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  Advanced Bank Management -CAIIB
Posted by: devender - 07-16-2015, 10:51 PM - Forum: CAIIB-- Advanced Bank Management - No Replies

Download Important points



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  LIBERALIZED REMITTANCES SCHEME (LRS)
Posted by: anupma - 06-25-2015, 09:07 PM - Forum: CAIIB-- Bank Financial Management - No Replies

LIBERALIZED REMITTANCES SCHEME (LRS)

Resident Indian individuals are permitted to freely remit up to USD 125,000 per financial year for any current or
capital account transactions or a combination of both. (For example to acquire and hold immovable property or
shares or any other asset outside India) without prior approval of RBI. Individuals will also be able to open,
maintain and hold foreign currency accounts with a bank outside India for making remittances under this scheme.
The foreign currency account may be used for putting through all transactions connected with or arising from
remittances eligible under this scheme.
LRS facility is in addition to the Remittances allowed as above except in the case of Gifts / Donations.
Gifts/Donations are subsumed under LRS. No sub-limit within the overall limit of USD 125,000. Should have been
a Customer of the bank for a minimum of one year. PAN number is mandatory. For this facility, applicants should
designate one branch of one bank.
Remittances can be consolidated in respect of family members subject to the individual family members
complying with the terms & conditions of the Scheme. The LRS for Resident Individuals is available to all resident
individuals including minors. In case the remitter is a minor, the LRS declaration form should be countersigned by
the minor's natural guardian. Facility is available only for Resident individuals and is not to corporates,
partnership firms, HUFs, trusts, etc. Facility is not available for the following:
Prohibited purposes such as purchase of Lottery tickets, Sweepstakes, Proscribed (prohibited) magazines etc.
Remittances either directly or indirectly to Nepal, Bhutan, Pakistan or Mauritius or Countries identified by Financial
Action task force. Remittances directly or indirectly to Individuals /entities identified by RBI as posing significant
risk of terrorism.

FX FOCILMES TO RESIDENTS OTHER THAN INDIVIDUALS
ADs have been permitted to make remittances on account of donations by Corporates for some specified purposes
subject to a limit of one per cent of the foreign exchange earnings during the previous three financial years or
USD 5 million, whichever is less. Other residents like partnership firms, trusts etc., are free to remit up to USD
5,000 per annum per donor / remitter each as gift and donation. Remittances exceeding the limit will require prior
permission from the Reserve Bank

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  BUDGET TERMS
Posted by: seema_bob - 06-24-2015, 08:09 PM - Forum: CAIIB-- Advanced Bank Management - No Replies

BUDGET TERMS

BUDGET: It is the Annual Financial Statement by the Finance Ministry inaccordance with provisions of Article 112 of the Indian Constitution,giving details of proposed govt expenditure and how money will be raised.
CENTRAL PLAN: It consists of the Government’s budget support to the Plan and the internal and extra budgetary resources raised by public enterprises.
PlanExpenditure: It includes both revenue and capital expenditure of the government on the Central Plan,Central assistance to States and Union Territory plans.
Non-PlanExpenditure: It includes bothrevenueandcapitalexpenditureoninterestpayments, theentiredefenceexpenditure(bothrevenueandcapitalexpenditure),subsidies,postaldeficit,policy,pensions,
economic services, loans topublic enterprises andloans aswellasgrants toStateGovt.,UTandforeignGovt.
BUDGET IS DIVIDED IN TO TWO PARTS: CAPITAL AND REVENUE:
CAPITALBUDGET: Itconsistsofcapital receiptsandpayments. Italsoincorporates transactions inthePublicAccount. Ithas twocomponents:CapitalReceiptandCapitalExpenditure.
Capital Receipt: Include loans raised by the government frompublicwhich are calledmarket loans, borrowings fromthe RBI and other parties through sale of Treasury Bills, loans received fromforeign
governments, recoveries of loans grantedbyCentretoState andUTgovernments and otherparties.
CapitalExpenditureTongueayments foracquisitionofassets likeland,buildings,machinery,equipment,as alsoinvestments inshares etc,andloansby theCentretoStates,Govt.companies,corporations and
otherparties.*REVENUEBUDGET:Revenuereceipts of thegovernment (tax revenuesplus other revenues)andtheexpendituremet fromtheserevenues. Ithas twocomponents:RevenueReceiptand
RevenueExpenditure.RevenueReceipt: It includes proceeds of taxes andotherduties leviedby theCentre, interestanddividendoninvestmentsmadeby theGovt. feesandother receipts forservices
renderedby thegovernment.
Revenue Expenditure: It ismeant for the normal running of government departments and various services, interest charges on debt incurred by the government and subsidies. Broadly speaking, expenditure
which does not result in creation of assets is treated as revenue expenditure. All grants given to StateGovt. and other parties are also treated as revenue expenditure even though some of the grantsmay be for
creationofassets.
*STEPS IN BUDGET PRESENTATION:
BudgetSpeech: It is thefirststepinpresentationofbudget.TheSpeechis presentedevery yearby theFinanceMinister intheLokSabha,usuallyonlastworkingdayofFebruary.
ExpenditureBudget:Containsexpenditureestimatesmadeforaschemeorprogrammeunderbothrevenueandcapitalheads.
FinanceBill:This contains thegovernment’sproposals for levyofnewtaxes,modificationof theexistingtaxstructureorcontinuanceof theexistingtaxstructurebeyondtheperiodapprovedbyParliament.
DemandsforGrants: It is astatement ofestimates ofexpenditurefromtheConsolidatedFundandis required tobe voted by theLokSabha.Generally, oneDemand forGrant is presented by each
Ministry.AppropriationBill: It is presented toParliament for its approval, so that the government canwithdrawfromtheConsolidatedFund the amounts required formeeting theexpenditurechargedon
theConsolidatedFund.No amount canbewithdrawn fromtheConsolidatedFundtill theAppropriationBill is voted and enacted.
*TYPES OF DEFICIT: Excess of Expenditure over Receipts is known as Deficit.
BudgetaryDeficit: It is the excess of total expenditure over total receipts.
CapitalDeficit: It refers to the excess of capital expenditure over capital receipts.
RevenueDeficit: It refers to the excess of revenue expenditure over revenue receipts.
Fiscal Deficit: It is the difference between the revenue receipts plus certain non-debt capital receipts and the total expenditure including loans (net of repayments). This indicates the total borrowing
requirementsof thegovernment fromall sources.
PrimaryDeficit: It is the difference between fiscal deficit and interest payments.
MonetisedDeficit: It indicates the level of support extended by theRBI to theGovt’s borrowing programme.
VARIOUS GOVT ACCOUNTS:
Consolidated Fund: It ismadeupofall revenues receivedby thegovernment, loans raisedby it,andalsoits receipts fromrecoveriesof loans grantedby it.Allexpenditureof thegovernment is incurredfromthe
ConsolidatedFundandnoamountcanbewithdrawnfromtheFundwithoutauthorisationfromParliament.
Public Account: It is an account inwhichmoney received through transactions not relating to theConsolidated Fund is kept.Besides the normal receipts and expenditure of the government relating to the
Consolidated Fund, certain other transactions enter government accounts in respect of which the government actsmore as a banker, for example, transactions relating to provident funds, small savings
collections, otherdeposits etc.Suchmoney is kept inthePublicAccount andtheconnecteddisbursements.
Contingency Fund: It is an imprest placed at the disposal of thePresident and is used by the government to incur all its urgent and unforeseen expenditure. Parliamentary approval for such expenditure and for
withdrawalofanequivalentamountfromtheConsolidatedFundissubsequentlyobtainedandtheamountspent fromtheContingencyFundisrecoupedtotheFund.

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  Time Value of Money
Posted by: sarita - 06-22-2015, 07:25 PM - Forum: CAIIB-- Advanced Bank Management - No Replies

Time Value of Money

When cash flows take place at different time intervals, their value is different for a no. of reasons such as interest factor, inflation,
uncertainty ettz. In order to ascertain their value, these flows are required to be compared. The comparison is possible by using a time
line that shows the value and timing of cash flows.
Terms associated with cash flow:
When cash flows take place at different time intervals, their value is different for a no. of reasons such as interest factor, inflation,
uncertainty ettz. In order to ascertain their value, these flows are required to be compared. The comparison is possible by using a time
line that shows the value and timing of cash flows.
Terms associated with cash flow:
Positive cash flow : When a firm receives cash which is called inflow, it is a positive cash flow. Negative cash flow: When a firm makes
payments, this is outflow of cash and is called negative cash flow.Future cash flow & present cash flow : Future cash flows are worth less than the present cash flow. Rs.ioo available with a person presently and Rs..100 to be received after a year, carry higher present value. It is  becausethe people prefer present consumption rather than in future and to put off their consumption for future, more value requires to be offered.Similarly due to inflation, there is erosion in money value.Further there is uncertainty about receipt of money in
future.Discounting: It is a process by which the future cash inflows are adjusted/discounted according the their present value. (say
Rs.ioo received at the end of a year, if discounted at say io%, will give a value around Rs.9o). For this purpose, the rate that used is
called discount rate.
Compounding : It is a process by which the present value is converted into future value by using a given rate of interest.
Trade-off: When present consumption is put-off, for some future time period in return for some monetary return such as interest, this is
called exchange or Trade Off.
Effect of Inflation and Risk on the discount rate.
The inflation reduces the purchasing power of future cash flows and it reduces the value of future cash flows. Hence, if the inflation is higher, the discount rate will be higher to calculate the present value.Risk is due to uncertainty. If risk is higher, the discount rate would be higher.
Importance of discounting of the cash flows.The comparison becomes easier for cash inflows of different periods.The user becomes
indifferent for present and future cash inflows and can take more rationale decisions.
Other kinds of cash flows: The cash flows can be simple cash flows, annuities, growing annuities, perpetuities and growing perpetuities.
Simple cash flow: It is single cash flow to occur at a specified future time. Say Rs.i000 to be received at the end of one year. Its
present value can be worked out by discounting back by using an appropriate discount rate.
CALCULATION OF PRESENT AND FUTURE VALUES OF CASH FLOWS Calculation of present value of a future (simple) cash
flow: The present value can be calculated by using the formula
PV = Discount Factor x CI OR PV = 1 / (1+r) x C1 (where CI is the expected cash flow at the end of period .1)
Example : A person wants to get Rs.10 lac after one year. With prevailing interest rate of 9%, how much he should invest.
= 10,00,000 / 1.09 = 917531.19
Calculation of net present value
It can be calculatdd as NPV= PV of future cash flow -required investment OR it can be calculated as
= [(Ci / (t+r) + (Ci / (i+r) + (Ci / (i+r) + (Cn (i+r)] - Co Co = Cash flow at time o i.e. today.
r' means rate of discount.
Ci = Present value of cash flow at end of period one.
  You proposes to invest Rs.8 lac in a house and expect that it will fetch Rs.io lac at the end of the year. At 9% interest rate,
what is the net present value. Use the data in the above problem.
NPV= PV-required investment
= 917531.19 - 800000 = 117531.19
Example-2 : X paid Rs.l00000 to Y on Jan 01, 2009. Y returned Rs.65000 after one year, Its.g0000 at end of 2nd year.
What is the present value of amount paid by Y to X and what is net present value of the cash flows for X at 10% discount rate ? Present value of amount paid by X = 100000
Present value of amount paid by after one year = 6500o / 1.1 = 59090 Present value of amount paid by Y after 2 years = 90000 / 1.1 x 1.1 = 74380 Present value of total amount paid by Y = 59090 + 74380 = 133470
Net present value of cash flows = 133470 - 100000 = Rs. 33470
Effect of Inflation and Risk on the present value.
The inflation reduces the purchasing power of future cash flows and it reduces the present value of future cash flows.
Risk is due to uncertainty. If risk is higher, the discount rate would be higher and present value of future cash flows would be lower.
Rule to take decision on making an investment:
If net present value at an acceptable discount rate is zero or positive, the investment can be made.

If internal rate of return (i.e. acceptable discount rate at which net present value is zero) is greater than the opportunity cost of capital, the investment can be made.
Ibbotson and Sinquefield's Study:
Ibbotson and Sinquefield conducted a study of returns on investment in bonds and stock between the period 1926 - 1992. It was found
that average return on stocks was 12.4%, on treasury bonds 5.2%, on treasury bills 3.6%. If investment is made in these 3 instruments at above rates of return, with a time horizon of 40 years, the future value of investment at 12.4% in stock will be 12 times more than
investment in treasury bonds at 5.2%
at 12.4% in stock will be 25 times more than investment in treasury bills at 3.6% This snows that if the time horizon is longer, the gap between the return will be greater.
Conversion of nominal cash flows of future period, to real cash flows. Real cash flow = (Nominal cash flow) / (1+ inflation rate) If the inflation rate is 10% per annum and an investor expects Rs.io lac, what will be his real cash flow. Real cash flow = (Nominal cash flow) / (1+ inflation rate) 10,00,000 / 1+10% = 10 lac / 1.10 = Rs. 909091
Calculation of future value of a present (simple) cash flow: This can be done by way of compounding by using the formula
CF o (1+0 where (1 = at the end of period 0 (CF o = present cash flow) and ( r = rate of discount)
Example : X deposited Rs.i0000 with bank at 10% rate of interest for 2 years. What is the future value (maturity value) of this amount: =
10000 (1+10)2 = 10000 x 1.10 x 1.10 = 12100
Rule of 72
By using this method, we can find out as to, in how much period (appx), an amount will become double at a particular interest rate. If 72 is divided by the interest rate, the resultant product, is the time period during which the amount will be doubled. For example if the
interest rate is 8%, the amount will double in 9 years.
Concept of effective rate of interest
It is the actual rate of interest that takes into account the compounding effect of interim interest payment, if any. At more frequent
compounding, the effective rate of interest would be more.
Determination of effective rate of interest It can be done by using the following formula:
(1+ given annual RoI /N )n - 1 (where N = no. of compounding periods. Say42= months).
Where the annual interest rate is 20%, what will be effective rate, where the compounding is on half-yearly (semi-annual) basis.
(1+ 'given annual Rol /N )n - 1
(1.10 2 - 1) = 1.21 — 1.00 = 21%
Effective rates for various compounding frequencies for 10% RoI:
Where compounding frequency is annual Effective Rol = 0.10 = 10% Where the compounding frequency is semi annual: Effective Rol = (1 + 10/2) 2 - 1) = 10.25% Where the compounding frequency is monthly : Effective RoI = (1 + 10/12) 12 -1) = 10.47% Where the
compounding frequency is daily : Effective Rol = (i + 10/365)3°5 - 1) = 10.5156% Where the compounding frequency is on continuous
basis: Effective Rol = e,1° - 1) = 10.5171% Continuous compounding & calculation of effectiveinterest rate :It can be computed as = exp r - 1 (where 'exp' means exponential number and 'r' means given interest rate).
Impact of frequency of compounding on effective rate of interest:
Effective rate increases and present value of future cash flows decreases if compounding is more frequent. ANNUITYIt is a constant cash
flow, accruing at regular intervals of time, for a pre-fixed period.It can occur at the beginning of each period (called annuity due) or at the
end of each period (called ordinary annuity)
Present value of amend-of-the period annuity (Ordinary ann ty):
= PV (A,r,n) = A fi-(1/ (1+r) n) r
(Alternative formulae : PV = A / r [{(1+r)n -1} / (1+r)n j
(A = annuity r=discount rate n=no. of years.
Example-1: Calculate the PV of Rs.9000 each year for 5 year/5 where R41$12%.
= PV (A,r,n) = A {1-(1/ (i+r) n r \ C) ‘'k
= 9000 {141/ (1+12)s) / 0.12 = 32442.98
Example-2 : X deposits Rs.i000 at end of each year for 4 y ars at io rate of Hite t. is the present value of the amount, +.1D be deposited:
= A + A/r [1-1/(i+r) n-i /(i+r) = moo+ 1000 / 0.1 [1-1/(1+0.10)4-1] / (Li) = 1000+ moo / 0.1 [1-1/(1.331)] (1.1) = woo+ moo / 0.1 [1-0.7513)] (1.1) = 1000+ 10000 [0.2487] (1.1) = woo + 2487 = 3487 (Li) = 317
Future value of an end-of-the period annuity (Ordinary annuity):
= FV (A,r,n) = A {(i+r)n -1} r
(Alternative formulae : FV = A / r {(1+1)n --1} (A = annuity r=discount rate n=uo. of years.
Example - Z deposits Rs.i0000 annually for next 5 years. At 10% rate of interest, what will he be getting?
= A [ (1 +r) n - 1] / r = 10000 [ (1 +0.10) 5 / 0.10]
= 10000 [1.61051-1/ 0.10] = 10000 [0.61051 / 0.10] = Rs.61051
P r e s e n t v a l u e o f b e g i n n i n g - o f - a - p e r i o d a n n u i t y ( A n n u i t y d u e ) o v e r n y e a r s : = A + A / r { [ 1 - 1 ( i + r ) n -
i ] (A = c a s h f l o w p e r p e r i o d o r a n n u i t y , r = r a t e o f i n t e r e s t , n = n o . o f p a yme n t s )
Example : X deposits Rs.i000 at beginning of each year for 4 years at 10% rate of interest. What is the present value of the amount, to be
deposited:
= A + A/r [1-1/(t+r) n-1] = 1000+ 1000 / 0.1 [1-1/(1+0.10)4-1]
= 1000+ 1000 / 0.1 [1-1/(1.331) = 1000+ 1000 / 0.1 [1-0.7513)]
= 1000+ 10000 [0.2487] = 1000 + 2487 = 3487
Future value of beginning-of-a-period annuity (Annuity due):
= C {[(i+r) n -1] r } x (i+r) OR A / r [(i+r) {(1+r)n-1)11
Example - Z wants to deposit Rs.10000 in a recurring deposit account for 3 years in the
beginning of the year. At io% p.a., how much will he be getting? =A/r{(1+r)[(i+r)n-i]}
10000/0.10 +0.0 [(1 +0.1) 3 - = 10000 / 0.10 [(1 +0.1) (1.331) - 1]
= 10000 / 0.10 [1.1 x .331] = 10000 / 0.10 x 0.3641 = Rs.36410
C a l c u l a t i o n o f A n n u i t y g i v e n f u t u r e v a l u e : = A ( F V , r , n ) = F V { r / ( i + r ) n - 1 } Z w a n t s t o
r e c e i v e R s . 6 1 0 5 1 a n d w a n t s t o d e p o s i t a n e q u a l a m o u n t f o r 5 y e a r s a t 1 0 % p . a . . H o w
much should deposit regularly?
= 61051{0.10 / (i+0.10)5- 1}
= 61051{0.10 / (1.61051)- 1}
Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai
26
= 61051{0.10 / 0.61051 = Rs.i0000
Baloon repayment loan
it is a loan in which repayment of interest only is made during life period of the loan. The amount o loan is repaid in one instalment
at the end of repayment period, such as debenturesand bond's. The companies raising bonds or debentures set aside funds in a
sinking fundsmaturing with maturity period of the loan, so that do not face any problem at the time ofrepayment.
Sinking fund -It is fund created by companies for meeting special repayment obligations in which regularcontributions are made on
annual or other basis.
Growing annuity- It a cash flow which grows at a constant rate for a specified period of time.If A is the current cash flow and g is the
expected growth rate, the value can be calculated asunder:
Present value of a growing annuity : =A [(i+g) / (r — g)] {(1-(1+g) n / (i+r) " ) (g stands for expected growth rate)The present value
can be estimated in cases except when the growth rate is equal to discountrate, the present value is equal to the nominal sums of
annuities over the period, without the
growth effect.
Present value of a growing annuity for n years be calculated when r = g It is = nA
PERPETUITY
It is a constant cash flow paid or received at regular time intervals forever, such as a life time pension or rentals received from use of land.
Calculation of present value of perpetuity : It can be calculated by use of the formula : A / rWhen the coupon rate is equal to interest
rate, the value will be equal to face value.
Growing perpetuity- It is a cash flow which forever, is expected to grow at a constant rate. The present value of a growing perpetuity can
be written as.. Ci / (r-g)
Console Bond- It is a bond which does not have maturity. On such bond fixed coupon or RoI is paid.An investor has a console bond of
Rs.i0000 with 8% fixed coupon. If the interest rate is 10%,the current value of the bond would be: When a firm receives cash which is called inflow, it is a positive cash flow. Negative cash flow: When a firm makes
payments, this is outflow of cash and is called negative cash flow.Future cash flow & present cash flow : Future cash flows are worth less than
the present cash flow. Rs.ioo available with a person presently and Rs..100 to be received after a year, carry higher present value. It is
becausethe people prefer present consumption rather than in future and to put off their consumption for future, more value requires to be
offered.Similarly due to inflation, there is erosion in money value.Further there is uncertainty about receipt of money in
future.Discounting: It is a process by which the future cash inflows are adjusted/discounted according the their present value. (say
Rs.ioo received at the end of a year, if discounted at say io%, will give a value around Rs.9o). For this purpose, the rate that used is
called discount rate.
Compounding : It is a process by which the present value is converted into future value by using a given rate of interest.
Trade-off: When present consumption is put-off, for some future time period in return for some monetary return such as interest, this is
called exchange or Trade Off.
Effect of Inflation and Risk on the discount rate.
The inflation reduces the purchasing power of future cash flows and it reduces the value of future cash flows. Hence, if the inflation is higher,
the discount rate will be higher to calculate the present value.Risk is due to uncertainty. If risk is higher, the discount rate would be higher.
Importance of discounting of the cash flows.The comparison becomes easier for cash inflows of different periods.The user becomes
indifferent for present and future cash inflows and can take more rationale decisions.
Other kinds of cash flows: The cash flows can be simple cash flows, annuities, growing annuities, perpetuities and growing perpetuities.
Simple cash flow: It is single cash flow to occur at a specified future time. Say Rs.i000 to be received at the end of one year. Its
present value can be worked out by discounting back by using an appropriate discount rate.
CALCULATION OF PRESENT AND FUTURE VALUES OF CASH FLOWS Calculation of present value of a future (simple) cash
flow: The present value can be calculated by using the formula
PV = Discount Factor x CI OR PV = 1 / (1+r) x C1 (where CI is the expected cash flow at the end of period .1)
Example : A person wants to get Rs.10 lac after one year. With prevailing interest rate of 9%, how much he should invest.
= 10,00,000 / 1.09 = 917531.19
Calculation of net present value
It can be calculatdd as NPV= PV of future cash flow -required investment OR it can be calculated as
= [(Ci / (t+r) + (Ci / (i+r) + (Ci / (i+r) + (Cn (i+r)] - Co Co = Cash flow at time o i.e. today.
r' means rate of discount.
Ci = Present value of cash flow at end of period one.
Example-i : You proposes to invest Rs.8 lac in a house and expect that it will fetch Rs.io lac at the end of the year. At 9% interest rate,
what is the net present value. Use the data in the above problem.
NPV= PV-required investment
= 917531.19 - 800000 = 117531.19
Example-2 : X paid Rs.l00000 to Y on Jan 01, 2009. Y returned Rs.65000 after one year, Its.g0000 at end of 2nd year.
What is the present value of amount paid by Y to X and what is net present value of the cash flows for X at 10% discount rate ? Present value
of amount paid by X = 100000
Present value of amount paid by after one year = 6500o / 1.1 = 59090 Present value of amount paid by Y after 2 years = 90000 / 1.1 x 1.1 =
74380 Present value of total amount paid by Y = 59090 + 74380 = 133470
Net present value of cash flows = 133470 - 100000 = Rs. 33470
Effect of Inflation and Risk on the present value.
The inflation reduces the purchasing power of future cash flows and it reduces the present value of future cash flows.
Risk is due to uncertainty. If risk is higher, the discount rate would be higher and present value of future cash flows would be lower.
Rule to take decision on making an investment:
If net present value at an acceptable discount rate is zero or positive, the investment can be made.
Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai
25
If internal rate of return (i.e. acceptable discount rate at which net present value is zero) is greater than the opportunity cost of capital, the
investment can be made.
Ibbotson and Sinquefield's Study:
Ibbotson and Sinquefield conducted a study of returns on investment in bonds and stock between the period 1926 - 1992. It was found
that average return on stocks was 12.4%, on treasury bonds 5.2%, on treasury bills 3.6%. If investment is made in these 3 instruments at
above rates of return, with a time horizon of 40 years, the future value of investment at 12.4% in stock will be 12 times more than
investment in treasury bonds at 5.2%
at 12.4% in stock will be 25 times more than investment in treasury bills at 3.6% This snows that if the time horizon is longer, the gap between
the return will be greater.
Conversion of nominal cash flows of future period, to real cash flows. Real cash flow = (Nominal cash flow) / (1+ inflation rate) If the inflation
rate is lo% per annum and an investor expects Rs.io lac, what will be his real cash flow. Real cash flow = (Nominal cash flow) / (1+ inflation
rate) io,00,000 / 1+1o% = 10 lac / 1.10 = Rs. 909091
Calculation of future value of a present (simple) cash flow: This can be done by way of compounding by using the formula
CF o (1+0 where (1 = at the end of period 0 (CF o = present cash flow) and ( r = rate of discount)
Example : X deposited Rs.i0000 with bank at 10% rate of interest for 2 years. What is the future value (maturity value) of this amount: =
10000 (1+10)2 = 10000 x 1.10 x 1.10 = 12100
Rule of 72
By using this method, we can find out as to, in how much period (appx), an amount will become double at a particular interest rate. If 72 is
divided by the interest rate, the resultant product, is the time period during which the amount will be doubled. For example if the
interest rate is 8%, the amount will double in 9 years.
Concept of effective rate of interest
It is the actual rate of interest that takes into account the compounding effect of interim interest payment, if any. At more frequent
compounding, the effective rate of interest would be more.
Determination of effective rate of interest It can be done by using the following formula:
(1+ given annual RoI /N )n - 1 (where N = no. of compounding periods. Say42= months).
Where the annual interest rate is 20%, what will be effective rate, where the compounding is on half-yearly (semi-annual) basis.
(1+ 'given annual Rol /N )n - 1
(1.10 2 - 1) = 1.21 — 1.00 = 21%
Effective rates for various compounding frequencies for 10% RoI:
Where compounding frequency is annual Effective Rol = 0.10 = 10% Where the compounding frequency is semi annual: Effective Rol = (1
+ 10/2) 2 - 1) = 10.25% Where the compounding frequency is monthly : Effective RoI = (1 + 10/12) 12 -1) = 10.47% Where the
compounding frequency is daily : Effective Rol = (i + 10/365)3°5 - 1) = 10.5156% Where the compounding frequency is on continuous
basis: Effective Rol = e,1° - 1) = 10.5171% Continuous compounding & calculation of effectiveinterest rate :It can be computed as = exp r
- 1 (where 'exp' means exponential number and 'r' means given interest rate).
Impact of frequency of compounding on effective rate of interest:
Effective rate increases and present value of future cash flows decreases if compounding is more frequent. ANNUITYIt is a constant cash
flow, accruing at regular intervals of time, for a pre-fixed period.It can occur at the beginning of each period (called annuity due) or at the
end of each period (called ordinary annuity)
Present value of amend-of-the period annuity (Ordinary ann ty):
= PV (A,r,n) = A fi-(1/ (1+r) n) r
(Alternative formulae : PV = A / r [{(1+r)n -1} / (1+r)n j
(A = annuity r=discount rate n=no. of years.
Example-1: Calculate the PV of Rs.9000 each year for 5 year/5 where R41$12%.
= PV (A,r,n) = A {1-(1/ (i+r) n r \ C) ‘'k
= 9000 {141/ (1+12)s) / 0.12 = 32442.98
Example-2 : X deposits Rs.i000 at end of each year for 4 y ars at io rate of Hite t. is the present value of the amount, +.1D be deposited:
= A + A/r [1-1/(i+r) n-i /(i+r) = moo+ 1000 / 0.1 [1-1/(1+0.10)4-1] / (Li) = 1000+ moo / 0.1 [1-1/(1.331)] (1.1) = woo+ moo / 0.1 [1-0.7513)]
(1.1) = 1000+ 10000 [0.2487] (1.1) = woo + 2487 = 3487 (Li) = 317
Future value of an end-of-the period annuity (Ordinary annuity):
= FV (A,r,n) = A {(i+r)n -1} r
(Alternative formulae : FV = A / r {(1+1)n --1} (A = annuity r=discount rate n=uo. of years.
Example - Z deposits Rs.i0000 annually for next 5 years. At 10% rate of interest, what will he be getting?
= A [ (1 +r) n - 1] / r = 10000 [ (1 +0.10) 5 / 0.10]
= 10000 [1.61051-1/ 0.10] = 10000 [0.61051 / 0.10] = Rs.61051
P r e s e n t v a l u e o f b e g i n n i n g - o f - a - p e r i o d a n n u i t y ( A n n u i t y d u e ) o v e r n y e a r s : = A + A / r { [ 1 - 1 ( i + r ) n -
i ] (A = c a s h f l o w p e r p e r i o d o r a n n u i t y , r = r a t e o f i n t e r e s t , n = n o . o f p a yme n t s )
Example : X deposits Rs.i000 at beginning of each year for 4 years at 10% rate of interest. What is the present value of the amount, to be
deposited:
= A + A/r [1-1/(t+r) n-1] = 1000+ 1000 / 0.1 [1-1/(1+0.10)4-1]
= 1000+ 1000 / 0.1 [1-1/(1.331) = 1000+ 1000 / 0.1 [1-0.7513)]
= 1000+ 10000 [0.2487] = 1000 + 2487 = 3487
Future value of beginning-of-a-period annuity (Annuity due):
= C {[(i+r) n -1] r } x (i+r) OR A / r [(i+r) {(1+r)n-1)11
Example - Z wants to deposit Rs.10000 in a recurring deposit account for 3 years in the
beginning of the year. At io% p.a., how much will he be getting? =A/r{(1+r)[(i+r)n-i]}
10000/0.10 +0.0 [(1 +0.1) 3 - = 10000 / 0.10 [(1 +0.1) (1.331) - 1]
= 10000 / 0.10 [1.1 x .331] = 10000 / 0.10 x 0.3641 = Rs.36410

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  GDP CONCEPTS
Posted by: devender - 06-19-2015, 08:06 PM - Forum: CAIIB-- Advanced Bank Management - No Replies

National income is the sum total of output of commodities and services produced by the economy as a whole during a given period of time
generally one year counted without duplication. In India, National Income estimates are related with the financial year i.e., 15t April to 31st
March. National Income is used as a measure of economic growth.
National Income includes the contribution of three sectors of the economy namely:
a) Primary Sector: Agriculture, Forestry, Fishery,Mining.
b) Secondary Sector: Industries, manufacturing, construction, electricity, gas, water.
c) Tertiary Sector: Trade, Banking, Insurance, Transport and Communication, Real Estate etc. The National Income is compiled by Central
Statistical Organisation (CSO) and presently is based on 1993-94 as base year. CONCEPTS OF NATIONAL INCOME
A) Gross Domestic Product (GDP) :
GDP is the market value of the final goods & services produced within the domestic territory of a country during one year.
B) Gross National Product (GNP): GNP = GDP + Net factor Income from abroad (X—M).
Where X = Income earned due to exports and money value of goods and services produced by nationals outside the country;M = Income
paid due to Imports and Income received by foreign nationals from within the country.
If Export minus imports = 0, Then GNP = GDP
C) Net Domestic Product (NDP): NDP = GDP - Depreciation
D) Net National Product (NNP): NNP = GNP - Depreciation
E) National Income: NNP is computed at factor cost. Further when we use a term national income we imply NNP at factor cost.
F) NNP at Factor cost
= NNP atMarket Price—Indirect Taxes + Subsidies Or = NNP at Market Price - Net Indirect Taxes Where
Net Indirect taxes means (Indirect taxes - Subsidies)
Market Price is the economic price for which goods and services offered in the market.
G) Per Capital Income: It is ratio between national income of the country & population of that country Per Capita Income = National Income /
Population.
H) Green GDP : GDP which factors in cost of its environment degradation.
MEASUREMENT OF NATIONAL INCOME: There are three methods of measuring the national income
a) Product Method (Value Added Method) b) Income Method I Distribution Method
c) Expenditure Method (Consumption Method)
a) PRODUCTMETHOD: Under this method, national income is equal to net national product at factor cost. This method
used fe'r agriculture and animal husbandry, forestry & mining & quarrying, registered manufacturing. In this method, net value o final goods
and services produced in a country during a year is obtained and the total obtained value is called total final product This represents GDP.
Real GDP or GDP at constant Price: Real GDP is calculated by tracking the volume or quantity of production after removing the influence of
changing prices or inflation. It reflects the real growth. It is the value of today's output at yesterday price.
Nominal GDP or GDP at current Prices: represents the total money value of final goods and services produced in a giver year, where the values
are expressed in terms of the market prices of each year. Simply it is the value of today's output a today's price.
b) INCOME METHOD: This method measures national income from the side of payment made to the factor of production lik
land, labor, capital and entrepreneur. This method is used to calculate gas, electricity & water supply banking & insurance transport,
communication and storage, unregistered manufacturing, trade, hotel, restaurants, public administration and defence In broad sense, by
Income method, national income is obtained by adding receipts of total rent, total wages, total interest an total profit.
c) EXPENDITURE METHOD: This method measure national income from the angle of expenditure of whole community. Thi method is basically used for estimating income in construction activity. GDP = Consumption + Gross investment + Government spending + (Exports - Imports) and the formula is GDP = C+I+G + (X-M)
The first compilation of national income in India was prepared by Dadabhai Narjii for year 1867-68. The first official estimates national income for Indian union were prepared by the Ministry of commerce, govt. of India in year 1948-49. The Central Statistical Organisation (CSO) has been entrusted with the work of estimating national income of India. CSO has introduced new series on national income with 1993-94 as the base year In India methods combination of product method and income method is used for estimation of National income. Product method is particularly used in primary sectors and in manufacturing sectors, and Income Method is used in territory sector or service sector.

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  Monetary Policy and Fiscal Policy
Posted by: harpreet_kour - 06-19-2015, 07:56 PM - Forum: CAIIB-- Advanced Bank Management - No Replies

Monetary policy consists of measures aimed at altering the economy's money supply and in turn the interest rates for stabilizing the
aggregate output, employment and price level. In effect, monetary policies are tools to regulate the interest rate and money supply expansion that prevail in the economy. Monetary policy controls supply of money, availability of money and cost of money. In India, RBI is vested with the powers for formulating, supervising and controlling the monetary and banking system.
Objectives of Monetary Policy:
Monitoring of global and domestic economic conditions and respond quickly Ensuring availability of credit to productive sectors of the
economy and protect the credit quality. Maintain price stability and financial stability Emphasis interest rate management, inflation
management and liquidity management. Category of instruments of monetary policy : RBI uses 2 categories of instrument
namely.
1. General category, it has powers to conduct open market operations (OMO), change the reserve ratios and alter
the discount rates.
2. Special category it can have various credit direction program (priority sector, export credit, food credit etc.) and specifying
margins and level of credit in special categories (called selective credit control).
Bank rate : Bank rate is the rate of interest which RBI charges from banks while lending to Banks. When Bank rate is increased, it
increases the cost of borrowing by banks from RBI. Thus banks tend to reduce their borrowing from RBI, which lowers the lend-able
resources of banks and consequent decline in money supply increases the interest rates. The opposite happens when RBI reduce bank
rate. Role of Bank rate has been very limited in affecting the lend-able resources with banks.
CASH RESERVE RATIO
CRR refers to the ratio of bank's cash reserve balances with RBI with reference to the bank's net demand and time liabilities to ensure the
liquidity and solvency of the scheduled banks.
Extent of CRR
Under RBI Act 1934 (Section 42(1) all scheduled banks are required to keep certain minimum cash reserves with RBI. Important features
are: Wef June 22, 2006 (as per RBI Amendment Act 2006), RBI has been empowered to fix CRR (without any floor or ceiling) at its discretion
(instead of earlier 3 to 2o% range by notification) of the net demand and time liabilities. It is to be maintained at fortnightly average basis
(Saturday to following Friday- 14 days) on reporting Friday (advised by RBI to banks at the commence of the year).on a Bail yhasi8 it should be
70% of the average balance wef Dec 23, 2002.
In order to check inflation, when RBI intends to reduce money supply with the banking system, it increases the CRR. On the other hand in
recessionary situation, when RBI wants to increase the liquidity, it reduces the CRR.
STATUTORY LIQUIDITY RATIO
Section 24 (2A) of Banking Regulation Act 1949 requires every banking company to maintain in India equivalent to an amount which shall not
at the close the business on any day be less than as prescribed by RBI (earlier 25%) as a percentage of the total of its net demand and time
liabilities (to be computed as in case of CRR) in India, which is known as SLR.
RBI powers - RBI can change SLR with minimum at its discretion and maximum 4o%).
SLR is to be maintained as at the close of business on every day i.e. on daily basis based on the NDTLs as obtaining on the last Friday of the
2nd preceding Fortnight.
Components of SLR : RBI issued the notification•dated Sept 08, 2009 giving the list of assets to be maintained by the banks (or Sec 24
of Banking Regulation Act, 1949, as under:
(a) Cash, or (b) Gold valued at a price not exceeding the current market price, or © Unencumbered investment in the following instruments
which will be referred to as "Statutory Liquidity Ratio (SLR) securities":
Objective of maintaining SLR :
1 It helps RBI to control the growth of bank credit. By changing SLR, RBI can impact the availability of funds with the banks for lending
purpose. Maintenance of SLR enhances the solvency position of the banks RBi can compel banks to meet the govt. borrowing program by
subscribing to Govt. securities. Open market operationsIt refers to buying and selling of govt. securities by RBI in the open market. By
its impact on the reserves of banks, OMO help control the money supply in the economy.When RBI sells Govt. securities to banks, the lendable
resources of4h&latter aze reduced and banks are forced to reduce or contain their lending, thus curbing themoney supply.When money supply is reduced, thaeonsequeattsiaerease=in,theinterest rates tends to limit spending and investment.

Repo and Reverse Repo
Under a Repo transaction RBI purchases_gqvt. securities from banks and thus inducts liquidity in the banking system. Repo transactions are undertaken at Repo rate, which keeps on changing fromtime to time. By increasing repo rate, RBI increases the cost of borrowing by banks.
Under a Reverse Repo transaction, RBI sells govt. securities to banks and thus absorbs, liquidity in the banking system.
Sterilization Operation (Market Stabilization Scheme).Under this mechanism, RBI uses MSS Bonds, with a view to absorb liquidity
created by inflow of foreign exchange in to India. The MOS-instruments are in the form of treasury bills or dated securities which RBI
isstiet through ailetion. This is also knows as Sterilization operation.
FISAL POLICY
Govt. uses fiscal policy, to influence the level of aggregate demand in the economy, with a view to achieve economic objectives of price
stability, full employment and economic growth. Fiscal policy is the process of policy decision making in relation to the financial structure
of the govt. receipts and payment. It includes the actions and strategies on tax policy, revenue and expenditure, loans and borrowing,
deficit financing etc. Primarily, it is the budgetary policy of the Govt. and is reflected through the annual budget formulation.
The objective of the policy are:
1 Moblisation of resources for meeting the financial requirements for economic growth. 2 Improve savings & investment rate to
improve the capital formation. 3 To initiate steps to remove poverty and unemployment and improve the standard of living of the people. 4
To reduce regional disparities.
FISCAL RESPONSIBILITY & BUDGET MANAGEMENT ACT 2002
With a view to bring the Central finance under discipline, The Fiscal Responsibility & Budget Management Act (FRBM) notified on July 02,
2004 has come into fore w.e.f July 5, 2004 (recommendations of Dr. EAS Sarma Committee). The Act provides for an institutional framework binding the Government to pursue a prudent fiscal policy. It casts responsibility on the Central Government to ensure fiscal  management and long-term macroeconomic stability by achieving sufficient revenue surplus, removing fiscal impediments in the conduct of monetary policy and prudential debt management through limits on borrowings and deficits.
Targets :
The Act provides for the following targets for the Central Govt.:
Reduce the fiscal deficits to 3% of GDP. To eliminate revenue deficit by March 31, 2009 (to be reduced minimum by 0.5% point beginning the financial year 2004-05 (Zero to be achieved by 31.3.2010 as per Budget 2008).To set a ceiling on guarantees - 0.5% of GDP.Total debt increase capped at 9% of GDP during 2004-05.
Report to the Parliament: Government is required to place before the Parliament, 3 statements each year along with the Budget, covering
Medium Term Fiscal Policy, Fiscal Policy Strategy and Macro Economic Framework. The Parliament is also to be informed through quarterly reviews on the implementation. No deviation permitted without approval of Parliament.
Borrowing from RBI : The Act prohibits the Center from borrowing from RBI (i.e. restriction on deficit financing through money creation.
Temporary Ways and Means Advances to tide over cash  flow problems are permitted till April, 2006.

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  Business Cycles
Posted by: rakesh_123 - 06-17-2015, 08:49 PM - Forum: CAIIB-- Advanced Bank Management - No Replies

Business cycle or economic cycle
The business cycle is the periodic but irregular up-and-down movements in economic activity, measured by fluctuations in real
GDP and other macroeconomic variables. In other words, a business cycle or an economic cycle refers to economy-wide
fluctuations in economic activity (including production of goods and services), over several months or years. Such cycle pass
through phases of prosperity and depression. A business cycle is not predictable, regular or repetitive. Its timing is random and
unpredictable. The business cycles influence the business decisions and lead to impact on individual firms and the economy as a
whole. Characteristics of a business cycle: It is synchronic : The upward or downward movement tend to occur almost at the same
time, in all industries. Prosperity or depression in one industry will have impact in other industries, almost immediately. It shows a
wave-like movement : The period of boom and depression comes alternatively. Cyclical fluctuations are recurring in nature:
Various phases are repeated. A boom is followed by depression which is followed by prosperity again.
Downward movements are more sudden, than the upward movements There is no indefinite depression or boom period. Phases
of a business cycle A business cycle has 4 phases namely (i) Boom (2) Recession (3) Depression (4) recovery
1.Boom : Production capacity is fully used. Products fetch more than normal price giving higher profits. This attracts more
investors. Increasing use of factors of production leads to increased cost of production. The fixed income groups find it difficult to
cope with the increase in prices. They are forced to reduce their consumption which leads to lower demand, which results in
recession.
2.Recession : In economics, a recession is a business activity contraction, a general slowdown in economic activity over a period
of time. During recessions, many macroeconomic indicators vary in a similar way. Production as measured by Gross Domestic
Product (GDP), employment, investment spending, capacity utilization, household incomes, business profits and inflation all fall
during recessions; while bankruptcies and the unemployment rate rise.
Recessions are generally believed to be caused by a widespread drop in spending.
Govt. policy in recession : Governments usually respond to 'recessions by adopting expansionary macroeconomic policies, such
as increasing money supply, increasing government spending and decreasing taxation.
3.Depression : In economics, a depression is a sustained, long-term downturn in economic activity in one or more economies. It is
a more severe downturn than a recession. A rare and extreme form of recession, a depression is characterized by its length, and
by abnormally large increases in unemployment, falls in the availability of credit— quite often due to some kind of banking/financial
crisis, shrinking output and investment, numerous bankruptcies— including sovereign debt defaults, significantly reduced amounts
of trade and commerce— especially international, as well as highly volatile relative currency value fluctuations— most often due to
devaluations.Common elements of depression : Price deflation, financial crisis and bank failures.
4. Recovery : The depression phase does not continue indefinitely. The retrenched workers offer their services at lower wages.
Prices.are,at,the -lowest level. Hence consumers start purchasing. Banks having surplus funds, startiending at low interest rates.
With increase in demand, the piled up stock get exhaust. The economic activity starts again. Increased incomes lead to increasing
demand, increasing production, investment, employment.

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  SUPPLY OF MONEY
Posted by: anupma - 06-17-2015, 08:46 PM - Forum: CAIIB-- Advanced Bank Management - No Replies

Supply of money, as assumed by Prof. Keynes, includes both types of money: currency notes and coins as well as bank credit. Since the supply of money depends upon the monetary policy of government and Central Bank, it can be assumed to remain fixed, at least over a
short period. According to this theory, rate of interest is determined at the point at which the demand and supply of money are equal.
D) Modern Theory of Interest (Hicks & Hensen Theory):
Hicks and Hensen theory has bought the synthesis between Keynes and Classical theory of rate of interest. IS curve is derived from
Classical theory, whereas LM curve is derived from Keynes liquidity preference theory of interest. Rate of interest is determined at the
point at which IS curve and LM curve intersect each other.

  •  IS curve = Investment Saving Schedule
  •  LM curve = Liquidity preference and money supply equilibrium.
  •  IS curve is locus of different combination of rate of interest and income which shows equilibrium in goods market and also shows
the saving investments equality.
  •  LM curve shows the different combination of rate of interest and income, which shows equilibrium in money market.
  •  Equilibrium of Liquidity Preferences (L) and supply of money (M) of Keynesian theory produces LM curve, which implies money market equilibrium.
  •  Equilibrium of Investment (I) and savings (S) of classical theory produces IS curve which implies goods market equilibri6m.
  •  IS curve slopes downward to the right— inverse relationship between the level of income and rate of interest.
  •  LM CURVE MOVES UPWARD TO THE RIGHT ( DIRECT RELATIONSHIP BETWEEN RATE OF INTEREST & LEVEL OF INCOME ).

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  THEORIES Of INTEREST
Posted by: sarita - 06-17-2015, 08:42 PM - Forum: CAIIB-- Advanced Bank Management - No Replies

INTEREST
As per Marshall, 'Interest is the price for the use of capital in a market'. In other words, interest is that part of national income which is paid to capitalists as a reward of the services of capital. However, in Keynes opinion, interest is a reward for parting with liquidity for a specified period.
Three distinct elements can be distinguished in interest:
a) Reward for the risk involved in making the loan;
b) Payment for the trouble involved;
c) Pure interest, i.e., price of the capital.
GROSS INTEREST = Net interest + reward for risk + reward for inconvenience + reward for pains + reward for management.
NET INTEREST = (Gross Interest)— (Reward for Risk + Reward for inconvenience + Reward for Pains + reward for management).
FACTORS AFFECTING THE RATE OF INTEREST:
a) Difference is risk perception.
b) Difference on account of credit rating of borrower.
c) Difference in maturity period of loan.
d) Purpose and end use of the loan.
f) Nature of the primary and collateral security.
g) Quality of third party guarantee.
IMPORTANT THEORIES OF INTEREST
A) Prof. Senior: Abstinence. heory of Interest: "Interest is the reward for waiting and abstinence".
B) Fishers Time Preference Theory of Interest: Interest is the reward paid to induce people to postpone their present consumption and to
lend their money.
C) Keynes Liquidity Preference Theory of Interest: Prof J.M. Keynes in his book, the General Theory of Employment, Interest and Money, has
viewed rate of interest as a purely monetary phenomenon and is determined by demard for money and supply of money. According to this
theory, rate of interest is determined by liquidity preference, i.e., demand of money on one side and the supply of money on the other.
Demand of money means the demand for keeping money in liquid form. Thus, demand of money means liquidity preference. The term
liquidity preference means the habit cf persons to keep their money in liquid form. When a person gets his income, he has to take two
important decisions:
a) How much to spend and how much to save, and
b) How much to save in liquid form and how much to save in non-liquid form.
The term liquid form means to keep money in the form of ready purchasing power i.e. cash or gold or any such way as can readily be
converted into cash. The term non-liquid form means to invest money in iong term securities and capital goods
FACTORS AFFECTING LIQUIDITY PREFERENCE
Keynes explained interest in terms of purely monetary forces. Keynes assumed a simplified economy where there are two assets which
people can keep in their portfolio balance. These two assets are:
a) Money in the form of currency and current deposits in the banks which earn no interest,
b) According to Keynes, rate of interest and bond prices are inversely rlated. When bond prices go up, rate of interest rises and vice versa.
The demand for money by the people depends upon how they decide to balance their portfolios between money and
bonds. This decision about portfolio bal?nre ran he influenced by two factors.
First, the higher the level of nominal income in a two-asset economy, more the money people would want to hold in their portfolio balance.
This is because of transactions motive according to which at the higher level of nominal income, the purchases by the people of goods and services in their daily life will be relatively larger, which require more money to be kept for transactions purposes.
Second, the higher the nominal rate of interest, the lower the demand for money for speculative motive. This is firstly because a higher
nominal rate of interest implies a higher opportunity cost for holding money. At higher rate of interest, holders of money can earn more
incomes by holding bonds instead of money. Secondly, if the current rate of interest is higher than what is expected in the future, the, people would like to hold more bonds and less money in their portfolio. On the other hand, if the current rate of interest is low (in other words, if the bond prices are currently high), the people will be reluctant to hold larger quantity of bonds (and instead they could hold more money in their portfolio) because of the inherent fear that bond prices would ne fall in the future causing capital losses to them.
Prof. Keynes cites three motives to explain why people prefer to keep their money in liquid form. These motives are as under
1.Transactional Motives: People keep a part of their income in liquid form so that they can pay their regular expenses. Liquidity preference
for transactional motives will depend upon the size of income, time of receipt and number of transactions.
2.Precautionary Motives: People keep some part of income to provide for contingencies, such as illness, accident, unemployment etc.
Liquidity preference for such motives depends upon the level of income, size of family, living conditions and habit of individuals etc.
3.Speculative Motives: Some persons like to keep their money in liquid form for speculative purposes also so that they can get the advantage of changes in the rate of interest.Thus, Demand of money = Transactional motive + Precautionary motive + Speculative motive.
Liquidity preference depends upon the income and rate of interest. There is an inverse relationship between rate of interest and demand for money (liquidity preference). If the rate of interest is high, liquidity preference will be less because the people would like to invest more and more amount. If the rate of interest is low, liquidity preference will be more because the people would like to keep the money with themselves.

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  Money Supply and Inflation
Posted by: suraj - 06-16-2015, 07:38 PM - Forum: CAIIB-- Advanced Bank Management - No Replies

Money : Anything that performs one of the following functions, is money:
Medium of exchange i.e. all goods and services or physical assets are priced in terms of money and exchanged by using money. A measure of value i.e. money is used to measure and record the value of goods and services A store of value of time i.e. money can be held for any time and can be used in future 4. Standard for deferred payments i.e. ukoney is used as an agreed measure of future receipts and payments in different contracts.
Money supply : It refers to stock of money in circulation in the economy at given point of time. This is decided by the Govt. and by the
Central Monetary Authority (RBI in India). Money stock measures were introduced by RBI during 1970 and the working group
under Y B Reddy suggested major changes in the money stock' measures, which gave its recommendations :during Dec
1997), implemented during June 1998. The current measures are monetary (M) and (L) aggregates.
MONEY SUPPLY MEASURES
Money Supply refers to amount of money in circulation. The working group under the chairmanship of Dr. V.V. Reddy, the thbn Deputy
Governor RBI, has suggested four new money measures (Mo, M1, Mz, M3) and three liquidity measures (Li, L2. L3). A ) MONETARY
AGGRECATES

  • Mo = Currency in Circulation + Bankers Deposits with the RBI + 'Other' Deposits with the RBI;
  • M1 = Currency with the Public + Demand Deposits with the Banking System + 'Other' Deposits with the RBI = Currency with the Public + Current Deposits with the Banking system + Demand Liabilities portion of Savings Deposits with the Banking System + 'Other'
Deposits with the RBI;
  • M2 = M1 4- Time Liabilities portion of Savings Deposits with the Banking System + Certificates of Deposit issued by Banks + Term
Deposits (excluding FCNR (B) deposits) with a contractual maturity up to and including one year with the Banking System; and
  • M3 = M2 + Term Deposits (excluding FCNR (B) Deposits) with a contractual maturity of over one year with the Banking System + Call
borrowings from 'Non-Depository' Financial Corporations by the Banking System.
  • M1 is known as Narrow Money ; M3 is known as Broad Money; Demand Deposits are those deposits which are payable on demand. It includes current deposits, demand liabilities portion of liabilities, etc.
B) LIQUIDITY AGGREGATES
  • M3 + all deposits with the Post Office Savings Banks (excluding National Savings Certificates).
  •  L2 = L1 + Term Deposits with Term Lending Institutions and Refinancing Institutions (Fls) + Term Borrowing by Fls + Certificates of Deposit issued by Fls, and
  • L3 = L2 + Public Deposits of Non-Banking Financial Companies
Sources of money supply
Sources of money supply include net bank credit to the govt., net bank credit to commercial sector, net foreign exchange assets of banking sector, Govt. currency liabilities to the"public,_net non monetary liabilities of RBI and the banks.
Inflation
Inflation refers to regular increase in the general price level of prices of goods and services, in an economy, over a period of time. Inflation
leads to fall in purchasing power,' because with rise in price of goods and services, the same amount of money, can purchase fewer goods and services. Inflation has positive as well as negative impact on the economy. Inflation helps in bringing an economy out of recession. The negative effect is loss in real value of money.
Demand pull inflation: It is a general increase in prices of goods and services due to increasing aggregate demand for goods and services.
The increasing demand is the result of increased quantity of money in the hands of consumers. 
Demand --> Supply--> Shortage of goods & Services--> Increase in Price
Cost-push inflation: It is caused by substantial increase in the prices of inputs used to produce goods and services. In such cases, the
producers adjust the production. Either they increase the price of the goods produced by them or they produce less that leads to shortage
and inflation.
Measures of inflation
The increase in general price level is measured by a price index. The price index is a weighted average of the prices of selected goods and
services, in comparison to the prices prevailing in the base year.
Inflation = (Price index in the current year – price index in the base year) / price index in the base year x 100

Important price indices include the following:
Wholesale price index (WPI) – This reflects change in the level of prices of goods at the wholesale level. It relates to exchange of goods the level of traders/suppliers and not at the level of consumers. WPI is also known as Headline Inflation. In India, WPI is the official inflation Index.
 Food inflation index : Within the overall WPI, this is a separate index for a group of food and-fuel commodities.
Consumer price index : This index reflects the change in price level of goods and services when these are purchased by the
consumers/households. It measures, the prices at retail level. This is more relevant for the consumer. It is also called core inflation. It is
released by Labour Bureau,Ministry of Labour and Employment, Govt. of India.. The CPI can be different for different groups of consumers
which include consumer price index for agricultural labour (CPI-AL), consumer price index for industrial workers (CPI-.IW)„ consumer price
index for urban non-manual employees (CPI-UNME )and consumer price index for rural labour (CPI-RL).
GDP deflator : It is a measure of the level of prices of all new, Domestically produced, final goods and services in an economy. It is not based on fixed basket of goods and services. The basket changes with consumption and investment pattern. Hence, new expenditure patters show up in the deflator as people respond to changing price.

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