between buyer and seller.
Adverse Selection - Adverse selection is a situation in which asymmetric
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information about quality eliminates high-quality goods from a market.

Moral Hazard - Moral hazard is opportunism characterized by an informed person’s
taking advantage of a less-informed person through an unobserved action.
UNIT – 3 : GOVERNMENT INTERVENTIONS TO CORRECT MARKET FAILURE
Government Intervention To Minimize Market Power

Competition Government brings rules and regulations designed to promote competition and
Based prohibit actions that are likely to restrain competition.
Regulations
Price Based Such legislations generally aim at setting maximum prices that firms can charge.
Regulations
Government Intervention To Correct Externalities
Direct Prohibition on Production, use and sale of many commodities.
Controls Stringent rules in place in respect of tobacco advertising etc.
Laws & rules to regulate the actions by producers and consumers.
Fixing emissions standard
Installation of pollution-abatement mechanisms
To charge an emissions fee
Market- Pollution Tax

based As the name says, these are the taxes imposed on pollution.
policies/ The size of the tax depends on the amount of pollution a firm produces.
Indirect Tax increases the private cost of production or consumption, and decreases the
Controls quantity demanded and therefore the output of the good which creates negative
externality.
The proceeds from the tax can be specifically earmarked for projects that
protect or enhance environment.
Tradable Emissions Permits/ Cap-and-Trade

These are marketable licenses to emit limited quantities of pollutants and can be
bought and sold by polluters.
The high polluters have to buy more permits, which increases their costs, and
makes them less competitive and less profitable.
The low polluters receive extra revenue from selling their surplus permits, which
makes them more competitive and more profitable.
Government Intervention In The Case Of Merit Goods

Meaning of Merit goods are goods which are deemed to be socially desirable and substantial
Merit positive externalities are involved in the consumption of merit goods. Like
Goods Education, health care etc.
Forms of Governments can prohibit some type of goods and activities, set standards and
Government issue mandates making others oblige.
Intervention The government can provide the merit goods at subsidized prices to increase their
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consumption.
When governments provide merit goods, it may give rise to large economies of
scale.
Government can provide such goods free of cost.
Government Intervention In The Case Of Demerit Goods

Meaning Demerit goods are goods which are believed to be socially undesirable and imposes
significant negative externalities on the society as a whole. Ex - Alcohol.
Forms of Complete Ban

Government Persuasion
Intervention Strict Regulations
High Taxes
Government Intervention In The Case Of Public Goods

Pure Public It covers goods where entry fees cannot be charged. In such cases, direct
Goods provision by governments through the use of general government tax revenues is
the only option.
Excludable It covers goods where the government can charge certain fees. Government can
public goods itself provide such goods or services and charge the entry fees. Government can
grant licenses to private firms to provide such goods or services. The goods are
provided to the public on payment of an entry fee.
Price Intervention
Meaning Under this, Government puts Price Controls in place to influence the outcomes of a
market on grounds of fairness and equity.
Types Price floor

Price Ceiling
Government Intervention For Correcting Information Failure

Ways Disclosure
Public Dis-semination by Govt.
Subsidies for dis-semination
Advertisement Standards
UNIT – 4 : FISCAL POLICY

Basics
Meaning Fiscal policy involves the use of government spending, taxation and borrowing to
influence both the pattern of economic activity and level of growth of aggregate
demand, output and employment.
Features Fiscal policy is designed to influence the pattern and level of economic activity in a
country. Fiscal policy is in the nature of a demand-side policy.
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Automatic Stabilizers/ Non-Discretionary Fiscal Policy

Meaning These are ‘built-in’ fiscal mechanisms that operate automatically to reduce the
expansions and contractions of the business cycle.
Example Income Tax
Recession The automatic adjustments work towards stimulating aggregate spending during
Phase the recessionary phase.
More disposable income is available for consumption with the households.
Expansion The automatic adjustments work towards reducing aggregate spending during this
Phase phase.
Less disposable income is available for consumption with the households.
Discretionary Fiscal Policy

Meaning It refers to deliberate policy actions on the part of government to change the
levels of expenditure and taxes to influence the level of national output,
employment and prices.
Government It includes governments’ expenditure towards consumption, investment, and

Expenditure transfer payments. It is an important instrument of fiscal policy.
as an Government expenditure increases during recession phase.
Instrument Government expenditure decreases during exapnsion phase.
of Fiscal
Policy
Taxes as an Tax as an instrument of fiscal policy consists of changes in government revenues
Instrument or in rates of taxes aimed at encouraging or restricting private expenditures on
of Fiscal consumption and investment.
Policy During recession, the tax policy is framed to encourage private consumption and
investment and taxes are reduced.
During inflation, new taxes are levied and the rates of existing taxes are raised to
reduce disposable incomes and to wipe off the surplus purchasing power.
Public Debt It involves public borrowing and debt repayment.

as an During Recession, Government reduces its borrowings and repays the existing debt
Instrument which increases the availability of money in the economy and increases aggregate
of Fiscal demand.
Policy During Expansion, Government increases its borrowings which decreases aggregate
demand.
Budget as The budget is simply a statement of revenues earned from taxes and other
an sources and expenditures made by a nation’s
Instrument government in a year.
of Fiscal It can be Balanced, Surplus or Deficit.
Policy
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CHAPTER 3 MONEY MARKET

UNIT – 1 : THE CONCEPT OF MONEY DEMAND: IMPORTANT THEORIES
Money
Meaning Money refers to assets which are commonly used and accepted as a means of
payment or as a medium of exchange or of transferring purchasing power.
Money has generalized purchasing power and is generally acceptable in settlement
of all transactions and in discharge of other kinds of business obligations
including future payments.
Features Totally liquid asset.

Can be used directly, instantly, conveniently and without any costs or restrictions
to make payments.
Convenient means to access goods and services.
Represents a certain value
Can also constitute electronic records.
Functions of Convenient medium of exchange

money Eliminates Double coincidence of wants
Separation of Time & Place
Common measure of value
Perfect Liquidity
Reversibility
Demand for Money

Need The demand for money is in the nature of derived demand; it is demanded for its
purchasing power.
Basically, people demand money because they wish to have command over real
goods and services with the use of money.
Variables Income - Higher the income of individuals, higher the expenditure and richer
affecting people hold more money to finance their expenditure.
demand for General level of prices - Higher the prices, higher should be the holding of
money money.
Rate of interest - higher the interest rate, higher would be opportunity cost of
holding cash and lower the demand for money.
Degree of Financial Innovation - Innovations such as internet banking, application
based transfers and automatic teller machines reduce the need for holding liquid
money.
Classical Approach: The Quantity Theory Of Money (Qtm)

Alternative It is also termed as ‘equation of exchange’ or ‘transaction approach’.
Names
Concept There is an aggregate demand for money for transactions purpose and more the
number of transactions people want, greater will be the demand for money.
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The total volume of transactions multiplied by the price level (PT) represents the
demand for money.
Basic MV = PT
Equation M= the total amount of money in circulation (on an average) in an economy
V = transactions velocity of circulation i.e. the average number of times across all
transactions a unit of money (say Rupee) is spent in purchasing goods and services
P = average price level (P=MV/T)
T = the total number of transactions
Fisher extended the equation of exchange to include demand (bank) deposits (M’)
and their velocity (V’) in the total supply of money.
MV + M'V' = PT
M' = the total quantity of credit money
V' = velocity of circulation of credit money
The Neo Classical Approach: The Cambridge Approach

Alternative It is also termed as cash balance approach.
Name
Concept The Cambridge version holds that money increases utility in the following two
ways :
❖ enabling the possibility of split-up of sale and purchase to two different
points of time rather than being simultaneous, and
❖ being a hedge against uncertainty.
While the first above represents transaction motive, just as Fisher envisaged,
the second points to money’s role as a temporary store of wealth.
Equation Md = k PY
Md = is the demand for money
Y = real national income
P = average price level of currently produced goods and services
PY = nominal income
k = proportion of nominal income (PY) that people want to hold as cash balances
The Keynesian Theory Of Demand For Money

Alternative Keynes’ theory of demand for money is known as ‘Liquidity Preference Theory’.
Name
Meaning Liquidity preference denotes people’s desire to hold money rather than
securities or long-term interest-bearing investments.
According to Keynes, people hold money (M) in cash for three motives:
❖ Transactions motive,
❖ Precautionary motive, and
❖ Speculative motive.
The The transactions motive for holding cash relates to ‘the need for cash for
Transactions current transactions for personal and business exchange.’
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Motive
The Demand for money arises due to the unforeseen and unpredictable
Precautionary contingencies involving money payments which occur in our day to day life.
Motive
The The speculative motive reflects people’s desire to hold cash in order to be
Speculative equipped to exploit any attractive investment opportunity requiring cash
Demand for expenditure.
Money
UNIT – 2 : THE CONCEPT OF MONEY SUPPLY
Estimating Money Supply

Meaning The term money supply denotes the total quantity of money available to the people
in an economy.
Stock The supply of money is a stock variable i.e. it refers to the total amount of
money at any particular point of time.
Inclusions It includes amount with public but not with producers of money.
and
exclusions
Sources of Money Supply
Decision of The central banks of all countries are empowered to issue currency and,
Central therefore, the central bank is the primary source of money supply in all countries.
Bank
Commercial The total supply of money in the economy is also determined by the extent of
Banking credit created by the commercial banks in the country.
system
Money Multiplier Approach To Supply Of Money
Formula The money supply is defined as :
M = m X MB
Where M is the money supply, m is money multiplier and MB is the monetary
base or high powered money.
Mechanism If some portion of the increase in high-powered money finds its way into currency,
this portion does not undergo multiple deposit expansion. In other words, as a rule,
an increase in the monetary base that goes into currency is not multiplied, whereas
an increase in monetary base that goes into supporting deposits is multiplied.
Determinants of money supply

Behaviour If govt. issues High Powered Money, the money supply will increase largely due to
of Central money multiplier approach.
Bank
Behaviour The behaviour of the commercial banks in the economy is reflected in the ratio of
of their cash reserves to deposits known as the ‘reserve ratio’.
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Commercial If this ratio increases, more reserves would be needed. This implies that banks
Banks must contract their loans, causing a decline in deposits and hence in the money
supply.
If this ratio falls, there will be greater expansions of deposits because the same
level of reserves can now support more deposits and the money supply will increase.
Behaviour The behaviour of public influences bank credit through the decision on ratio of
of Public currency to the money supply designated as the ‘currency ratio’.
Higher is this ratio, means higher is currency holding and less amount being
deposited in banks. Thus, less is the credit creation.
Lower is this ratio, means lower is currency holding and more amount being
deposited in banks. Thus, higher is the credit creation.
UNIT – 3 : MONETARY POLICY
Basics
Meaning Monetary policy is essentially a programme of action undertaken by the monetary
authorities, normally the central bank, to control and regulate the demand for and
supply of money with the public and the flow of credit with a view to achieving
predetermined macroeconomic goals.
Nature Monetary policy is in the nature of ‘demand-side’ macroeconomic policy and works
by stimulating or discouraging investment and consumption spending on goods and
services.
Objectives
Price Establishment and maintenance of stability in prices has been the most
stability conventional objective which focuses towards controlling inflation.
Economic This objective aims to achieve high level of economy’s growth and maintenance of
Stability full employment.
Cash Reserve Ratio (CRR)

Meaning Cash Reserve Ratio (CRR) refers to the fraction of the total net demand and time
liabilities (NDTL) of a scheduled commercial bank in India which it should maintain
as cash deposit with the Reserve Bank.
Extent The RBI may set the ratio in keeping with the broad objective of maintaining
monetary stability in the economy.
Applicability This requirement applies uniformly to all scheduled banks in the country
irrespective of its size or financial position.
Statutory Liquidity Ratio (SLR)

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Meaning Statutory Liquidity Ratio (SLR) refers to the fraction of the total Demand and
Time Liabilities (DTL)/ Net DTL (NDTL) of a scheduled commercial bank in India,
which it should maintain in one of the following forms:
❖ Cash
❖ Gold, or
❖ Investments in un-encumbered instruments
Importance The SLR is also a powerful tool for controlling liquidity in the domestic market by
means of manipulating bank credit.
Changes in the SLR chiefly influence the availability of resources in the banking
system for lending.
Liquidity Adjustment Facility (LAF)

Meaning The Liquidity Adjustment Facility (LAF) is a facility extended by the Reserve Bank
of India to the scheduled commercial banks (excluding RRBs) and primary dealers
to avail of liquidity in case of requirement (or park excess funds with the RBI in
case of excess liquidity) on an overnight basis against the collateral of government
securities including state government securities.
Objective Its objective is to assist banks to adjust their day to day mismatches in liquidity.
REPO
Meaning Repo is a collaterised lending under which, other banks borrow money from RBI by
giving securities.
The rate charged by RBI for this transaction is called the ‘repo rate’.
Impact It injects liquidity into the system.

If the RBI wants to make it more expensive for banks to borrow money, it
increases the repo rate.
Reverse Repo
Meaning Reverse repo operation takes place when RBI borrows money from banks by giving
them securities.
The rate paid by RBI for this transaction is called the ‘repo rate’.
Impact Reverse Repo operations absorbs liquidity from the system.
Marginal Standing Facility

Meaning It refers to the facility under which scheduled commercial banks can borrow
additional amount of overnight money from the central bank over and above what
is available to them through the LAF window.
Last Resort MSF would be the last resort for banks once they exhaust all borrowing options
including the liquidity adjustment facility on which the rates are lower compared
to the MSF.
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Open Market Operartions

Meaning Open Market Operations (OMO) is a general term used for market operations
conducted by the Reserve Bank of India by way of sale/ purchase of Government
securities to/ from the market.
Impact When the RBI feels there is excess liquidity in the market, it resorts to sale of
securities thereby sucking out the rupee liquidity.
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CHAPTER 4 INTERNATIONAL TRADE

UNIT – 1 : THEORIES OF INTERNATIONAL TRADE
International Trade
Meaning International trade is the exchange of goods and services as well as resources
between countries.
It involves transactions between residents of different countries.
Currency Domestic trade or internal trade involves exchange of goods and services within
the domestic territory of a country using domestic currency, whereas
international trade involves transactions in multiple currencies.
Advantages/ Increased Efficiency

Arguments Efficient deployment of productive resources
in favour Economies of scale
Division of labour
Enhanced competition
End of Domestic Monopoly
Foreign exchange reserves
Economic Welfare
Growth of service sector
Human Resource development
Criticism/ Loss for labour

Dis- Economic exploitation
advantages/ Transmission of trade cycles
Arguments Danger to political sovereignty
against Import of harmful products
Lack of transparency
The Mercantilists’ View Of International Trade

Concept It was based on the premise that national wealth and power are best served by
increasing exports and collecting precious metals in return.
Mercantilists also believed that the more gold and silver a country accumulates,
the richer it becomes.
Exports vs. Mercantilism advocated maximizing exports in order to bring in more “specie”
Imports (precious metals) and minimizing imports through the state imposing very high
tariffs on foreign goods.
The Theory Of Absolute Advantage

Concept Adam Smith supported unrestricted trade and free international competition.
According to him, absolute cost advantage is the determinant of mutually
beneficial international trade.
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Operation The absolute cost advantage theory points out that a country will specialize in
the production and export of a commodity in which it has an absolute cost
advantage.
In other words, exchange of goods between two countries will take place only if
each of the two countries can produce one commodity at an absolutely lower
production cost than the other country. As a result, each nation has an absolute
advantage in the production of one good.
The Theory Of Comparative Advantage

Concept The law of comparative advantage states that even if one nation is less efficient
than (has an absolute disadvantage with respect to) the other nation in the
production of all commodities, there is still scope for mutually beneficial trade.
Operation The first nation should specialize in the production and export of the commodity
in which its absolute disadvantage is smaller (this is the commodity of its
comparative advantage) and import the commodity in which its absolute
disadvantage is greater (this is the commodity of its comparative disadvantage).
The Heckscher-Ohlin Theory Of Trade

Alternative It is also referred to as Factor-Endowment Theory of Trade or Modern Theory
Name of Trade.
In view of the contributions made by P. A. Samuelson, this theory is also
sometimes referred to as Heckscher-Ohlin-Samuelson theorem.
Basis of The Heckscher-Ohlin (H-O) model studies the case that two countries have
theory different factor endowments which results in two countries having different
factor prices in the beginning. Thus, the two countries will have different cost
functions.
The Heckscher-Ohlin theory of trade states that comparative advantage in cost
of production is explained exclusively by the differences in factor endowments of
the nations. In a general sense of the term, ‘factor endowment’ refers to the
overall availability of usable resources including both natural and man-made means
of production.
Nevertheless, in the exposition of the modern theory, only the two most
important factors, labour and capital are taken into account.
UNIT – 2 : THE INSTRUMENTS OF TRADE POLICY
Trade Policy
Meaning Trade policy encompasses all instruments that governments may use to promote
or restrict imports and exports.
Types of The instruments of trade policy that countries typically use to restrict imports
Instruments and/ or to encourage exports can be broadly classified into
❖ price-related measures such as tariffs and
❖ non-price measures or non-tariff measures (NTMs).
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Tariffs
Meaning Tariffs, also known as customs duties, are basically taxes or duties imposed on
goods and services which are imported or exported.
It is defined as a financial charge in the form of a tax, imposed at the border on
goods going from one customs territory to another.
Specific A specific tariff is an import duty that assigns a fixed monetary tax per physical
Tariff unit of the good imported.
It is calculated on the basis of a unit of measure, such as weight, volume, etc., of
the imported good.
Ad valorem An ad valorem tariff is levied as a constant percentage of the monetary value of

tariff one unit of the imported good.
Mixed Mixed tariffs are expressed either on the basis of value of imported goods (an
Tariffs ad valorem rate) or on the basis of a unit of measure of imported goods (a
specific duty) depending on which generates the most income for the nation.
Compound It is a combination of an ad valorem and a specific tariff.

Tariff or a That is, the tariff is calculated on the basis of both the value of the imported
Compound goods (an ad valorem duty) and a unit of measure of the imported goods (a
Duty specific duty).
It is generally calculated by adding up a specific duty to an ad valorem duty.
Technical/ These are calculated on the basis of the specific contents of the imported goods
Other Tariff i.e. the duties are payable by its components or related items.
Tariff Rate Tariff rate quotas (TRQs) combine two policy instruments, quotas and tariffs.
Quotas Imports entering under the specified quota portion are usually subject to a lower
(sometimes zero) tariff rate.
Preferential A lower tariff is charged from goods imported from a country which is given
Tariff preferential treatment.
Bound Tariff A bound tariff is a tariff which a WTO member binds itself with a legal
commitment not to raise it above a certain level.
The bound rates are specific to individual products and represent the maximum
level of import duty that can be levied on a product imported by that member.
Applied An 'applied tariff' is the duty that is actually charged on imports on a most-
Tariffs favoured nation (MFN) basis.
Prohibitive A prohibitive tariff is one that is set so high that no imports will enter.
tariff
Anti- Dumping occurs when manufacturers sell goods in a foreign country below the
dumping sales prices in their domestic market or below their full average cost of the
Duties product.
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Anti-dumping duties which are tariffs to offset the effects of dumping which
may be initiated as a safeguard instrument by imposition of additional import
duties so as to offset the foreign firm's unfair price advantage.
Counter- Countervailing duties are tariffs that aim to offset the artificially low prices
vailing charged by exporters who enjoy export subsidies and tax concessions offered by
Duties the governments in their home country.
Non Tariff Measures

Meaning Non-tariff measures (NTMs) are policy measures, other than ordinary customs
tariffs, that can potentially have an economic effect on international trade in
goods, changing quantities traded, or prices or both.
Technical Sanitary and Phytosanitary (SPS) Measures

Measures SPS measures are applied to protect human, animal or plant life from risks arising
from additives, pests, contaminants, toxins or disease-causing organisms and to
protect biodiversity.
Technical Barriers To Trade (TBT)

Technical Barriers to Trade (TBT) refer to mandatory ‘Standards and Technical
Regulations’ that define the specific characteristics that a product should have,
such as its size, shape, design, labelling/ marking/ packaging, functionality or
performance and production methods, excluding measures covered by the SPS
Agreement.
Non- Import Quotas

Technical An import quota is a direct restriction which specifies that only a certain physical
Measures amount of the good will be allowed into the country during a given time period,
usually one year.
Non-automatic Licensing and Prohibitions

These measures are normally aimed at limiting the quantity of goods that can be
imported, regardless of whether they originate from different sources or from
one particular supplier.
Financial Measures
The objective of financial measures is to increase import
costs by regulating the access to and cost of foreign exchange for imports and to
define the terms of payment.
Trade-Related Investment Measures

These measures include rules on local content requirements that mandate a
specified fraction of a final good should be produced domestically.
Restriction on Post-sales Services

Producers may be restricted from providing after- sales services for imported
goods in the importing country.
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Rules of origin
Rules of origin are the criteria needed by governments of importing countries to
determine the national source of a product.
Embargos
An embargo is a total ban imposed by government on import or export of some or
all commodities to particular country or regions for a specified or indefinite
period. This may be done due to political reasons or for other reasons such as
health, religious sentiments. This is the most extreme form of trade barrier.
UNIT – 3 : TRADE NEGOTIATIONS
Basics
Meaning International trade negotiations are complex interactive processes engaged in by
countries having competing objectives.
Complex Trade negotiations are not just face to face discussions; rather they are
Nature multilevel or network games and involve intricate and time consuming processes.
Regional Trade Agreements (Rtas)

Meaning Regional Trade Agreements (RTAs) are defined as groupings of countries, (not
necessarily belonging to the same geographical region) which are formed with the
objective of reducing barriers to trade between member countries.
Types Regional Preferential Trade Agreements

Trading Bloc
Free-trade area
Customs Union
Common Market
Economic and Monetary Union
The General Agreement On Tariffs And Trade (Gatt)

Background In an effort to give an early boost to trade liberalization after the Second
World War, tariff negotiations were opened among the 23 founding GATT
"contracting parties" in 1946.
Evolvement The tariff concessions and rules together became known as the General
of GATT Agreement on Tariffs and Trade and entered into force in January 1948.
Loss of The GATT lost its relevance by 1980s because

Relevance ❖ it was obsolete to the fast evolving contemporary complex world trade
scenario characterized by emerging globalisation
❖ international investments had expanded substantially
❖ intellectual property rights and trade in services were not covered by
GATT
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❖ world merchandise trade increased by leaps and bounds and was beyond
its scope
❖ the ambiguities in the multilateral system could be heavily exploited
❖ efforts at liberalizing agricultural trade were not successful
❖ there were inadequacies in institutional structure and dispute settlement
system
WTO
Beginning of The seeds of the Uruguay Round were sown in November 1982 at a Ministerial
Uruguay Meeting of GATT members in Geneva.
Round
Evolvement The agreement was signed by most countries on April 15, 1994, and took effect
of WTO on July 1, 1995.
It also marked the birth of the World Trade Organization (WTO) which
is a single institutional framework encompassing the GATT, as modified by the
Uruguay Round.
Objective of The principal objective of the WTO is to facilitate the flow of international
WTO trade smoothly, freely, fairly and predictably.
Guiding Trade without discrimination/ Most-favoured nation (MFN)

Principles of Under the WTO agreements, countries cannot normally discriminate between
World Trade their trading partners.
Organization If a country lowers a trade barrier or opens up a market, it has to do so for the
(WTO) same goods or services from all other WTO members.
National Treatment Principle (NTP)

A country should not discriminate between its own and foreign products, services
or nationals.
Freer trade
Lowering trade barriers is one of the most obvious means of encouraging trade.
The barriers concerned include customs duties (or tariffs) and measures such as
import bans or quotas that restrict quantities selectively.
Predictability
Investments will be encouraged only if the business environment is stable and
predictable.
The foreign companies, investors and governments should be confident that the
trade barriers will not be raised arbitrarily.
Greater competitiveness
This is to be achieved by discouraging “unfair” practices such as export
subsidies, dumping etc.
Special privileges to less developed countries

With majority of WTO members being developing countries, the WTO
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deliberations favour less developed countries by giving them greater flexibility,

special privileges etc.
Also, these countries are granted transition periods to make adjustments to the
not so familiar and intricate WTO provisions.
A transparent, effective and verifiable dispute settlement mechanism

Trade relations frequently involve conflicting interests.
Any dispute arising out of violation of trade rules is to be settled through
consultation.
In case of failures, the dispute can be referred to the WTO and can pursue a
carefully mapped out, stage-by-stage procedure that includes the possibility of a
judgment by a panel of experts, and the opportunity to appeal the ruling on legal
grounds.
The decisions of the dispute settlement body are final and binding.
Concerns Slow Process

Rigidity
Uncertainty
Sector biasness
Concerns of Developing countries
UNIT – 4 : EXCHANGE RATE AND ITS ECONOMIC EFFECTS
Exchange Rate
Meaning The exchange rate, also known as a foreign exchange (FX) rate, is the price of
one currency expressed in terms of units of another currency and represents
the number of units of one currency that exchanges for a unit of another.
Concept Exchange rate is the rate at which the currency of one country exchanges for
the currency of another country.
It is the minimum number of units of one country’s currency required to
purchase one unit of the other country’s currency.
Direct quote A direct quote is the number of units of a local currency exchangeable for one
unit of a foreign currency.
For example, Rs. 66/US$ means that an amount of Rs. 66 is needed to buy one
US dollar or Rs. 66 will be received while selling one US dollar.
Indirect An indirect quote is the number of units of a foreign currency exchangeable for
quote one unit of local currency. For example: $ 0.0151 per rupee.
Buying Rate It is the price at which the dealer buys the currency.
It is also called bid rate.
Selling Rate It is the price at which the dealer sells the currency.
It is also called ask rate or offer rate.
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Exchange Rate Regime

Floating Under floating exchange rate regime, the equilibrium value of the exchange rate
exchange of a country’s currency is market-determined i.e. the demand for and supply of
rate regime currency relative to other currencies determine the exchange rate.
Fixed A fixed exchange rate, also referred to as pegged exchanged rate, is an

exchange exchange rate regime under which a country’s Central Bank and/ or government
rate regime announces or decrees what its currency will be worth in terms of either another
country’s currency or a basket of currencies or another measure of value, such
as gold.
Intermediate It refers to an exchange rate policy under which the exchange rate is generally
exchange determined by the market, but in case the exchange rate tend to be move
rate regimes speedily in one direction, the central bank will intervene in the market.
The Foreign Exchange Market

Meaning The wide-reaching collection of markets and institutions that handle the
exchange of foreign currencies is known as the foreign exchange market.
Features Operates worldwide.

The largest market in the world in terms of cash value traded.
Over-the-counter market, no physical place.
No central trading location and no set hours of trading.
Enormous volume of foreign exchange trading worldwide.
Major Central bank

participants Commercial banks
Foreign exchange brokers
Arbitrageurs
Speculators
Type of Spot
Transactions Forward
Changes In Exchange Rates

Home- Under a floating rate system, if for any reason, the demand curve for foreign
currency currency shifts to the right representing increased demand for foreign
depreciation currency, and supply curve remains unchanged, then the exchange value of
foreign currency rises and the domestic currency depreciates in value.
The home currency thus becomes relatively less valuable.
Home- Under a floating rate system, if for any reason, the supply curve for foreign
currency currency shifts to the right representing increased supply for foreign currency,
appreciation and demand curve remains unchanged, then the exchange value of foreign
currency falls and the domestic currency appreciates in value.
The home currency thus becomes relatively more valuable.
P a g e | 75
Devaluation (Revaluation) Vs Depreciation (Appreciation)

Devaluation Devaluation is a deliberate downward adjustment in the value of a country's
currency relative to another currency, group of currencies or standard.
Depreciation Depreciation is a non-deliberate downward adjustment in the value of a

country's currency relative to another currency, group of currencies or
standard.
Revaluation Revaluation is a deliberate upward adjustment in the value of a country's

Appreciation Appreciation is a non-deliberate upward adjustment in the value of a country's

UNIT – 5 : INTERNATIONAL CAPITAL MOVEMENTS
Foreign Direct Investment (FDI)

Meaning Foreign direct investment is a process whereby the resident of one country (i.e.
home country) acquires ownership of an asset in another country (i.e. the host
country) and such movement of capital involves ownership, control as well as
management of the asset in the host country.
Extent of According to the IMF and OECD definitions, the acquisition of at least ten
Control percent of the ordinary shares or voting power in a public or private enterprise
by non-resident investor makes it eligible to be categorized as foreign direct
investment (FDI).
Main forms Opening of a subsidiary or associate company in a foreign country.

of FDI Acquiring a controlling interest in an existing foreign company.
Mergers and acquisitions(M&A).
Joint venture with a foreign company.
Joint development of natural resources.
Types of FDI Horizontal Direct Investment

on the basis Vertical investment
of nature Conglomerate Investment
Foreign Portfolio Investment (FPI)

Meaning Foreign portfolio investment is a process whereby the resident of one country
(i.e. home country) acquires ownership of a financial asset in another country (i.e.
the host country).
Modes It moves to investment in financial stocks, bonds and other financial instruments
and is effected largely by individuals and institutions through the mechanism of
P a g e | 76
capital market.
Foreign portfolio investment (FPI) is not concerned with either manufacture of
goods or with provision of services.
Intention of The singular intention of a foreign portfolio investor is to earn a remunerative

investor return through investment in foreign securities and is primarily concerned about
the safety of their capital, the likelihood of appreciation in its value, and the
return generated.
Nature of These investments are typically of short term nature.

FPI
Benefits & Limitations Of Foreign Direct Investment
Benefits Increased competition
Increase in Investment
Acceleration of growth
Political Reforms
Generation of Direct employment
Generation of Indirect employment
Higher wages
International relations
Promotion of ancillary units
Increase in Exports
Tax Revenue
Reduced Cost
Weakens monopoly
Favorable impact on BOP
Problems Capital Intensive Techniques

Regional Disparity
Loss of Tax Revenue
Less investment for development needs
Stress on Balance of Payments
No development of human resource
Focus on elite goods/ services
Unethical Practices
Labour related issues
Lower standards
Security considerations
Environmental damage
Dual economy
Foreign Direct Investment In India (Fdi)

Initiatives Automatic approval of FDI
taken by Simplification of procedures
Government Setting up of Foreign Investment Promotion Board
to promote 100% FDI in multitude of sectors
FDI Enactment of Foreign Exchange Management Act (FEMA)
P a g e | 77
Passing of the SEZ Act in 2005

Encouragement to foreign technology collaboration agreements
Routes for Automatic Route

FDI Approval Route
Instruments An Indian Company can receive foreign investment by issue of ‘FDI compliant
instruments’ namely :
❖ equity shares,
❖ fully and mandatorily convertible preference shares and debentures,
❖ partly paid equity shares and warrants.
Prohibition In India, foreign investment is prohibited in the following sectors:

of FDI ❖ Lottery business including Government/ private lottery, online lotteries,
etc.
❖ Gambling and betting including casinos etc.
❖ Chit funds
❖ Nidhi company
❖ Trading in Transferable Development Rights (TDRs)
❖ Real Estate Business or Construction of Farm Houses
❖ Manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or
of tobacco substitutes
❖ Activities/ sectors not open to private sector investment e.g. atomic
energy and railway operations (other than permitted activities).

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CA RAHUL GARG’s

RAHUL SHIKHA ACADEMY

CHAPTER 1 COST OF CAPITAL

CONCEPT FINANCING DECISION & COST OF CAPITAL

CONCEPT COMPONENTS OF CAPITAL

CONCEPT COMPONENTS OF COST OF CAPITAL

CONCEPT COST OF DEBT

Cost of Irredeemable Debt

Cost of Redeemable Debt

CONCEPT COST OF PREFERENCE SHARE CAPITAL

Cost of Irredeemable Preference Share

Cost of Redeemable Preference Share

CONCEPT COST OF EQUITY SHARE CAPITAL

Dividend Yield Model

Earnings Yield Model

Dividend Growth Model

Earnings Growth Model

Realised Yield Approach

Capital Asset Pricing Model

CONCEPT COST OF RETAINED EARNINGS

In absence of Personal Taxes

In presence of Personal Taxes

CONCEPT WEIGHTED AVERAGE COST OF CAPITAL

S.No. Source of Finance Amount Weight Cost W × C

CONCEPT BOOK VALUE WEIGHTS VS. MARKET VALUE WEIGHTS

CONCEPT OPERATING RISK

Meaning and Basic Condition

It is measured by Degree of Operating Leverage (DOL).

DOL measures the effect of change in Sales on EBIT.

Consider the following information for RSA Ltd:

CONCEPT FINANCING RISK

Meaning and Basic Condition

It is measured by Degree of Financial Leverage (DFL).

DFL measures the effect of change in EBIT on EPS.

Consider the following information for RSA Ltd:

CONCEPT COMBINED RISK

Meaning and Basic Condition

It takes into account operating as well as financing risk.

DCL measures the effect of change in sales on EPS.

Consider the following information for Omega Ltd:

CHAPTER 3 CAPITAL STRUCTURE

CONCEPT CHOOSING OPTIMUM CAPITAL STRUCTURE

Particulars Option 1 Option 2 Option 3

= Earnings for Equity

That option shall be chosen which provides maximum MPS.

CONCEPT FINDING OLD RATE OF RETURN

CONCEPT FINDING NEW RATE OF RETURN

CONCEPT FINDING NEW EBIT

CONCEPT INDIFFERENCE POINT

CONCEPT CHOICE OF PLAN

CHAPTER 4 THEORIES OF CAPITAL STRUCTURE

CONCEPT IMPORTANT FORMULAS

CONCEPT NET INCOME THEORY

CONCEPT NET OPERATING INCOME THEORY

CONCEPT TRADITIONAL APPROACH

CONCEPT M-M THEORY

CHAPTER 5 CAPITAL BUDGETING

CONCEPT IMPORTANCE OF CAPITAL BUDGETING DECISION

Huge sum of money

CONCEPT CAPITAL BUDGETING TECHNIQUES

Traditional Techniques Modern Techniques

CONCEPT ACCOUNTING RATE OF RETURN

It is the rate of return generated by the project during its life.