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1. Definition of accounting: the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least of a financial character and interpreting the results there of. 2. Book keeping: It is mainly concerned with recording of financial data relating to the business operations in a significant and orderly manner. PRINCEPLES OF ACCOUNTING (3, 4) 3. Concepts of accounting: A. separate entity concept B. going concernconcept C. money measurement concept D. cost concept E. dual aspect concept F. accounting period concept G. periodic matching of costs and revenue concept H. realization concept. 4 Conventions of accounting A. conservatism B. full disclosure C. consistency D materiality. 5. Systems of book keeping: A. single entry system B. double entry system 6. Systems of accounting A. cash system accounting B. mercantile system of accounting. 7. Roles of accounting a. personal a/c : debit the receiver Credit the giver b. real a/c : debit what comes in credit what goes out c. nominal a/c : debit all expenses and losses credit all gains and incomes 8. Meaning of journal: journal means chronological record of transactions. 9. Meaning of ledger: ledger is a set of accounts. It contains all accounts of the business enterprise whether real, nominal, personal. 10. Posting: it means transferring the debit and credit items from the journal to their respective accounts in the ledger. 11. Trial balance: trial balance is a statement containing the various ledger balances on a particular date. 12. Credit note: the customer when returns the goods get credit for the value of the goods returned. A credit note is sent to him intimating that his a/c has been credited with the value of the goods returned.
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13. Debit note: when the goods are returned to the supplier, a debit note is sent to him indicating that his a/c has been debited with the amount mentioned in the debit note. 14. Contra entry: which accounting entry is recorded on both the debit and credit side of the cashbook is known as the contra entry. 15. Petty cash book: petty cash is maintained by business to record petty cash expenses of the business, such as postage, cartage, stationery, etc. 16.promisory note: an instrument in writing containing an unconditional undertaking igned by the maker, to pay certain sum of money only to or to the order of a certain person or to the barer of the instrument. 17. Cheque: a bill of exchange drawn on a specified banker and payable on demand. 18. Stale cheque: a stale cheque means not valid of cheque that means more than six months the cheque is not valid. 20. Bank reconciliation statement: it is a statement reconciling the balance as shown by the bank passbook and the balance as shown by the Cash Book. Obj: to know the difference & pass necessary correcting, adjusting entries in the books. 21. Matching concept: matching means requires proper matching of expense with the revenue. 22. Capital income: the term capital income means an income which does not grow out of or pertain to the running of the business proper. 23. Revenue income: the income, which arises out of and in the course of the regular business transactions of a concern. 24. Capital expenditure: it means an expenditure which has been incurred for the purpose of obtaining a long term advantage for the business. 25. Revenue expenditure: an expenditure that incurred in the course of regular business transactions of a concern. 26. Differed revenue expenditure: an expenditure, which is incurred during an accounting period but is applicable further periods also. Eg: heavy advertisement. 27. Bad debts: bad debts denote the amount lost from debtors to whom the goods were sold on credit. 28. Depreciation: depreciation denotes gradually and permanent decrease in the value of asset due to wear and tear, technology changes, laps of time and accident. 29. Fictitious assets: These are assets not represented by tangible possession or property. Examples of preliminary expenses, discount on issue of shares, debit balance in the profit and loss account when shown on the assets side in the balance sheet. 30.Intanglbe Assets: Intangible assets mean the assets which is not having the physical appearance. And its have the real value, it shown on the assets side of the balance sheet. 31. Accrued Income : Accrued income means income which has been earned by the business during the accounting year but which has not yet been due and, therefore, has not been received. 32. Out standing Income : Outstanding Income means income which has become due during the accounting year but which has not so far been received by the firm. 33. Suspense account: the suspense account is an account to which the difference in the trial balance has been put temporarily.
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34. Depletion: it implies removal of an available but not replaceable source, Such as extracting coal from a coal mine. 35. Amortization: the process of writing of intangible assets is term as amortization. 36. Dilapidations: the term dilapidations to damage done to a building or other property during tenancy. 37. Capital employed: the term capital employed means sum of total long term funds employed in the business. i.e. (Share capital+ reserves & surplus +long term loans (Non business assets + fictitious assets) 38. Equity shares: those shares which are not having pref. rights are called equity shares. 39. Pref.shares: Those shares which are carrying the pref.rights is called pref. shares. Pref.rights in respect of fixed dividend. Pref.right to repayment of capital in the even of Company winding up. 40. Leverage: It is a force applied at a particular work to get the desired result. 41. Operating leverage: the operating leverage takes place when a changes in revenue greater changes in EBIT. 42. Financial leverage : it is nothing but a process of using debt capital to increase the rate of return on equity 43. Combine leverage: it is used to measure of the total risk of the firm = operating risk + financial risk. 44. Joint venture: A joint venture is an association of two or more the persons who combined for the execution of a specific transaction and divide the profit or loss their of an agreed ratio. 45. Partnership: partnership is the relation b/w the persons who have agreed to share the profits of business carried on by all or any of them acting for all. 46. Factoring: It is an arrangement under which a firm (called borrower) receives advances against its receivables, from a financial institutions (called factor) 47. Capital reserve: The reserve which transferred from the capital gains is called capital reserve. 48.General reserve: the reserve which is transferred from normal profits of the firm is called general reserve 49. Free Cash: The cash not for any specific purpose free from any encumbrance like surplus cash. 50. Minority Interest: minority interest refers to the equity of the minority shareholders in a subsidiary company. 51. Capital receipts: capital receipts may be defined as non-recurring receipts from the owner of the business or lender of the money crating a liability to either of them. 52. Revenue receipts: Revenue receipts may defined as A recurring receipts against sale of goods in the normal course of business and which generally the result of the trading activities. 53. Meaning of Company: A company is an association of many persons who contribute money or moneys worth to common stock and employs it for a common purpose. The common stock so contributed is denoted in money and is the capital of the company.
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54. Types of a company: 1.Statutory companies 2.government company 3.foreign company 4.Registered companies: a. Companies limited by shares b. Companies limited by guarantee c. Unlimited companies D. private company E. public company 55. Private company: A private co. is which by its AOA: Restricts the right of the members to transfer of shares Limits the no. Of members 50. Prohibits any Invitation to the public to subscribe for its shares or debentures. 56. Public company: A company, the articles of association of which does not contain the requisite restrictions to make it a private limited company, is called a public company. 57. Characteristics of a company: Voluntary association Separate legal entity Free transfer of shares Limited liability Common seal Perpetual existence. 58. Formation of company: Promotion Incorporation Commencement of business 59. Equity share capital: The total sum of equity shares is called equity share capital. 60. Authorized share capital: it is the maximum amount of the share capital, which a company can raise for the time being. 61. Issued capital: It is that part of the authorized capital, which has been allotted to the public for subscriptions. 62. Subscribed capital: it is the part of the issued capital, which has been allotted to the public 63. Called up capital: It has been portion of the subscribed capital which has been called up by the company. 64. Paid up capital: It is the portion of the called up capital against which payment has been received. 65. Debentures: Debenture is a certificate issued by a company under its seal acknowledging a debt due by it to its holder. 66. Cash profit: cash profit is the profit it is occurred from the cash sales. 67. Deemed public Ltd. Company: A private company is a subsidiary company to public company it satisfies the following terms/conditions Sec 3(1)3:
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1.having minimum share capital 5 lakhs 2.accepting investments from the public 3.no restriction of the transferable of shares 4.No restriction of no. of members. 5.accepting deposits from the investors 68. Secret reserves: secret reserves are reserves the existence of which does not appear on the face of balance sheet. In such a situation, net assets position of the business is stronger than that disclosed by the balance sheet. These reserves are crated by: 1.Excessive dep.of an asset, excessive over-valuation of a liability. 2.Complete elimination of an asset, or under valuation of an asset. 69. Provision: provision usually means any amount written off or retained by way of providing depreciation, renewals or diminutions in the value of assets or retained by way of providing for any known liability of which the amount can not be determined with substantial accuracy. 70. Reserve: The provision in excess of the amount considered necessary for the purpose it was originally made is also considered as reserve Provision is charge against profits while reserves is an appropriation of profits Creation of reserve increase proprietors fund while creation of provisions decreases his funds in the business. 71. Reserve fund: the term reserve fund means such reserve against which clearly investment etc., 72. Undisclosed reserves: Sometimes a reserve is created but its identity is merged with some other a/c or group of accounts so that the existence of the reserve is not known such reserve is called an undisclosed reserve. 73. Finance management: financial management deals with procurement of funds and theireffective utilization in business. 74. Objectives of financial management: financial management having two objectives that Is: 1. Profit maximization: the finance manager has to make his decisions in a manner so that the profits of the concern are maximized. 2. Wealth maximization: wealth maximization means the objective of a firm should be to maximize its value or wealth, or value of a firm is represented by the market price of its common stock.

75. Functions of financial manager: Investment decision Dividend decision Finance decision Cash management decisions Performance evaluation Market impact analysis
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76. Time value of money: the time value of money means that worth of a rupee received today is different from the worth of a rupee to be received in future. 77. Capital structure: it refers to the mix of sources from where the long-term funds required in a business may be raised; in other words, it refers to the proportion of debt, preference capitaland equity capital. 78. Optimum capital structure: capital structure is optimum when the firm has a combination of equity and debt so that the wealth of the firm is maximum. 79. Wacc: it denotes weighted average cost of capital. It is defined as the overall cost of capital computed by reference to the proportion of each component of capital as weights. 80. Financial break-even point: it denotes the level at which a firms EBIT is just sufficient to cover interest and preference dividend. 81. Capital budgeting: capital budgeting involves the process of decision making with regard to investment in fixed assets. Or decision making with regard to investment of money in long-term projects. 82. Pay back period: payback period represents the time period required for complete recovery ofthe initial investment in the project. 83. ARR: accounting or average rate of return means the average annual yield on the project. 84. NPV: the net present value of an investment proposal is defined as the sum of the present values of all future cash in flows less the sum of the present values of all cash out flows associated with the proposal. 85. Profitability index: where different investment proposal each involving different initial investments and cash inflows are to be compared. 86. IRR: internal rate of return is the rate at which the sum total of discounted cash inflows equalsthe discounted cash out flow. 87. Treasury management: it means it is defined as the efficient management of liquidity and financial risk in business. 88. Concentration banking: it means identify locations or places where customers are placed and open a local bank a/c in each of these locations and open local collection canter. 89. Marketable securities: surplus cash can be invested in short term instruments in order to earn interest. 90. Ageing schedule: in a ageing schedule the receivables are classified according to their age. 91. Maximum permissible bank finance (MPBF): it is the maximum amount that banks can lend a borrower towards his working capital requirements. 92. Commercial paper: a cp is a short term promissory note issued by a company, negotiable by endorsement and delivery, issued at a discount on face value as may be determined by the issuing company. 93.Bridge finance: It refers to the loans taken by the company normally from a commercial banks for a short period pending disbursement of loans sanctionedby the financial institutions.
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94. Venture capital: It refers to the financing of high-risk ventures promoted by new qualified entrepreneurs who require funds to give shape to their ideas. 95. Debt securitization: It is a mode of financing, where in securities are issued on the basis of a package of assets (called asset pool). 96. Lease financing: Leasing is a contract where one party (owner) purchases assets and permits its views by another party (lessee) over a specified period 97. Trade Credit: It represents credit granted by suppliers of goods, in the normal course of business. 98. Over draft: Under this facility a fixed limit is granted within which the borrower allowed to overdraw from his account. 99. Cash credit: It is an arrangement under which a customer is allowed an advance up to certain limit against credit granted by bank. 100. Clean overdraft: It refers to an advance by way of overdraft facility, but not back by any tangible security. 101. Share capital: The sum total of the nominal value of the shares of a company is called share capital. 102. Funds flow statement: It is the statement deals with the financial resources for running business activities. It explains how the funds obtained and how they used. 103.Sources of funds: There are two sources of funds Internal sources and external sources.Internal source: Funds from operations is the only internal sources of funds and some important points add to it they do not result in the outflow of funds Depreciation on fixed assets (b) Preliminary expenses or goodwill written off, Loss on sale of fixed assets Deduct the following items, as they do not increase the funds: Profit on sale of fixed assets, profit on revaluation Of fixed assets External sources: (a) Funds from long-term loans (b)Sale of fixed assets (c) Funds from increase in share capital 104. Application of funds: (a) Purchase of fixed assets (b) Payment of dividend (c)Payment of tax liability (d) Payment of fixed liability 105. ICD (Inter corporate deposits): Companies can borrow funds for a short period. For example 6 months or less from another company which have surplus liquidity. Such eposits made by one company in another company are called ICD. 1 06. Certificate of deposits: The CD is a document of title similar to a fixed deposit receipt issued by banks there is no prescribed interest rate on such CDs it is based on the prevailing market conditions. 107. Public deposits: It is very important source of short term and medium term finance. The company can accept PD from members of the public and shareholders. It has the maturity period of 6 months to 3 years. 108.Euro issues: The euro issues means that the issue is listed on a European stock Exchange. The subscription can come from any part of the world except India.
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109.GDR (Global depository receipts): A depository receipt is basically a negotiable certificate , dominated in us dollars that represents a non-US company publicly traded in local currency equity shares. 110. ADR (American depository receipts): Depository receipt issued by a company in the USA are known as ADRs. Such receipts are to be issued in accordance with the provisions stipulated by the securities Exchange commission (SEC) of USA like SEBI in India. 111.Commercial banks: Commercial banks extend foreign currency loans for international operations, just like rupee loans. The banks also provided overdraft. 112.Development banks: It offers long-term and medium term loans including foreign currency loans 113.International agencies: International agencies like the IFC,IBRD,ADB,IMF etc. provide indirect assistance for obtaining foreign currency. 114. Seed capital assistance: The seed capital assistance scheme is desired by the IDBI for professionally or technically qualified entrepreneurs and persons possessing relevant experience and skills and entrepreneur traits. 115. Unsecured l0ans: It constitutes a significant part of long-term finance available to an enterprise. 116. Cash flow statement: It is a statement depicting change in cash position from one period to another.

117.Sources of cash: Internal sources(a)Depreciation (b)Amortization (c)Loss on sale of fixed assets (d)Gains from sale of fixed assets (e) Creation of reserves External sources(a)Issue of new shares (b)Raising long term loans (c)Short-term borrowings (d)Sale of fixed assets, investments 118. Application of cash: (a) Purchase of fixed assets (b) Payment of long-term loans (c) Decrease in deferred payment liabilities (d) Payment of tax, dividend (e) Decrease in unsecured loans and deposits 119. Budget: It is a detailed plan of operations for some specific future period. It is an estimate prepared in advance of the period to which it applies. 120. Budgetary control: It is the system of management control and accounting in which all operations are forecasted and so for as possible planned ahead, and the actual results compared with the forecasted and planned ones.
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121. Cash budget: It is a summary statement of firms expected cash inflow and outflow over a specified time period. 122. Master budget: A summary of budget schedules in capsule form made for the purpose of presenting in one report the highlights of the budget forecast. 123. Fixed budget: It is a budget, which is designed to remain unchanged irrespective of the level of activity actually attained. 124.Zero- base- budgeting: It is a management tool which provides a systematic method for evaluating all operations and programmes, current of new allows for budget reductions and expansions in a rational manner and allows reallocation of source from low to high priority programs. 125. Goodwill: The present value of firms anticipated excess earnings. 126. BRS: It is a statement reconciling the balance as shown by the bank pass book and balance shown by the cash book. 127. Objective of BRS: The objective of preparing such a statement is to know the causes of difference between the two balances and pass necessary correcting or adjusting entries in the books of the firm. 128.Responsibilities of accounting: It is a system of control by delegating and locating theResponsibilities for costs. 129. Profit centre: A centre whose performance is measured in terms of both the expense incurs and revenue it earns. 130.Cost centre: A location, person or item of equipment for which cost may be ascertained and used for the purpose of cost control. 131. Cost: The amount of expenditure incurred on to a given thing. 132. Cost accounting: It is thus concerned with recording, classifying, and summarizing costs for determination of costs of products or services planning, controlling and reducing such costs and furnishing of information management for decision making. 133. Elements of cost: (A) Material (B) Labour (C) Expenses (D) Overheads 134. Components of total costs: (A) Prime cost (B) Factory cost (C)Total cost of production (D) Total c0st 135. Prime cost: It consists of direct material direct labour and direct expenses. It is also known as basic or first or flat cost. 136. Factory cost: It comprises prime cost, in addition factory overheads which include cost of indirect material indirect labour and indirect expenses incurred in factory. This cost is also known as works cost or production cost or manufacturing cost. 137. Cost of production: In office and administration overheads are added to factory cost, office cost is arrived at. 138. Total cost: Selling and distribution overheads are added to total cost of production to get the total cost or cost of sales.
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139. Cost unit: A unit of quantity of a product, service or time in relation to which costs may be ascertained or expressed. 140.Methods of costing: (A)Job costing (B)Contract costing (C)Process costing (D)Operation costing (E)Operating costing (F)Unit costing (G)Batch costing. 141. Techniques of costing: (a) marginal costing (b) direct costing (c)absorption costing (d) uniform costing. 142. Standard costing: standard costing is a system under which the cost of the product is determined in advance on certain predetermined standards. 143. Marginal costing: it is a technique of costing in which allocation of expenditure to production is restricted to those expenses which arise as a result of production, i.e., materials, labour, direct expenses and variable overheads. 144. Derivative: derivative is product whose value is derived from the value of one or more basic variables of underlying asset. 145. Forwards: a forward contract is customized contracts between two entities were settlement takes place on a specific date in the future at todays pre agreed price. 146. Futures: a future contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Future contracts are standardized exchange traded contracts. 147. Options: an option gives the holder of the option the right to do some thing. The option holder option may exercise or not. 148. Call option: a call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price. 149. Put option: a put option gives the holder the right but not obligation to sell an asset by a certain date for a certain price. 150. Option price: option price is the price which the option buyer pays to the option seller. It is also referred to as the option premium. 151. Expiration date: the date which is specified in the option contract is called expiration date. 152. European option: it is the option at exercised only on expiration date it self. 153. Basis: basis means future price minus spot price. 154. Cost of carry: the relation between future prices and spot prices can be summarized in terms of what is known as cost of carry. 155. Initial margin: the amount that must be deposited in the margin a/c at the time of first entered into future contract is known as initial margin. 156 Maintenance margin: this is some what lower than initial margin. 157. Mark to market: in future market, at the end of the each trading day, the margin a/c is adjusted to reflect the investors gains or loss depending upon the futures selling price. This is called mark to market. 158. Baskets : basket options are options on portfolio of underlying asset. 159. Swaps: swaps are private agreements between two parties to exchange cash flows in the future according to a pre agreed formula. 160. Impact cost: impact cost is cost it is measure of liquidity of the market. It reflects the costs faced when actually trading in index.
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161. Hedging: hedging means minimize the risk. 162. Capital market: capital market is the market it deals with the long term investment funds. It consists of two markets 1.primary market 2.secondary market. 163. Primary market: those companies which are issuing new shares in this market. It is also called new issue market. 164. Secondary market: secondary market is the market where shares buying and selling. In India secondary market is called stock exchange. 165. Arbitrage: it means purchase and sale of securities in different markets in order to profit from price discrepancies. In other words arbitrage is a way of reducing risk of loss caused by price fluctuations of securities held in a portfolio. 166. Meaning of ratio: Ratios are relationships expressed in mathematical terms between figures which are connected with each other in same manner. 167. Activity ratio: it is a measure of the level of activity attained over a period. 168. mutual fund : a mutual fund is a pool of money, collected from investors, and is invested according to certain investment objectives. 169. characteristics of mutual fund : Ownership of the MF is in the hands of the of the investors MF managed by investment professionals The value of portfolio is updated every day 170.advantage of MF to investors : Portfolio diversification Professional management Reduction in risk Reduction of transaction casts Liquidity Convenience and flexibility 171.net asset value : the value of one unit of investment is called as the Net Asset Value 172.open-ended fund : open ended funds means investors can buy and sell units of fund, at NAV related prices at any time, directly from the fund this is called open ended fund. For ex; unit 64 173.close ended funds : close ended funds means it is open for sale to investors for a specific period, after which further sales are closed. Any further transaction for buying the units or repurchasing them, happen, in the secondary markets. 174. dividend option : investors who choose a dividend on their investments, will receive dividends from the MF, as when such dividends are declared. 175.growth option : investors who do not require periodic income distributions can be choose the growth option. 176.equity funds : equity funds are those that invest pre-dominantly in equity shares of company. 177.types of equity funds : Simple equity funds Primary market funds Sectoral funds Index funds 178. sectoral funds : sectoral funds choose to invest in one or more chosen sectors of the equity markets. 179.index funds :the fund manager takes a view on companies that are expected to perform well, and invests in these companies 180.debt funds : the debt funds are those that are pre-dominantly invest in debt securities. 181. liquid funds : the debt funds invest only in instruments with maturities less than one year.
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182. gilt funds : gilt funds invests only in securities that are issued by the GOVT. and therefore does not carry any credit risk. 183.balanced funds :funds that invest both in debt and equity markets are called balanced funds. 184. sponsor : sponsor is the promoter of the MF and appoints trustees, custodians and the AMC with prior approval of SEBI . 185. trustee : trustee is responsible to the investors in the MF and appoint the AMC for managing the investment portfolio. 186. AMC : the AMC describes Asset Management Company, it is the business face of the MF, as it manages all the affairs of the MF. 187. R & T Agents : the R&T agents are responsible for the investor servicing functions, as they maintain the records of investors in MF. 188. custodians : custodians are responsible for the securities held in the mutual funds portfolio. 189. scheme take over : if an existing MF scheme is taken over by the another AMC, it is called as scheme take over. 190.meaning of load: load is the factor that is applied to the NAV of a scheme to arrive at the price. 192. market capitalization : market capitalization means number of shares issued multiplied with market price per share. 193.price earning ratio : the ratio between the share price and the post tax earnings of company is called as price earning ratio. 194. dividend yield : the dividend paid out by the company, is usually a percentage of the face value of a share. 195. market risk : it refers to the risk which the investor is exposed to as a result of adverse movements in the interest rates. It also referred to as the interest rate risk. 196. Re-investment risk : it the risk which an investor has to face as a result of a fall in the interest rates at the time of reinvesting the interest income flows from the fixed income security. 197. call risk : call risk is associated with bonds have an embedded call option in them. This option hives the issuer the right to call back the bonds prior to maturity. 198. credit risk : credit risk refers to the probability that a borrower could default on a commitment to repay debt or band loans 199.inflation risk : inflation risk reflects the changes in the purchasing power of the cash flowsresulting from the fixed income security. 200.liquid risk : it is also called market risk, it refers to the ease with which bonds could be traded in the market. 201.drawings : drawings denotes the money withdrawn by the proprietor from the business for his personal use. 202.outstanding Income : Outstanding Income means income which has become due during the accounting year but which has not so far been received by the firm.

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203.Outstanding Expenses : Outstanding Expenses refer to those expenses which have become due during the accounting period for which the Final Accounts have been prepared but have not yet been paid. 204.closing stock : The term closing stock means goods lying unsold with the businessman at the end of the accounting year. 205. Methods of depreciation : 1.Unirorm charge methods : a. Fixed installment method b .Depletion method c. Machine hour rate method. 2. Declining charge methods : a. Diminishing balance method b.Sum of years digits method c. Double declining method 3. Other methods : a. Group depreciation method b. Inventory system of depreciation c. Annuity method d. Depreciation fund method e. Insurance policy method. 206.Accrued Income : Accrued Income means income which has been earned by the business during the accounting year but which has not yet become due and, therefore, has not been received. 207.Gross profit ratio : it indicates the efficiency of the production/trading operations. ] Formula : Gross profit -------------------X100 Net sales 208.Net profit ratio : it indicates net margin on sales Formula: Net profit --------------- X 100 Net sales 209. return on share holders funds : it indicates measures earning power of equity capital. Formula : profits available for Equity shareholders -----------------------------------------------X 100 Average Equity Shareholders Funds 210. Earning per Equity share (EPS) : it shows the amount of earnings attributable to each equity share. Formula :profits available for Equity shareholders ---------------------------------------------Number of Equity shares
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211.dividend yield ratio : it shows the rate of return to shareholders in the form of dividends based in the market price of the share Formula : Dividend per share ---------------------------- X100 Market price per share 212. price earning ratio : it a measure for determining the value of a share. May also be used tomeasure the rate of return expected by investors. Formula : Market price of share(MPS) -------------------------------X 100 Earning per share (EPS) 213.Current ratio : it measures short-term debt paying ability. Formula : Current Assets -----------------------Current Liabilities 214. Debt-Equity Ratio : it indicates the percentage of funds being financed through borrowings; a measure of the extent of trading on equity. Formula : Total Long-term Debt --------------------------Shareholders funds 215.Fixed Assets ratio : This ratio explains whether the firm has raised adepuate longterm funds to meet its fixed assets requirements. Formula Fixed Assets ------------------Long-term Funds 216 . Quick Ratio : The ratio termed as liquidity ratio. The ratio is ascertained y comparing theliquid assets to current liabilities. Formula : Liquid Assets -----------------------Current Liabilities 217. Stock turnover Ratio : the ratio indicates whether investment in inventory in efficiently used or not. It, therefore explains whether investment in inventory within proper limits or not. Formula: cost of goods sold -----------------------Average stock 218. Debtors Turnover Ratio : the ratio the better it is, since it would indicate that debts are beingcollected more promptly. The ration helps in cash budgeting since the flow of cash from customers can be worked out on the basis of sales. Formula: Credit sales ---------------------------Average Accounts Receivable
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219.Creditors Turnover Ratio : it indicates the speed with which the payments for credit purchases are made to the creditors. Formula: Credit Purchases ----------------------Average Accounts Payable 220. Working capital turnover ratio : it is also known as Working Capital Leverage Ratio. This ratioIndicates whether or not working capital has been effectively utilized in making sales. Formula: Net Sales ---------------------------Working Capital 221.Fixed Assets Turnover ratio : This ratio indicates the extent to which the investments in fixed assets contributes towards sales. Net Sales -------------------------Fixed Assets 222 .Pay-out Ratio : This ratio indicates what proportion of earning per share has been used for paying dividend. Formula: Dividend per Equity Share --------------------------------------------X100 Earning per Equity share 223.Overall Profitability Ratio : It is also called as Return on Investment (ROI) or Return on Capital Employed (ROCE) . It indicates the percentage of return on the total capital employed in the business. Formula : Operating profit ------------------------X 100 Capital employed The term capital employed has been given different meanings a.sum total of all assets whether fixed or current b.sum total of fixed assets, c.sum total of long-term funds employed in the business, i.e., share capital +reserves &surplus +long term loans (non business assets + fictitious assets). Operating profit means profit before interest and tax 224 . Fixed Interest Cover ratio : the ratio is very important from the lenders point of view. Itindicates whether the business would earn sufficient profits to pay periodically the interestcharges. Formula : Income before interest and Tax --------------------------------------Interest Charges 225. Fixed Dividend Cover ratio : This ratio is important for preference shareholders entitled to get dividend at a fixed rate in priority to other shareholders. Formula : Net Profit after Interest and Tax -----------------------------------------15

Formula:

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Preference Dividend 226. Debt Service Coverage ratio : This ratio is explained ability of a company to make payment of principal amounts also on time. Formula : Net profit before interest and tax ---------------------------------------- 1-Tax rate Interest + Principal payment installment 227. Proprietary ratio : It is a variant of debt-equity ratio . It establishes relationship between the proprietors funds and the total tangible assets. Formula : Shareholders funds ---------------------------Total tangible assets 228.Difference between joint venture and partner ship : In joint venture the business is carried on without using a firm name, In the partnership, the business is carried on under a firm name.In the joint venture, the business transactions are recorded under cash system In the partnership, the business transactions are recorded under mercantile system. In the joint venture, profit and loss is ascertained on completion of the venture In the partner ship , profit and loss is ascertained at the end of each year. In the joint venture, it is confined to a particular operation and it is temporary. In the partnership, it is confined to a particular operation and it is permanent. 229.Meaning of Working capital : The funds available for conducting day to day operations of an enterprise. Also represented by the excess of current assets over current liabilities. 230.concepts of accounting : 1.Business entity concepts :- According to this concept, the business is treated as a separate entity distinct from its owners and others. 2.Going concern concept :- According to this concept, it is assumed that a business has a reasonable expectation of continuing business at a profit for an indefinite period of time. 3.Money measurement concept :- This concept says that the accounting records only those transactions which can be expressed in terms of money only. 4.Cost concept :- According to this concept, an asset is recorded in the books at the price paid to acquire it and that this cost is the basis for all subsequent accounting for the asset. 5.Dual aspect concept :- In every transaction, there will be two aspects the receiving aspect and the giving aspect; both are recorded by debiting one accounts and crediting another account. This is called double entry. 6.Accounting period concept :- It means the final accounts must be prepared on a periodic basis. Normally accounting period adopted is one year, more than this period reduces the utility of accounting data. 7.Realization concept :- According to this concepts, revenue is considered as being earned on the data which it is realized, i.e., the date when the property in goods passes the buyer and he become legally liable to pay.
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8.Materiality concepts :- It is a one of the accounting principle, as per only important information will be taken, and un important information will be ignored in the preparation of the financial statement. 9.Matching concepts :- The cost or expenses of a business of a particular period are compared with the revenue of the period in order to ascertain the net profit and loss. 10.Accrual concept :- The profit arises only when there is an increase in owners capital, which is aresult of excess of revenue over expenses and loss. 231. Financial analysis :The process of interpreting the past, present, and future financial condition of a company. 232. Income statement : An accounting statement which shows the level of revenues, expenses and profit occurring for a given accounting period. 233.Annual report : The report issued annually by a company, to its share holders. it containing financial statement like, trading and profit & lose account and balance sheet. 234. Bankrupt : A statement in which a firm is unable to meets its obligations and hence, it is assets are surrendered to court for administration 235 . Lease : Lease is a contract between to parties under the contract, the owner of the asset gives the right to use the asset to the user over an agreed period of the time for a consideration 236.Opportunity cost : The cost associated with not doing something. 237. Budgeting : The term budgeting is used for preparing budgets and other producer forplanning,co-ordination,and control of business enterprise. 238.Capital : The term capital refers to the total investment of company in money, tangible andintangible assets. It is the total wealth of a company. 239.Capitalization : It is the sum of the par value of stocks and bonds out standings. 240. Over capitalization : When a business is unable to earn fair rate on its outstanding securities. 241. Under capitalization : When a business is able to earn fair rate or over rate on it is outstanding securities. 242. Capital gearing : The term capital gearing refers to the relationship between equity and long term debt. 243.Cost of capital : It means the minimum rate of return expected by its investment. 244.Cash dividend : The payment of dividend in cash 245.Define the term accrual : Recognition of revenues and costs as they are earned or incurred . it includes recognition of transaction relating to assets and liabilities as they occur irrespective of the actual receipts or payments. 245. accrued expenses : An expense which has been incurred in an accounting period but for which no enforceable claim has become due in what period against the enterprises. 246.Accrued revenue : Revenue which has been earned is an earned is an accounting period but in respect of which no enforceable claim has become due to in that period by the enterprise.
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247.Accrued liability : A developing but not yet enforceable claim by an another person whichaccumulates with the passage of time or the receipt of service or otherwise. it may rise from the purchase of services which at the date of accounting have been only partly performed and are not yet billable. 248.Convention of Full disclosure : According to this convention, all accounting statements should be honestly prepared and to that end full disclosure of all significant information will be made. 249.Convention of consistency : According to this convention it is essential that accounting practices and methods remain unchanged from one year to another. 250.Define the term preliminary expenses : Expenditure relating to the formation of an enterprise. There include legal accounting and share issue expenses incurred for formation of the enterprise. 251.Meaning of Charge : charge means it is a obligation to secure an indebt ness. It may be fixedcharge and floating charge. 252.Appropriation : It is application of profit towards Reserves and Dividends. 253.Absorption costing : A method where by the cost is determine so as to include the appropriate share of both variable and fixed costs. 254.Marginal Cost : Marginal cost is the additional cost to produce an additional unit of a product. It is also called variable cost. 255. What are the ex-ordinary items in the P&L a/c : The transaction which are not related to the business is termed as ex-ordinary transactions or ex-ordinary items. Egg:profit or losses on the sale of fixed assets, interest received from other company investments, profit or loss on foreign exchange, unexpected dividend received. 256 . Share premium : The excess of issue of price of shares over their face value. It will be showed with the allotment entry in the journal, it will be adjusted in the balance sheet on the liabilities side under the head of reserves & surplus. 257.Accumulated Depreciation : The total to date of the periodic depreciation charges on depreciable assets. 258.Investment : Expenditure on assets held to earn interest, income, profit or other benefits. 259.Capital : Generally refers to the amount invested in an enterprise by its owner. Ex; paid up share capital in corporate enterprise. 260. Capital Work In Progress : Expenditure on capital assets which are in the process of construction as completion. 261. Convertible Debenture : A debenture which gives the holder a right to conversion wholly or partly in shares in accordance with term of issues. 262.Redeemable Preference Share : The preference share that is repayable either after a fixed (or) determinable period (or) at any time dividend by the management. 263. Cumulative preference shares : A class of preference shares entitled to payment of umulatesdividends. Preference shares are always deemed to be cumulative unless they are expressly made non-cumulative preference shares.
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264.Debenture redemption reserve : A reserve created for the redemption of debentures at a future date. 265. Cumulative dividend : A dividend payable as cumulative preference shares which it unpaid cumulates as a claim against the earnings of a corporate before any distribution is made to the other shareholders. 266. Dividend Equalization reserve : A reserve created to maintain the rate of dividend in future years. 267. Opening Stock : The term opening stock means goods lying unsold with the businessman in the beginning of the accounting year. This is shown on the debit side of the trading account. 268.Closing Stock : The term Closing Stock includes goods lying unsold with the businessman at the end of the accounting year. The amount of closing stock is shown on the credit side of the trading account and as an asset in the balance sheet. 269.Valuation of closing stock : The closing stock is valued on the basis of Cost or Market price whichever is less principle. 272. Contingency : A condition (or) situation the ultimate out come of which gain or loss will be known as determined only as the occurrence or non occurrence of one or more uncertain future events. 273.Contingent Asset : An asset the existence ownership or value of which may be known or determined only on the occurrence or non occurrence of one more uncertain future events. 274. Contingent liability : An obligation to an existing condition or situation which may arise infuture depending on the occurrence of one or more uncertain future events. 275. Deficiency : the excess of liabilities over assets of an enterprise at a given date is called deficiency. 276.Deficit : The debit balance in the profit and loss a/c is called deficit. 277.Surplus : Credit balance in the profit & loss statement after providing for proposed appropriation & dividend , reserves. 278.Appropriation Assets : An account sometimes included as a separate section of the profit and loss statement showing application of profits towards dividends, reserves. 279. Capital redemption reserve : A reserve created on redemption of the average cost:the cost of an item at a point of time as determined by applying an average of the cost of all items of the same nature over a period. When weights are also applied in the computation it is termed as weight average cost. 280.Floating Change : Assume change on some or all assets of an enterprise which are not attached to specific assets and are given as security against debt. 281.Difference between Funds flow and Cash flow statement : A Cash flow statement is concerned only with the change in cash position while a funds flow analysis is concerned with change in working capital position between two balance sheet dates. A cash flow statement is merely a record of cash receipts and disbursements. While studying the short-term solvency of a business one is interested not only in cash balance but also in the assets which are easily convertible into cash.
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282. Difference Between the Funds flow and Income statement : A funds flow statement deals with the financial resource required for running the business activities. It explains how were the funds obtained and how were they used, Whereas an incomestatement discloses the results of the business activities, i.e., how much has been earned and how it has been spent.A funds flow statement matches the funds raised and funds applied during a particular period. The source and application of funds may be of capital as well as of revenue nature. An income statement matches the incomes of a period with the expenditure of that period, which are both of a revenue nature.

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1. What is the purpose of the Profit & Loss account? a) To show the financial position for a particular period. b) To show the profitability position for a particular period c) To show the financial position as on particular date. d) To show the profitability position as on particular date. 2. What do you understand by Time value of the Money? a) Different values for a unit of money in different time periods. b) Same value for a unit of money in same time periods. c) Different values for a unit of money in same time periods. d) Same value for a unit of money in different time periods. 3. The ratio of expected return to the standard deviation is called as _______________. a) Standard deviation ratio b) Sharpes ratio c) Best Ratio d) Standard ratio 4. Calculate the value 5 years hence of deposit of Rs.5, 000 made today if the interest rate is 10%. a) 5082.00 b) 7500.00 c) 8052.55 d) 8082.75 5. What is the present value of Rs. 1,00,000 receivable after 5 years at discount rate of 10%? a) 60,000 b) 62,902 c) 69092 d) 62092 6. The profits available to the ordinary share holders on a per share basis, after deduction of taxes are called as _____________________. a) Earnings per share b) Dividends
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Finance Material

c) Net profits d) Preference Dividends. 7. What is Price to Earnings Ratio (P/E ratio)? a) Market price of share / Earnings per share. b) Earnings per share / Marker price of share. c) Profits / Earnings ratio. d) None of the above. 8. Financial Leverage ratio is also known as ______________________. a) Debt x Equity ratio b) Debt / Equity ratio c) Equity ratio d) Debt ratio 9. Which of the following ratio is used to judge the liquidity of a firm? a) Current assets ratio b) Profitability ratio c) Current ratio d) Debt / Equity ratio 10.The measure of risk (standard deviation) is calculated by ______________. a) Variance b) Square Root of variance c) Square of variance d) None of the above. 11.The ratio of Gross Profit margin to net sales is called as ___________________. a) Net sales ratio b) Liquidity ratio c) Profit margin ratio d) Gross profit ratio. 12.What is the formula for calculating the future value of money? a) FV=PV x (1+r)t b) FV=PV x (1+r) c) FV=PV x (1+t)r d) FV=PV x (1+t)
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13.Which of the following is true about private placements? a) It is cost & time effective method of raising funds. b) Not required detailed compliance with formalities c) Both a & b d) Only a 14.The market where securities are brought and sold is called as ___________________. a) primary market b) secondary market c) stock exchange d) none of the above 15.Government Securities are issued and auctioned by ________________. a) Central Government b) RBI c) SEBI d) Both RBI & SEBI 16.Which of the following is not a market participant? a) RBI b) Money lender c) Merchant Bankers d) Under writers 17.What do you mean by GDRs? a) Global Depository Receipts b) Gold Deposit Receipts c) Gold Deposit Rates d) Gross Deposit Receipts 18.What is NCFM? a) National Certification for Financial Markets b) NSEs Certification in Financial Markets c) National Certification of Financial Markets d) National Certification in Financial Markets 19.Which of the following is FALSE about Reforms of Securities Market? a) FIIs have been permitted to invest in all types of securities.
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b) Indian Companies have been permitted to raise resources form abroad through issue of ADRs & GDRs. c) Indian companies have not been permitted to setup trading terminals abroad d) Trading platform of Indian exchanges accessible throughout world. 20.Which of the following is TRUE about NEAT? a) Trading system is called as NATIONAL EXCHANGE FOR AUTOMATED TRADING. b) It is an order driven system which matches buy & sell orders on price time priority. c) The system discloses the identity of buyer and seller. d) All of the above statements e) Only a & b 21.Derivative trading in India was introduced in _______________________. a) August 2000 b) June 2000 c) July 2000 d) Sept 2000 22.Which of the following are considered very safe by the Indian Investors? a) Mutual Funds b) Units of UTI c) Bank Deposits d) Equity Shares 23.What is the main reason for Corporates to enter in primary market for Issues? a) To meet long term capital needs b) To meet working capital requirement. c) For expansion of operations. d) All of the above e) Only a & b 24.Which of the following are the statutory powers of SEBI, which are empowered by SEBI Act 1992? a) protecting the interests of investors in securities b) promoting the development of securities market c) regulating the securities market d) All of the above

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25.________________ deals with issue, allotment and transfer of securities and various aspects relating to company management. a) SEBI Act 1992. b) Companies Act 1956 c) Depositories Act 1996 d) SCRA Act 1956 26._____________ was passed to provide for the establishment of depositories in securities with the objective of ensuring free transferability of securities with speed & accuracy. a) SEBI Act 1992. b) Companies Act 1956 c) Depositories Act 1996 d) SCRA Act 1956 27.The governing regulators of securities market are __________________. a) Department of Economic Affairs, Securities Appellate Tribunal b) RBI, SEBI c) Only a d) Only b e) Both a & b 28.________________ provides for direct and indirect control of virtually all aspects of securities trading and the running of stock exchanges. a) SEBI Act 1992. b) Companies Act 1956 c) Depositories Act 1996 d) SCRA Act 1956 29.A contract which derive its value from the prices, or index of prices of underlying securities is known as ___________________. a) Derivative b) Options c) Futures d) Stock Futures 30.Which of the following are bye-laws of the Stock-Exchange? a) Opening & Closing of markets b) Regulation of hours of trade c) Fixing, altering or postponing the days of settlements
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d) Regulation of taravani business e) All of the above. 31.Which of the following should be comply with, in order to list the securities in an exchange? a) Listing agreement b) Listing Period c) Listing proposal d) All of the above 32.SCRA Act 1956 is not applicable to ________________. a) RBI b) SEBI c) DCA d) DEA 33.Companies aggrieved with refusal of listing by a recognised stock exchange can make appeal to _____________. a) RBI b) SEBI c) DCA d) SAT 34.Which of the following is not required for the qualification for membership of recognised stock exchange? a) He is of twenty one years of age. b) He is citizen of India c) He has compounded with his creditors d) He has not been convicted of an offence e) He has not been expelled or declared defaulter. 35.All the intermediaries in the market such as Brokers, Sub-brokers, Underwriters, Merchant Bankers are required to register with ________________. a) RBI b) SEBI c) NSE d) DCA 36.Which of the following is/are the functions of SEBI? a) Regulating the business in stock exchanges and other securities market.
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b) c) d) e)

Promoting investors education and training of Intermediaries. Promoting Insider Trading regulations Only a & b a, b & c

37.Number of Members in the Board of SEBI are _________ a) 3 b) 4 c) 5 d) 6 38.Which of the following punishment(s) is/are imposed by SEBI, for violation of provisions of SEBI Act 1992? a) Suspension or Cancellation of registration. b) Monetary Penalties c) Either a or b d) Both a & b 39._______________ is a person whose name is recorded as such with a depository. a) Beneficial Owner b) Registered Owner c) Depository Participant d) Actual Owner 40.Any information which relates to the financial results of a company and is not generally known or published by that company is called as ________________. a) Financial Information b) Unpublished price sensitive Information c) Unpublished information d) Sensitive information 41.As per _________________, a contract is an agreement enforceable by the law. a) Indian Contract Act 1872 b) SEBI Act 1992 c) SCRA Act 1956 d) Companies Act 1956 42.A certificate under the common seal of a company, specifying the number of shares held and is prima facie evidence of the title to such shares is called as ____________.
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a) b) c) d)

Share Certificate Certificate of Shares Shares All of the above

43.A general meeting of a company may be called by giving at least __________ days of notice in writing. a) 7 b) 15 c) 21 d) 30 44.A Stock-broker or sub-broker shall not buy, sell and deal in securities, unless he holds the certificate granted by _____________ a) RBI b) SEBI c) NSE d) All of the above 45.A Broker is a person who arranges to buy and sell securities on behalf of _____________. a) Different exchanges b) Buyer & Seller c) Purchaser & Exchange d) Seller & Exchange 46.The Contract Note should contain name, ___________________ and SEBI registration number of Trading Member. a) Registered Office Address b) Dealing Office Address c) Registered Office Address as well as Dealing Office Address d) Registered Office Address and / or Dealing Office Address 47.Every Trading Member shall make payments to his clients or deliver securities purchased within ______________ of pay-out. a) T+2 days b) 2 working days c) 24 hours d) 48 hours 48.Purchase / Sale note is issued by _____________. a) Stock-Broker b) Sub-Broker
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c) Either a & b d) Both a & b 49.Which of the following not falls under code of conduct of SEBI regulation 1992? a) Execution of orders b) Breach of Trust c) Issuance of Contract Notes d) Fairness to Clients 50. The following is the Balance Sheet of ABC Co. Ltd. Crores) Liabilities Amoun Assets t Share Capital 15.00 Fixed Assets Reserves & Surplus 8.50 Cash & Bank Secured Loans 12.80 Debtors Unsecured Loans 22.30 Prepaid Expenses Current Liabilities 12.60 Stock Long Term Investments Total 71.20 Calculate Debt to Equity ratio from the above the table? a) 1.49 b) 1.91 c) 0.86 d) 3.06 51.Calculate current ratio from the above the table? a) 1.24 b) 2.33 c) 1.44 d) 2.39 52.Which of the following is not currently available in Normal market? a) Pre-Open phase b) Opening phase c) Open phase d) Market Close
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(Rs.in Amou nt 39.00 00.60 15.60 0.75 13.20 2.05 71.20

Finance Material

53. Which of the following is CORRECT about SURCON period? a) It is a Surveillance & Control period after market close. b) It is the period during which users have inquiry access only. c) It is the period during which system processes the data for making system available for the next Trading day. d) All of the above e) None of the above 54. Which of the following is the top most level in hierarchy? a) Corporate Manager b) Branch Manager c) Dealer d) User 55. Which of the following is lowest level in hierarchy? a) Corporate Manager b) Branch Manager c) Dealer d) User 56. The NEAT system supports an order driven market, wherein order match on the basis of ___. a) time priority b) price priority c) time price priority d) price time priority 57. What do you mean by abbreviation of word NEAT? a) National Exchange for Automated Trading b) National stock Exchanges Automated Trading. c) Both a& b d) None of the above 58. Which of the following symbol is used to indicate that a security is Ex-Bonus? 101. Bonus 102. Ex-B 103. XB 104. EB

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59._____________ is a facility for setting up the securities in the market watch screen and also to setup the users own portfolio. 100. Market Watch 101. Security / Portfolio list 102. Market By Price 103. Basket Trading 60. Which of the following indicator is displayed for a security, when the company for the security announces Extraordinary General Meeting (EGM)? a) XO b) XE c) XD d) XB 61. Internet trading on NSE started from ___________ a) January 2000 b) February 2000 c) March 2000 d) April 2000 62._________ is a party who enters on the opposite side as of the initiator. a) Competitor b) Exchange c) Initiator d) Solicitor 63. Which of the following indicator is displayed when a scrip goes ex-dividend on a trading day? a) XB b) XD c) X* d) ED 64. Which of the following indicator is displayed against a security, if that security comes along with rights? a) XR b) CR c) ER d) X* 65. No delivery period for a security is displayed in ____________ option. a) security information
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b) security descriptor c) security analysis d) security window 66. S&P CNX Defty consists of _____________. a) 50 securities expressed in Rupees b) 50 securities expressed in Dollars c) 50 securities expressed in Pounds d) 50 securities 67. Closing prices of securities traded on a day can be had from ___________ a) Online Back-up b) Security Information c) Reports d) Bhav Copy 68. How many depositories are there in India? a) 2 b) 3 c) 85 d) None of the above 69. What do you mean by NSDL? a) National Securities Depository Limited b) NSEs Security Depository Limited c) National Stock Depository Limited d) National Securities Depositories Limited 70. Which of the following account is used by Clearing Members to deliver securities to NSCCL? a) Pool b) Delivery c) Receipts d) Beneficiary 71. What do you mean by ISIN? a) International Share Identification Number b) Indian Securities Identification Number c) International Shares Identification Number d) International Securities Identification Number
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72. The conversion of electronic form of security into physical form is called as ________. a) Dematerialisation b) Rematerialisation c) Materialisation d) Hypothecation 73. How many banks have been empanelled by NSCCL, in the list of clearing banks/ a) 8 b) 9 c) 10 d) 12 74. Which of the following is not treated as a Public Company? a) Company which is not a private company b) Company which has a minimum paid-up capital of 5 Lakhs rupees. c) Private company which is a subsidiary of a company which is not a private company d) Company which is formed by 2 number of persons 75. Which of the following conditions must be satisfied by the company before buying back its own shares? a) The buy-back must be authorised by its articles b) Special resolution to be passed in general meeting of the company authorising buy-back c) The buy-back shall be or equal to or less than 25% of the total paid up capital. d) All the shares for the buy-back may or may not be fully paid up. a) only A & B b) only B, C & D c) only A, B & C d) only A, B & D 76. An Indian company or any other company which, in respect of its income liable to tax, has made prescribed arrangements for declaration & payment of dividends within India is called as ______________. A. Domestic Company B. Public Company C. Private Company D. Widely Held company
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126. Which is the leading stock exchange in India? (a) Delhi Stock Exchange (b) National Stock Exchange of India (c) OTCEI (d) Calcutta Stock Exchange 77. A Company does NOT announce a record date for ______. (a) holding general meeting (b) declaring dividends (c) rights issue (d) bonus issue 78. Which is the underlying asset for index futures traded on NSE? (a) S&P CNX Defty (b) CNX Midcap 200 (c) CNX Nifty Junior (d) S&P CNX Nifty 79. SEBI made it mandatory for all brokers to use _____________ for all clients. a) Permanent Account number b) Driving License number c) Bank Account number d) Unique client code 80. The minimum paid-capital of private company is Rs._____________. a) 10 lakhs b) 5 lakhs c) 1 lakh d) 2 lakhs 81. The minimum paid-capital of public company is Rs._____________. 282. 10 lakhs 283. 5 lakhs 284. 1 lakh 285. 2 lakhs 82. The private company limits the number of its member to ____________. a) seven b) two c) fifty
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d) No limit 83. The public company limits the number of its member to ____________. a) seven b) two c) fifty d) No limit 84. The minimum number of persons required to form a private company is ________. a) two b) ten c) five d) seven 85. The minimum number of persons required to form a public company is ________. a) two b) ten c) five d) seven 86. Every public company, making initial public offer of any security for a sum of rupees of ________ or more, shall issue the same only in dematerlised form. a) two crores b) fifty crores c) ten crores d) five crores 87. What is the difference between listed and permitted shares? a) Listed shares belong to public companies while permitted shares belong to private Cos. b) Shares of companies which have entered into a listing agreement with an exchange are called listed, while shares permitted for trading without entering into a listing agreement are called permitted shares. c) Listed shares are regulated by SEBI while permitted shares by Exchange. d) There is no difference. 88. Dividend yield is given by: a) Dividend per share / Market Value per share * 100
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b) Net profit available to equity shareholders / Market Value per share * 100 c) Dividend per share / Face Value per share * 100 d) Net profit available to equity shareholders / Face Value per share * 100 89. Acid Test Ratio of a firm is given by: a) Current Assets / Total Liabilities b) Current Assets (Inventory + Prepaid expenses) / Current Liabilities c) Total Assets / Current Liabilities d) Current Assets / Current Liabilities 90. Inventory Turnover ratio is given by: a) Cost of goods sold / Inventory b) Cost of goods sold / Sales c) Purchases / Inventory d) Sales / Inventory 91. Calculate Price to Earnings from the following details? Market Price of share Rs. 35.00, Share Capital 30 crores (1,00,00, 000 equity shares of Rs.10 each), Gross Profit - 15 crores, Income Tax 7.5 crores, Equity Dividend 2 crores, Current liabilities 12 crores, Fixed Assets 40 crores & Reserves 22 crores a) 5.66 b) 4.66 c) 4.83 d) 5.98 92. Which of the following is the purpose of Balance Sheet? a) To show the operational position of a business. b) To show the financial position of a business. c) Both a & b. d) None of the above.

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1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

b a b c d a a b c b d a c b b a a b c b b c d b c e d a e a

31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60

a d c b d d c a b a b c b b c b b b b d a d a c c a c b a b

61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90

d b b b b d a a b d b c d c a b a d d c b c d a d c b a b a

91 b 92 b

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Finance Material ACCOUNTING DEFINITION: Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part atleast, of a financial character, and interpreting the result thereof. SUB-FIELDS OF ACCOUNTING: 1. BOOK-KEEPING: It covers procedural aspects of accounting work and embraces record keeping function. Obviously book-keeping procedures governed by the end product, the financial statements, i.e. profit and loss account, and balance sheet including schedules and notes forming part of accounts. Profit and Loss account gives result of economic activities for a period and Balance Sheet states the financial position at the end of the period. Record keeping also requires suitable classification of transactions and events. This is also determined with reference to the requirements of financial statements. 2. FINANCIAL ACCOUNTING: It covers the preparation and interpretation of financial statements and communication to the users of accounts. 3. MANAGEMENT ACCOUNTING: It covers the generation of accounting information for management decisions. So it addresses to a single user group, the management. It includes cost accounting which deals with keeping cost records, measurement of cost of product/service and cost control methods. ACCOUNTING EQUATION: EQUITY + LIABILITIES = ASSETS (or) EQUITY + LONG TERM LIABILITIES = FIXED ASSETS + CURRENT ASSETS CURRENT LIABILITIES. MEASUREMENT BASES: There are four generally accepted measurement bases. These are: i) Historical Cost ii) Current Cost iii) Realisable Value iv) Present Value

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Finance Material HISTORICAL COST: It means acquisition price. Assets are recorded at an amount of cash or cash equivalent paid or the fair value of consideration given at the time of acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation. In some circumstances a liability is recorded at the amount of cash or cash equivalent expected to be paid to satisfy it in normal course of business. CURRENT COST: Assets are recorded at the amount of cash or cash equivalent that would have to be paid if the same or an equivalent asset was acquired currently. Liabilities are carried at the discounted amount of cash or cash equivalents that would be required to settle the obligation currently. REALISABLE VALUE: As per realizable value, assets are carried at the amount of cash or equivalent that could currently be obtained by selling the assets in an orderly disposal. Haphazard disposal may yield something less. Liabilities are carried at their settlement values; i.e., the undiscounted amounts of cash or cash equivalents expressed to be paid to satisfy the liabilities in the normal course of business. PRESENT VALUE: As per present value, an asset is carried at the present discounted value of the future net cash inflows that the item is expected to generate in the normal course of business. Liabilities are carried at the present discounted value of future net cash outflows that are expected to be required to settle the liabilities in the normal course of business. EX: Mr. X found that he can get Rs.20,00,000/- if he would sell the machine purchased, on 1-1-82 paying Rs.7,00,000/- and which would cost Rs.25,00,000/- in case he would buy it currently. ACCOUNTING CONCEPTS: Accounting Concept is generally used to mean a Notion only or mental idea about something. For example, Cost, Income and Capital, Debit and Credit, Assets and Liabilities etc., are concepts i.e., basic assumptions or conditions upon which science of accounting is based. There is no authoritative list of these concepts. In other words, concept means such ideas which are coupled with different accounting procedures e.g. Appropriation and Charge, Reserve and Provisions, Depletion and Amortisation etc. The following are some of the important generally acceptable concepts: (ICWA) Accounting is the language of business; affairs of a business unit are communicated to others as well as to those who own or manage it through accounting information which has to be suitably recorded, classified, 39

Finance Material summarized and presented. To make it full of meaning, accountants have agreed on a number of concepts which they try to follow. These are given below: (SHUKLA) BUSINESS ENTITY CONCEPT: Accountants treat a business as distinct from the persons who own it; then it becomes possible to record transactions of the business with the proprietor also. Without such a distinction, the affairs of the firm will be all mixed up with the private affairs of the proprietor and the true picture of the firm will not be available. This concept has now been extended to accounting separately for various division of a firm in order to ascertain the results for each division separately. It has been of immense value in determining results by each responsibility centre Responsibility Accounting. MONEY MEASUREMENT CONCEPT: Accounting records only those transactions which are expressed in monetary terms, though quantitative records are also kept. An event, even though important, like a quarrel between the production manager and the sales manager, will not be recorded unless its monetary effect can be measured with a fair degree of accuracy. It should be remembered that money enables various things of divers nature to be added up only through money values and not otherwise. COST CONCEPT: Transactions are entered in the books of account at the amounts actually involved. Suppose a firm purchases a piece of land for Rs. 1,50,000/- but considers it as worth Rs.3,00,000/-. The purchase will be recorded at Rs.1,50,000/- and not any more. This is one of the most important concepts it prevents arbitrary values being put on transactions, chiefly those resulting in acquisition of assets. Another way of saying the same thing would be that the amount to be recorded is objectively arrived at as a result of the mutual agreement of the two parties involved. Of course, sometimes accountants have necessarily to be satisfied with an estimate only the amount of depreciation to be charged each year in respect of machinery is an example; the amount has to be an estimate since the future life of the machinery cannot be known precisely. GOING CONCERN CONCEPT: It is assumed that the business will exist for a long time and transactions are recorded from this point of view. It is this that necessitates distinction between expenditure that will render benefit over a long period and that whose benefit will be exhausted quickly, say, within the year, of course, if it is certain that the concerned venture will exist only for a limited time, the accounting record will be kept accordingly.

40

Finance Material DUAL ASPECT CONCEPT: Each transaction has two aspects, if a business has acquired an asset, it must have resulted in one of the following: a) some other asset has been given up; or b) the obligation to pay for it has arisen; or rather, c) there has been a profit, leading to an increase in the amount that the business owes to the proprietor; or d) the proprietor has contributed money for the acquisition of the asset. The reserve is also true. If, for instance, there is an increase in the money owed to others, there must have been an increase in assets or a loss. At any time: Assets = Liabilities + Capital; or, rather, Capital = Assets - Liabilities In other words, capital, i.e., the owners share of the assets of the firm, is always what is left out of assets after paying off outsiders. This is called the Accounting Equation. It is self evident but very useful. REALISATION CONCEPT: Accounting is a historical record of transactions; it records what has happened. It does not anticipate events though anticipated adverse effects of events that have already occurred are usually recorded. This is of great importance in stopping business firms from inflating their profits by recording sales and incomes that are likely to accrue. Unless money has been realized either cash has been received or a legal obligation to pay has been assumed by the customer no sale can be said to have taken place and no profit or income can be said to have arisen. ACCRUAL CONCEPT: If an event has occurred or a transaction has been entered into, its consequences will follow. Normally, all transactions are settled in cash but even if cash settlement has not yet taken place, it is proper to bring the transaction or the event concerned into the books. Income or profit arises only out of business operations when there has been an increase in the owners share of the assets of the firm (called owners equity) but not if the increase has resulted from money contributed by the owner himself. Any increase in the owners equity is called revenue and anything that reduces the owners equity is expense (or loss); profit results only when the total of revenues exceeds the total of expenses or losses MATCHING CONCEPT: This concept recognizes that the determination of profit or loss on a particular accounting period is a problem of matching the expired cost allocated to an activity period. In other words, the expenses which are actually incurred during a specific activity period, in order to earn 41

Finance Material the revenue for the said period, must be matched against the revenue which are realized for that period. For this purpose, expenses which are specially incurred for earning the revenue which are realized period are to be considered. In short, all expenses incurred during the activity period must not be taken. Only relevant cost should be deducted from the revenue of a period for periodic income statement, i.e., the expenses that are related to the accounting period shall be considered for the purpose of matching. This process of relating costs to revenue is called matching process. It should be remembered that cost of fixed asset is not taken but only the depreciation on such fixed asset related to the accounting period is taken. (For the purpose of matching, prepaid expenses are excluded from the total costs but outstanding expenses are added to the total cost for ascertaining the cost related to the period). Like costs, all revenues earned during the period are not taken, but revenue which are related to the accounting period are considered. Application of matching concept creates some problems which are noted below: a) Some special items of expenses, e.g., preliminary expenses, expenses in connection with the issue of shares and debentures, advertisement expenses etc., cannot be easily identified and matched against revenues of a particular period. b) Another problem is that how much of the capital expenditure should be written off by way of depreciation for a particular period for matching against revenue creates the problems of finding out the expected life of the asset. As such, accurate matching is not possible. c) In case of long term contracts, usually, amount is not received in proportion to the work done. As a result, expenditures which are carried forward and not related to the income received, may create some problems. CONVENTIONS: It refers to the general agreement on the usage and practices in social or economic life, it is a customary practice, rule, method or usage. In other words, it is an accounting procedure followed by the accounting community on the basis of long standing customs. Accounting Conventions can be used as follows: CONSISTENCY: The accounting practices should remain in the same from one year to another for instance, it would not be proper to value stock-intrade according to one method one year and according to another method next year. If a change becomes necessary, the change and its effect should be stated clearly. 42

Finance Material

DISCLOSURE: Apart from legal requirements, good accounting practice also demands that all significant information should be disclosed. Not only various assets, for example, have to be stated but also the mode of valuation should be disclosed. Various types of revenues to be stated but also the mode of valuation should be disclosed. Whether something should be disclosed or not will depend on whether it is material or not. Materially depends on the amounts involved in relation to the asset or transaction group involved or to profits. CONVERVATISM: Financial Statements are usually drawn up on rather a conservative basis. Window-dressing, i.e., showing a position better that what it is, is not permitted. It is also not proper to show a position substantially worse than what it is. In other words, secret reserves are not permitted. MATERIALITY: Materiality means relative importance. In other words, whether a matter should be disclosed or not in the financial statements depends on its materiality, i.e., whether it is material or not. American Accounting Association defines Materiality as under: An item should be regarded as material if there is reason to believe that knowledge of it would influence the decision of informed investors. An accountant cannot ignore the consideration of materiality of procedures. The term itself is a subjective term. As such, an accountant should record an item of material even though it is of small amount if the same influences the decisions of the users, viz. proprietors, auditors, or investors etc. On the other hand if it is found that an information is not sufficiently important to influence the quality of periodical financial statements, the same should be treated as immaterial and hence should be avoided. It has been stated above that materiality depends on the amounts involved and the account so affected. As a result, whether a particular item is material or immaterial depends on the amount and nature of the same. Because, the material information helps the management to avoid unnecessary wastage of time and money on principal matters. It should be noted that this doctrine of materiality refers to separate disclosure of information in the published financial statements for the user of the same. In short, material items should separately be disclosed whereas immaterial items may not be disclosed separately but may be combined in a consolidated form in the published financial statements.

43

Finance Material FUNDAMENTAL ACCOUNTING ASSUMPTIONS: Certain fundamental accounting assumptions underlie the preparation of financial statements. They are usually not specifically stated because their acceptance and use are assumed. Disclosure is necessary if they are not followed, together with the reasons. The following are recognized by the International Standards Committee as fundamental accounting assumptions.: Accounting

a) Going Concern: The Enterprise is normally viewed as a going concern, that is as continuing in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtaining the scale of its operations. b) Consistency: It is assumed that accounting policies are consistent with one period to another. c) Accrual: Revenues and costs are accrued, that is, recognized as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements or the periods to which they relate. (The considerations affecting the process of matching costs with revenues under the accrual assumption are not dealt with in this statement). NOTES TO ACCOUNTS: Notes to accounts are the explanation of the management about the items in the financial statements i.e., profit and loss account and balance sheet. The management gives more explanation and information about the item of profit and loss account and the balance sheet and any other items, by way of notes of accounts Notes to accounts are integral part of financial statement. ACCOUNTING STANDARDS: An Accounting Standard is a selected set of accounting policies or broad guidelines regarding the principles and methods to be chosen out of several alternatives. Standards conform to applicable laws, customs, usages and business environment. So there is no universally acceptable set of standards. In India, Accounting Standards Board (ASB) has the authority of issuing Accounting Standards. The sole objective of Accounting Standards is to harmonise the diversified policies to make the system more useful and effective. 44

Finance Material

The Council of the ICAI has so far issued twenty eight Accounting Standards. However, AS-8 on Research & Development is withdrawn consequent to issue of AS-26 Intangible Assets. These are as follows: Date from which mandatory (accounting periods commencing on or after) 1-4-1993 1-4-1999 1-4-2001 1-4-1995 All 1-4-1996 All 1-4-1995 1-4-2003 Withdrawn and included in AS-26 1-4-1993 1-4-1993 1-4-2004 (Any foreign exchange transaction entered before 1-4-2004 shall be accounted for as per Revised AS - 11(2004) 1-4-1994 1-4-1995 1-4-1995 -All All All All Enterprises to which applicable at present All All See Note - 2

AS

Title of the AS Disclosure of Accounting Policies

2 Valuation of Inventories (Revised) 3 Cash Flow Statements (Revised) Contingencies and Events 4 Occurring after the Balance (Revised) Sheet Date Net Profit or Loss for the 5 period, Prior Period Items (Revised) and Changes in Accounting Policies 6 Depreciation Accounting (Revised) 7 Accounting for Construction (Revised) Contracts Accounting for Research & 8 Development 9 Revenue Recognition 10 Accounting for Fixed Assets

11 The Effects of Changes in (Revised) Foreign Exchange Rates

All

12 13 14

Accounting for Government Grants Accounting for Investments Accounting for 45

All All All

Finance Material Amalgamations Accounting for retirement benefits in Financial Statements of Employers Borrowing Costs Segment Reporting Related Party Disclosures Leases Earning Per Share Consolidated Financial Statements Accounting for Taxes on Income Accounting for Investment in Associates in Consolidated Financial Statements Discontinuing Operations Interim Financial Reporting Intangible Assets Financial Reporting of Interest in Joint Venture Impairment of Asset

15 16 17 18 19 20 21 22 23 24 25 26 27 28

1-4-1995 1-4-2000 1-4-2001 1-4-2001 1-4-2001 1-4-2001 1-4-2001 See Note - 4 1-4-2002 1-4-2004 1-4-2002 1-4-2003 1-4-2004 1-4-2004 1-4-2005 1-4-2004

All All See Note - 2 All All See Note - 2 See Note - 3 See Note - 4 All All All All All See Note - 2 All All (with certain exceptions in respect of paragraphs 66 & 67 of the Standard)

29

Provisions, Contingent Liabilities and Contingent Assets

NOTE 1: a) Sole Proprietary concerns / Individuals b) Partnership Firms c) Societies registered under the Societies Registration Act d) Trusts e) Hindu Undivided Family f) Association of persons NOTE 2: AS - 3, AS - 17, and AS - 20 have been made mandatory in respect of following enterprises: i) Enterprises whose equity or debt securities are listed on a recognized stock exchange in India, and enterprises that are in the 46

Finance Material process of issuing or debt securities that will be listed on a recognized stock exchange in India as evidenced by the board of directors resolution in this regard. ii) All other commercial, industrial and business reporting enterprising, whose turnover for the accounting period exceeds Rs. 50 Crores. NOTE 3: AS - 21 is mandatory if an enterprise presents consolidated financial statements. In other words, the accounting standard does not mandate an enterprise to present consolidated financial statements but, if the enterprise presents consolidated financial statements for complying with the requirements of any status or otherwise, it should prepare and present consolidated financial statements in accordance with AS - 21. NOTE 4: AS - 22 comes into effect in respect of accounting period commencing on or after 1-4-2001. It is mandatory in nature for: (a) All the accounting periods commencing on or after 1-4-2001, in respect of the following: (i) Enterprise whose equity or debt securities are listed on a recognized stock exchange in India and enterprises that are in the process of issuing equity or debt securities that will be listed on a recognized stock exchange in India as evidenced by the board of directors resolution in this regard. (ii) All the enterprises of a group, if the parent consolidated financial statements and the Accounting Standard is mandatory in nature of respect of any of the enterprises of that group in terms of (i) above. (b) All the accounting periods commencing on or after 1-4-2002, in respect of companies not covered by (a) above (c) All the accounting periods commencing on or after 1-4-2003, in respect of all other enterprises. E.O.Q. (Economic Order Quantity): It is a quality of material that can be ordered at which both ordering costs and carrying costs are minimum. E.O.Q.= Root 2AO/C A= Annual Consumption O= Ordering Cost per order 47

Finance Material C= Carrying Cost per unit per annum Semi-Variable Cost: These costs are partly fixed and partly variable, in relation to output. Ex: Telephone Bill, Electricity Bill. Angle of Incidence: When both the cost curve and sales curve cuts or meet at a point that point is called as Break Even Point. The angle left after their inter section is called profit angle or angle of incidents. Sales Curve

Margin of Safety: Difference between Total Actual Sales - Break Even Sales Margin of Safety = Total Sales - B.E.P. Margin of Safety will be reached faster if angle of incidents is more and vice versa. Ex: Total Sales = 30000 ; B.E.P. Sales = 20000 therefore Margin of Safety = 30000 - 20000 = Rs. 10000 Absorption Costing : Each and every item of cost i.e., variable cost and fixed cost is charged to the product. Case 1 :In this case fixed cost are charged to the product on the basis of normal capacity. [Normal capacity The number of units normally produced by the company] Case 2: in case of under absorption, that amount should be charged to the P&L A/c Ex: Case-1 : Normal units = 10,000 Actual production = 12,000 Fixed over heads = Rs.1,00,000/The absorption rate : fixed over heads = 48

1,00,000

Finance Material Normal units 1,0000 = Rs.10/- per unit And total absorption should be Restricted to Rs.1,00,000/In any case the absorbed amount should not exceed the actual fixed cost. Case-2 : if the actual production is 8,000 units The absorption Rate :1,00,000 =Rs.10/- per unit 10,000 The amount absorbed =8000X10 = Rs.80,000 Under absorbed Amount : 1,00,000 - 80,000= Rs.20,000/Which is charged to the Profit and Loss A/c. Marginal Costing: This is a technique of Decision Making. In the case of Marginal Costing only variable cost are absorbed by the product. In this case the fixed costs are considered as period cost and this should be charged to P & L A/c. Costing: The Process of determining cost is called as costing. Variable Cost: 1. Cost which is changing with every change in production additionally if you want to producing one more unit we need to expend additional cost. Ex: for 10 units Rs.100/for 11th unit additionally Rs.10/2. Cost per unit will not change but there is change in total cost. Ex: for 10 units Rs.100/Cost per unit = cost/unit =100/10= Rs.10/11 units 110/Cost per unit= 110/11 = Rs.10/Fixed Cost: 1. This cost is fixed will not change with increase or decrease in production. Ex: Factory rent 2. The total cost will not change but cost per unit will change. Ex: Rent = Rs.10000/1 person share =Rs.10000/2 persons share= Rs.5000/- each 4 persons share = Rs.2500/- each 49

Finance Material

P/V Ratio (Profit - Volume Ratio) : It is a Ratio between Contribution and Sales. P/V Ratio = Contribution / Sales x 100 Contribution per unit: Selling Price per unit - Variable Cost per unit Break - Even - Point (B.E.P.): This is a point at which there is no profit or no loss. At this point to total amount received is equal to the total cost incurred. Total Sales amount= Total Cost Amount (Fixed Cost + Variable Cost) Total Contribution = Total Fixed Cost Ex: Selling Price = Rs.10/Variable Cost= Rs.5/Fixed Cost= Rs.10000/Contribution= Rs.10-Rs.5 = Rs.5/P/V Ratio = Contribution x 100 = 5/10x100=50% Sales B.E.P.Units= Fixed Cost/ Contribution per unit = 10000/5= 2000 units. B.E.P.Value= Fixed Cost/ PV Ratio = 10000/50x100 = Rs.20000/Statement of Marginal Cost: Total Sales - Variable Cost = Contribution Contribution - Fixed Cost = Profit Current Ratio: Current Assets / Current Liabilities Current Assets are those which can be converted into cash in the short run. The term short run means - generally a period of one year. Current Assets = Inventories + Sundry Debtors + Cash and Bank Balances + Short Term Loans & Advances + Marketable Non-Trade Securities + Prepaid Expenses. Current Liabilities = Cash Credit + Bank O.D. + Short Term Borrowings + Creditors + Proposed Dividend + Unclaimed Dividend + Provision for Taxation (Provision for Tax Advance Tax Paid) Quick Ratio: Quick Assets / Quick Liabilities Quick Assets = Current Assets - Stock and Prepaid Expenses - Other Liquid Portion of Current Assets Quick Liabilities = Current Liabilities Cash Credit, Bank Borrowings and Other Short Term Borrowings Debt Equity Ratio: Debt / Equity 50

Finance Material Debt = Secured Loan and Unsecured Loan minus Cash Credit and Bank O.D. Equity = Paid-up Share Capital including Preference Capital and PreReserves Capital Employed = Net Fixed Assets + Working Capital Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory Debt Service Coverage Ratio = Profit after Tax + Interest + Depreciation + Non-Cash Items Interest + Debt Installment Interest Coverage Ratio = Earning Before Interest Interest P.E.Ratio (Price Earning Ratio) = Market Price Per Share Earning Per Share Dividend Yield Ratio = Dividend Per Share Market Price Per Share Operating Leverage = Contribution___________ Earning Before Interest & Tax (EBIT)

Finance Leverage = Earning Before Interest & Tax (EBIT) Earning Before Tax Total Leverage = Operating Leverage x Finance Leverage EPS =Earnings available to Equity Shareholders No.of Equity Shares outstanding

Memorandum of Association (MOA) Memorandum defines the companies constitution and scope. MOA is the companies

Articles of Association (AOA) AOA represents Rules and Regulations of the company.

51

Finance Material constitution and scope. It is a primary document. It is subordinate to the Act. It is a must for every company. Strict provisions for alteration.

2 3 4 5

Ultra virus MOA even all the members cannot ratify it. (change).

It is a secondary document. It is subordinate to MOA and Act. Can be written or taken from Companys Act. Special resolution is sufficient except where the amendment brings into effect a private from public. Ultra virus AOA but intra virus the MOA can be ratified.

1 2 3 4 5 6 7 8

Shares Shares are part of the capital of the company. Shareholders are members or owners of the company. When recommended by the board dividend could be declared to shareholders. Shares do not carry on any charge. Shares have restrictions issue at a discount. Shareholders have voting rights. Dividend is payable only when profits are there. No fixed dividend.

Debentures Debentures constitute a loan. Debenture holders are creditors. Fixed amount of interest on debentures paid before dividend declaration. Debentures generally have a charge on the asset of the company. Debentures do not have restrictions issue at a discount. Debenture holders do not have voting rights. Interest is payable whether profits are there or not. Rate of interest is fixed.

1 2

Shareholder One of the owner of the company and has proprietary interest in the company. When the company makes profits and the board recommends, shareholder gets a share in the profits. No security for his investment.

Debenture holder Only a creditor of the company Get a fixed rate of interest whether the company makes profit or not. Normally debentures are secured. 52

Finance Material 4 5 Eligible for voting rights. On liquidation, shareholders are paid last. No voting rights. Ranks priority with regard repayment.

1 2 3 4 5 6

Shares Has a nominal value. May be fully paid or partly paid. Can be transferred in whole numbers and not in fractions. Each and every share shall be of equal denominations. Shares are identified with distance numbers. Can be issued directly to the public.

Stock No nominal value. Always fully paid. Can be transferred in fractions also. May be unequal amounts. Do not have any distinctive numbers. Only fully paid up shares can be converted in to stock and cannot be issued directly.

1 2 3 4

Capital expenditure Expenditure for the purchase and installation of asset. These assets are shown at the assets side of the balance sheet

6 7

Revenue expenditure Expenditure incurred for the maintenance of asset. These expenses are shown in the debit side of profit and loss account. Expenses are incurred for long Expenditure incurred for short term investment. term investment. The benefits will flow or enjoyed The benefits for the expenditure by the organization for more than will flow or enjoyed by the one year. organization for the current year Ex: plant and machinery only. Ex: salaries, printing & stationary etc. The item dealt is called as asset. The item dealt is called goods or It is expressed or identified in its merchandise. own name. Plant Goods ; T.V. Goods. Plant Plant ; T.V. T.V. Asset is purchased for utilization Goods are purchased with an in the business, in the normal intention to sell. course of business. Depreciation is to be considered There is no need of depreciation. for the life of asset.

53

Finance Material Profit and Loss Account Objective of preparing P & L Account to ascertain the net profit or loss of the business during the year. In this account having debit and credit as such To and By are used Revenue expenditure and incomes are recorded in the Profit and Loss Account. Balancing figure of this account either net profit or net loss. Balance Sheet The objective of the preparing Balance Sheet is to know the financial position of the business on a specific date. Balance Sheet is a statement and hence To and By are not used. Capital incomes and expenditures are shown in the Balance Sheet. Balance Sheet will not show any balancing figure. A total of Liabilities and Assets side should always be equal. Non-Recurring Expenses Items Which Are Not Regular And Repeated. Ex: Buying of Machinery or Other Fixed Assets, Legal Expenses, Loss or Profit on sale of Asset, Insurance Claims. Private Limited Company Minimum number of members are 2. Maximum number of members are 50. Minimum directors are 2. Can start business after incorporation. Private Limited Company shall not issue its shares to outsiders. Reserve Reserve is an appropriation on profits. It is made for future unknown liability. It can be utilized for any future purpose. 54

2 3 4

Recurring Expenses Items which are repeated. Ex: Salaries & Wages

1 2 3 4 5

Public Limited Company Minimum number of members are 7. Maximum number of members are unlimited. Minimum directors are 3. After getting business commencement certificate they can do business. Public Limited Company can go for public issue. Provision Provision is a charge against the profits. Is made for known liability or expenditure. It is utilized for that purpose only.

1 2 3

Finance Material 4 5 Is shown above the line. Above the line means Profit and Loss Account. Partnership It is a going concern. It always has a name. Persons carrying on business are called partners. Profits are ascertained at regular intervals, i.e., annually. Is shown below the line. Below the line means Profit and Loss Appropriation Account. Joint Venture It is a terminable venture. It may not bear a name. Persons carrying on business are called Co-venturers. The profits are ascertained for each venture separately cash basis of accounting is followed.

1 2 3 4

1 2 3 4

Deposit Deposits are amounts, received by the company from the public.

Debenture Debenture is a document, which acknowledge debt, which is issued by company Deposits are short term or middle Debentures are long term financial term financial sources. sources. Deposits are unsecured. Debentures are generally secured. It is easy to rise public deposits. Issue of debentures restricted by RBI. Member Name entered in the register of members. Member is also a share holder. Share warrant holder is not a member. Share holder Name not entered in the register on members. Share holder is not a member unless name is entered in the register of members. Share warrant holder is share holder.

1 2 3

1 2 3

Partner Partner is one of the owner. Partnership is governed by Partnership Act, 1932. Partner is a unlimited liability.

Director Director is one of the member of the executive body. Companies is governed by the Companies Act, 1956. Director is generally not liable.

Company 55

Partnership

Finance Material 1 2 Company comes into existence only when it is registered under the companies act. Members: minimum Private : 2 Members Public : 7 Members Maximum Private : 50 Public : un limit. A company on its incorporation enjoys a separate legal entity. In case of company members liability is limited. A firm is created by mutual agreement between partners. Registration is optional. Members: Minimum 2 Partners. Maximum In case of Banking Business : 10 In case of Other Business : 20. A firm does not have separate legal entity. In case of firm, partners are jointly or severably liable.

3 4

1 2

Company A company is a trading association. A company is required to be registered under the companies act.

Club Club is a non trading association. Registration of a club is not mandatory.

1 2 3 4 5

Trial Balance The Trial Balance is prepared to check the arithmetical accuracy of the books of accounts. Trail Balance does not show the financial position of business. The Trial Balance is prepared based on the ledger accounts. The preparation of Trial Balance is not compulsory. Trial Balance cannot be shown as a documentary evidence.

Balance Sheet Balance Sheet is prepared to know the true position of assets and liabilities on a particular date. The financial position can be known from balance sheet. The Balance Sheet is prepared on the basis of information from Trial Balance. The preparation of Balance Sheet is must. Balance Sheet will be accepted as documentary evidences by tax authorities and courts. Surrender of Shares Surrender is affected with the assent of share holder.

Forfeiture of Shares Forfeiture is proceeding against reluctant shareholder. ( defaulted in call payment)

56

Finance Material 2 Forfeiture can be done only partly Surrender can be done only fully paid up shares. paid up shares.

1 2 3 4 5 6 7

Share Certificate The holder is a registered member of the company. The holder of a share certificate is essentially a member.

Share Warrant The bearer of a share warrant is not a registered member. The bearer of a share warrant can be a member only if the article so provided in and as. For the issue of share certificate Share warrant can be issued may not required approval of the Central Govt. approval is must. Central Government. All companies must issue share Share warrant can be issued only certificates. by public companies. Share certificate is issued is Share warrant can be issued only partly or fully paid shares. fully paid shares. Share certificate is not Share warrant is negotiable. negotiable. The holder of a share certificate The holder of a share warrant can present a petition for winding cannot present a petition for up. winding up.

1 2 3

Promissory Note In promissory note there is a promise to pay.. In promissory note there are two parties, namely, the maker and the payee. A promissory note is signed by the person liable to pay. So no acceptance is needed.

Bill of Exchange In a bill there is an order to pay. In a bill there are three parties, namely, drawee, drawer, and payee. A bill has to be accepted by the drawee before he can be held liable.

Journal Journal is the book of first or original entry. It is also called the

Ledger The ledger is the book of second entry. 57

Finance Material book of first entry or primary entry. Transaction in the journal will be recorded immediately.

2 3 4 5

Depending upon his conveniences the trader records the transaction in the ledger. When once the entries are posted It will never lose importance as it in to ledger, the journal losses its is the main book of accounts which importance. is relied upon permanently. In the preparation of final In the preparation of trial balance accounts journal in not useful. and final accounts ledger is a must. The tax authorities generally may In the finalization of income tax to not depend on journal. be paid, the tax authorities depend on ledger.

Book-keeping : is complement to the accounting process. Book-keeping is the systematic recording of financial and economic transactions. Accounting: is the analysis and interpretation of Book-keeping records. Cash Book : The Cash Book is a sub division of the original entry recording transactions involving receipts and payments of cash. All cash transactions are first entered in the cash book and then posted from cash book in to the ledger. Transactions are recorded chronologically in the cash book. Bill of Exchange : is a instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of a certain person or to the bearer of the instrument. Prudence: Incomes are recognized when they are realized, all possible expenses are provide. Term Loans : Term Loans represents secured borrowing and at present are the most important source of finance for new projects. They generally carry a rate of interest. These loans are generally repayable over a period of 6 to 10 years in annual, semi annual, or quarterly in installments. Term loans are also provided by banks, state financial institutions and all India term lending institutions. Cash Profit: Cash is arrived by adjusting the non-cash transactions to the net profit after tax. Net profit after tax xxxx 58

Finance Material Add: Non-cash expenses Add: Depreciation xxxx xxxx Less: Non-cash incomes(credit sales) Cash Profit xxxx xxx xxx xxx

Cash Flow Statement: Accounting Standard 3 explains about this. The statement shows how much cash is generated and expended in the organization during the year. It also shows opening and closing balance of cash. It is use full for investors and creditors. It provides vital (important) information about companies ability to generate future cash flow to satisfy investors and creditors expectations. Methods in preparing cash flows: There are two methods, these are a) Direct Method, and b) Indirect Method. In Direct Method : Gross Receipts Gross Payments = Net Cash Flow In Indirect Method : Net Profit + Non-cash Expenditure Non-cash Incomes (Credit Sales) = Net Cash Flow. Classification of Cash Flows : i) Operating Cash Flow ii) Investing Cash Flow iii) Financing Cash Flow Cash : The purchasing power in hand is called cash. Cash Expenses : Cash is paid for expenses incurred. Ex: Salaries, Wages paid etc. Non-cash Expenses : it is an expenditure, there is no cash involvement. Expenses are incurred but cash is not paid ( that is cash is not going out of the business) Ex: depreciation writing off, goodwill, patents, writing off preliminary expenses, discount on issue of shares and debentures, loss on revaluation of assets and liabilities etc., in this cases income is reduced since tax saving is effected. Amalgamation : Involves merger of two existing companies or a company takeover the another company.

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Finance Material Absorption : A company take over another company. Amalgamation includes absorption. Fixed Assets : These assets are acquired for long term use in the business. Liquid Assets : These assets also known as circulating, fluctuating, or current assets. These assets can be converted in to cash as early as possible. Fictitious Assets : Fictitious assets are those assets, which do not have physical form. They do not have any real value. Ex: loss on issue of shares, preliminary expenses etc. Intangible Assets : Intangible assets are those having no physical existence and cannot touch. Ex: Goodwill, Patents, and Trademarks etc. Contingent Liabilities : These are not the real liabilities. They are not actual liabilities at present. They right become a liability in respect of pending. This is not shown in balance sheet. That may be shown as notes under balance sheet. Del-credre Commission : It is extra commission paid to bear the bad debts collection loss. Demat Account : Demat means the materialized account. It is a separate account maintained for investments (Shares, Securities, Debentures, Bonds etc.). It gives information about shares sought and sold, prices at which shares were bought and sold, shares presently holding and amount held. IRR (Internal Rate of Return) : This method takes in to consideration time value. It can be said as discounted rate of return. Purchase Consideration : Consideration paid by the transferor company to the shareholders of Transferee Company. Economic Value Added : A company or business earning profit which is more than cost of capital (Return expected by Investors). Impairment : Permanent decline in value of asset. ABC Analysis : ABC Analysis is a method of inventory control. It is popular system of inventory control. The item of inventory is generally classified in to three types. These are: A : Usage value is Maximum and number of items is Minimum. 60

Finance Material B : Usage value is Medium and number of items is also Medium. C : Usage value is Lowest and number of items is Highest. Annual Report : Annual Report is a report, which will contain the all financial statements of the company and auditors report and main opinions on performance of company. It is useful with previous reports. Sweat Equity Shares : means equity shares issued by the company to employees, directors. Such issue should be authorized by a special resolution passed by the company in general meeting. Memorandum : means MOA as originally framed or altered from time to time in pursuance of any previous company law or of this act. Issue of Share at a Discount : Shares can be issued at a discount, if the following conditions are fulfilled. The issue of shares at a discount must be a resolution passed by the members at the general meeting. The issue should be sanctioned by the company law tribunal. The resolution authorizing the issue of shares specified the maximum rate of discount at which the shares are to be issued. The rate of discount shall not exceed 10%. Unless company law tribunal allowed such excess under special circumstances. The issue can be made only after one year. One year has elapsed since the company was entitled to commence business. The shares shall be issued with in two months of the sanction by the company law tribunal or such other period as permitted. Shares issued at a price less than the nominal value : Then it is called shares issued at discount. The difference between the issued price and nominal value is discount on issue of share. It is shown in balance sheet under the head of miscellaneous expenditure not written off. Shares issued at Premium: When a company issues shares at a price higher than the nominal value of the share (securities) then the difference in the nominal value and the issue price is the premium. The premium may be received in cash or in kind. But the share premium collected by a company on issue of shares is required to be retained in a separate accounts titled as share (securities) premium account. Securities premium account can be used only for paying up of fully paid bonus shares to be issued by the company to its members. To write off preliminary expenses. 61

Finance Material To write off underwriting expenses / commission paid discount allowed on any issue of shares or debentures of the company. To provide premium payable by a company on redemption of debentures of the company. Distribution of securities premium amount as dividend is not permitted. Security premium is not a free reserves. It is in the nature of capital reserve.

Portfolio Management : Classification of assets get aims at minimizing the total risk while taking the maximum returns is called portfolio management. It refers to diversification of assets which means not keeping all eggs in the same basket. Good will : It is an amount paid over and above the value of assets and liabilities of the under taking. Goodwill is the reputation of the business. This reputation is due to excess sales and profit made then normal sales and profit. Reasons for goodwill are: Good reputation Favourable location Ability and skill of employees Good management. Goodwill is of two types, these are i) Purchased Goodwill and ii) Developed Goodwill Purchased goodwill: more amounts paid for assets than required Ex: Total Assets = 100000 Amount Paid= 150000 Developed Goodwill: This goodwill not be written in books. Goodwill is to be calculated basically on the basis of following methods, i) Capitalization method and ii) Super Profit Method Capitalization Method: Normal Capital Employed = Future Maintainable Profits Normal Rate of Return Goodwill = Normal Capital Employed Actual closing capital employed Super Profit Method: Super Profit = Future Maintainable Profits Actual Capital Employed x Normal Rate of Return.

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Finance Material Goodwill = Super Profit x No. of years for which super profit can be maintained. Capital Employed = Total Assets of the Company Outsiders Liabilities. Annual Report : Annual Report contains Balance Sheet, Profit and Loss Account and Notes to accounts of the company during the last year. Notes to Accounts : it gives the information on the following aspects, i) Accounting policies with respect to Fixed assets and depreciation Research and development expenditure Foreign exchange transactions Excise duty Interim / proposed dividend Investments Miscellaneous expenditure We are downloaded more than 12W Companys annual report from their web sites and internet. Then we can access more than 600 files. Cash Accounting System : Only cash transactions are recorded if the system is followed. Mercantile Accounting System : Both cash transactions and credit transactions are recorded in this system. If cash transactions are incurred first they are recorded first. If credit transactions are incurred first they are recorded first. In simple to say what ever is incurred first will be recorded first. Discount : Discounts are two types. These are i) Trade Discount and ii) Cash Discount Trade Discount : It is deducted from list price or catalogue price or tag. It is generally allowed by whole seller to retailer. Trade Discount are not recorded in books. Ex: Tag Price = Rs. 100 - Trade Discount = Rs. 10 Rs. 90 This amount is recorded in the books. Purchase A/c Dr 90 To Cash A/c 90 Cash Discount : This discount is given to debtors to make them pay debts as early as possible.

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Finance Material Ex: Immediately - 5%, within 15 days 4%, within one month 2% etc. Cash discount is given for early or prompt payment. Cash discount are recorded in books. Purchase A/c Dr 100 To Cash 90 To Discount 10

Substance over form :Information is to be present in accordance with their substance and not nearly their legal from. Ex: Rights and benefits in Plant and Machinery, Transferred but registration is pending. It means the expenses before starting of the production or company or for extension of existing undertaking. Preliminary expenditure : is an expenditure incurred for setting or undertaking. Ex: i) for drafting legal documents (MOA and AOA) Legal Documents ii) Fees for registration of the company iii) Underwriting Commission iv) Brokerage and Charges for drafting, printing, typing and advertising the prospectus. Deferred Revenue Expenses : The benefit of the expenditure will be differed to the future periods for which the expenditure is charges. Differed revenue expenditure is known as asset in balance sheet. Ex: Preliminary expenses, Advertisement expenses Deferred Revenue Income : which is income differed to the future periods. That means it is not related to one period but related to more than one period. Ex: Pension Fund Scheme Capital Reserve : Amounts received on capital items. Revenue Receipts : Amount receive on revenue items. Amount received by sale of goods or services show the trading and profit and loss account credit side. Capital Profits : Capital profits are profits realized on sale of fixed assets or on discount of investments. They may be distributed by way of dividend.

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Finance Material Revenue Profits : Revenue profits are the profits earned by the company through its ordinary activities. Debenture : Debenture is a document bearing the company common seal. Which creates or acknowledges a debt. It need not be secured (It may be secured or It may not be secured). It does not carry any voting rights, but it carries interest. Dividend : Dividend is a return on the investment to the share holders. It is paid out of the divisible profits of the company. Dividend is normally expressed in terms of percentage of the face value of the share. Types of Dividend : Dividend is 3 types. These are, i) Dividend of Preference Shares, ii) Dividend on Equity Shares and, iii) Interim Dividend. General Reserve : General Reserve is a Reserve which is created to meet any future unknown liability. It can be utilized as dividend. Capital Reserve : Profits in the nature of capital or profits in the form of capital nature. Ex: Share Premium, Share Forfeiture. Reserve Capital : Reserve Capital is called up only at the time of liquidation if assets held are not sufficient to meet the liabilities. Subsidiary Company : A company who is selling more than 51% of their shares to another company is called subsidiary company. Holding Company : A company who is buying more than 51% of shares from another company, is called holding company. A company shall be deemed to be a subsidiary of another company, if that other company, Controls the composition of its Board of Directors. Holds more than 50% of the voting power or paid up capital in the other company. Is the subsidiary any other company, which is the subsidiary of holding company. Government Company : A Government Company is a company in which not less than 51% of the paid up share capital of the company is held by Central Government, or State Government, or partly by the by the Central Government and partly by one or more State Governments.

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Finance Material Memorandum of Association : It is the main document of the company. This document represents constitution of that company. It contains i) Name Clause, ii) Objective Clause, iii) State Clause, iv) Capital Clause, v) Liability Clause, and vi) Situation Clause. Articles of Association : This document represents rules and regulations of the company. It defines duties, rights, and regulations of the company between themselves and company. Limited Liability : Liability is limited to the face value of the share. Minority Interest : In a Subsidiary Company, the majority shareholding is held by holding company (say 60% or 80% or so, the remaining 40% or 20% is held by sum other people who are little interested in the company. This little interest is called as minority interest). These people are called as minority shareholders. Stock Exchange : Stock Exchange is the place, where stocks, shares and other securities of the listed companies bought and sold. Mutual Fund : Mutual Fund is a fund, which collects the investments of small saving holders and re-invest in capital markets, like share market, debt market. It creates link between small saving holders and capital markets. Ex: U.T.I. Mutual Funds. Debt Securitization : It is a mode of financing, where in securities are issued on the basis of package of assets (called pooled). This involves the following process of activities: Organizing function Pooling function Securitization function Primary Market : Shares are purchased directly at the time of allotment by the company. Secondary Market : Shares are purchased from market through the stock exchange. Working Capital : For running day to day activities of a business, same capital is required which is called working capital. Working Capital = Current Assets Current Liabilities or, Excess of Total Current Assets over Current Liabilities.

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Finance Material Working Cycle or Operating Cycle : There is a complete operating cycle is the time duration required to convert cash in to cash cycle from cash to cash Conversion of cash into raw material Conversion of raw material into work in progress Conversion of work in progress into finished goods Conversion of finished goods into debtors and Conversion of debtors into cash No. of Operating Cycle = No. of Days in a year/Operating Cycle Period Objective of Working Capital Management : Optimum Investment in current assets reducing current liabilities. Working Capital Management : Decisions are to be taken for effective financing of current assets required for day to day running of the organization. Working Capital Management refers to the procedures and policies required to manage the working capital. Accrued Interest :The accrued interest is to be added to the concerned income in the credit side of the profit and loss account. The accrued interest is to be shown as an asset, Asset side of Balance Sheet Accrued Interest A/c Dr Interest A/c Accrued Income : means income earned, but which is not due (no right to receive on this date). Earned during the current accounting year but have not been actually received by the end of the same year. Ex: Interest on loan, Commission etc. Outstanding Income : Income accrued and due but was not receive. Debtors : means taken goods on credit. People who owes us i.e. people who has taken loan or money. Creditors : means from whom have taken goods on credit people to whom we owes i.e., these people have lent money to us or given money to us. Out Standing Salary : Salaries A/c Dr To Out Standing Salaries A/c Prepaid Salary : Prepaid Salary A/c Dr To Salary A/c Bad Debts : Debts which are bad. 67

Finance Material Bad Debts A/c Dr To Debtors A/c Provision for Bad Debts : Profit and Loss A/c Dr To Provision for Bad and Doubtful Debts Accrued Expenses : The expenditure which is incurred and the payment there of might or might not be paid. Prepaid Expenses :Prepaid expenses are to be deducted from such expenses in the debit side of profit and loss account. Shown as an asset in the assets side of Balance Sheet. The amount paid for the expenditure relating to the future years. Out Standing Expenditure : Expenditure incurred but the payment for which is not yet paid and will be shown in the balance sheet liabilities side, debited to profit and loss account Amortization : Writing off Intangible Asset Ex: Patents, Good will, for this asset there is no physical existence. Del credre Commission : It is extra commission paid to bear to the bad debts collection. Depreciation : Accounting Standard 6 deals with depreciation. It is charge for the use of assets in the operation, It may arise due to usage time or change of technology. Two methods are normally followed for charging the depreciation i) Written Down Method, and ii) Straight Line Method The rates of depreciation have been specified in Schedule XIV to the Companies Act, 1956. It is mandatory for the companies to charge depreciation Depreciation cannot be charged on land. Due to fluctuation in foreign exchange, if the value of asset increases, then depreciation should be charged on the increased value of the asset. Written Down Value : Every year depreciation is changing. Year by year it goes on decreasing. Depreciation is calculated on the opening balance of this year. Straight Line Method : Every year depreciation is same Ex: Total Value/Its Life 68

Finance Material (Note: In any method the total amount of asset must be depreciated is 95%). Annuity Method : Interest is taken care or Interest is added and depreciation is found. Depreciation Fund Method: Every year depreciation amount is invested in investments. Interest on investments receive in also invested. All this investments are sold, when new assets is to be purchased. Depletion Method : This method is use in mines, quarries. The total quantity of tones are estimated. Depreciation per tone is now calculated. Cost per tone = Total Cost / Estimated Tones Capital Budgeting : Analyzing and selection of investment projects whose returns are expected to extend beyond one year. Net Present Value : It is the difference between inflows and outflows. IRR : The rate which present value of inflows are equal to present value of outflows. PI: also called as benefit cost ratio. It shows relationship between present value of inflow and present value of outflows. i.e. inflows / outflows. Capital Structure : It refers to the proportion of debt equity and preference capital. Beta : Market Risk Systematic Risk Stand Demat : Industry Risk Unsystematic Risk Portfolio Management : means group of securities.

ADVANCED FINANCIAL ACCOUNTING

Funds Flow Statement: A statement that uses net working capital as a measure of liquidity position is referred to as funds flow statement.To go to the roots, this funds flow statement was termed where got and where gone statement. This statement records the increases and decreases in different items of the 69

Finance Material balance sheet. Later it was called funds statement. In 1963 Accounting Principles Board (APB) changed the name of the statement as statement of sources and applications of funds. Uses and importance of Funds Flow Statement: An essential too for the financial analysis and management. Reveals the changes in the working capital and gives the details of the sources from which working capital has been financed. Helps in the analysis of the financial operations and explains causes for the changes on the liquidity position of the company. Helps in dividend distribution and the formulation of an ideal dividend policy. Helps in making correct decisions in planning and development of the company. Concept of Sources and uses of Funds: An increase in non-current liabilities or a decrease in non-current assets of the firm is considered as source of funds. An increase in the non-current assets and a decrease in the noncurrent liabilities is a use of funds. A decrease in net working capital during the accounting period, is considered to be a source of funds. An increase on net working capital during the accounting period is considered to be a use of funds. Net Working Capital = Current Assets Current Liabilities Funds: The term funds means working capital i.e., the excess of current assets over current liabilities. Flow of Funds: The term flow means movement and includes both Inflow and Outflow. Ratio Analysis: It is the relationship between two financial values. To make it clear the word relationship stands for a financial ratio which is the result of two mathematical values. Gross Profit Ratio = Gross Profit / Sales x 100 This ratio tells us the result from trading Activity (from Buying and Selling). To know the Operating Efficiency of the Organisation. Net Profit Ratio = Net Profit / Sales x 100 It indicates the final result to organization and overall efficiency of the organization. 70

Finance Material

Operating Profit Ratio = Operating Profit / Sales x 100 This ratio speaks of the operational performance of the organization and refer the managerial efficiency of the firm. Earning per Share = Equity Shareholders / No. of Equity Shareholders It reveals the profit available to ordinary shareholders. Dividend Yield Ratio = Dividend per Share / Market Value per Share It is very significant to the new investors. Dividend per Ratio = Dividend Payable / No. of Ordinary Shares. It indicates the amount of dividend to be paid to ordinary shareholders. Return on Investment = Return / Investment x 100 Cost of Goods Sold Ratio = Cost of Goods Sold / Sales x 100 Cost of Goods Sold = Opening Stock +Purchases + Wages Closing Stock Operating Exp. Ratio = Operating Exp. / Sales x 100 Operating Expenses = (Office Administrative Exp. + Selling & Distribution Exp. + Financial Exp.) Office & Administration Exp. Ratio = Office & Admn. Exp. / Sales x 100 Selling & Distribution Exp. Ratio = Selling & Distribution Exp. / Sales x 100 Financial Exp. Ratio = Financial Exp. / Sales x 100 Above five ratios make us know the relationship between various expenses and sales. The lower the ratio the greater is the profitability, and higher the ratio the lower is the profitability Operating Ratio = Cost of Goods Sold + Operating Expenses / Sales x 100 Operating Ratio tells us the efficiency of the conduct of business operation. A high ratio means the operating expenses are high and margin is less. Therefore the lower is the ratio the higher is the position. Non-Operating Expenses Ratio = Non Operating Expenses / Sales x 100 Current Ratio = Current Assets / Current Liabilities This ratio explains whether the firm is able to meet short term obligations or not. The higher ratio is an indication of the soundness of the organization. 71

Finance Material Current Assets = Cash in Hand + Cash at Bank + Sundry Debtors + Bills Receivable + Stock + Prepaid Exp. + Short term investment etc. Current Liabilities = Sundry Creditors + Bills Payables + Overdraft + Outstanding Expenses. The current ratio tells us the ability of the firm to meet its short term obligation. Liquidity Ratio = Liquid Assets / Current Liabilities Liquid Assets = Current Assets Stock The liquid ratio is very helpful in measuring liquidity position and firms capacity to pay off short term obligation. The liquid ratio is a measure of liquidity. Absolute Liquidity Ratio = Liquid Assets Debtors / Liquid Liabilities Liquidity Liabilities = Current Liabilities Bank Overdraft It gives a more meaningful measure of liquidity. The satisfactory ratio will be 1 : 1 i.e., Rs.1 worth of absolute liquid assets are sufficient for Rs.1 worth of current liabilities. Fixed Assets to Proprietors Funds = Fixed Assets / Proprietors Funds This ratio establishes the relationship between the fixed assets and proprietors funds. Proprietors funds also indicates the general financial strength of a firm. Total Assets to Proprietary Funds = Total Assets / Proprietary Funds Current Assets to Proprietor Funds = Total Funds Current Assets / Proprietary

Capital Gearing Ratio = Equity Share Capital / Fixed Interest - Bearing Securities Debt Equity Ratio = Debt or External Equities / Equity or Internal Equities It is one of the important structural ratios and establishes relationship between debt capital and equity capital. Debt capital is a cheaper source of finance. This ratio helps us in assessing the risk factor that arises in the use of debt capital in capital structure. Stock Turnover Ratio = Cost of Goods Sold / Average Stock It reveals the movement of stock in the organization. If the no. of times is more it indicates the fast movement of stock. If the no. is less it indicates slow movement of stock in the organization.

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Finance Material Debtors Turnover Ratio = Credit Sales / Average Debtors & Bills Receivable This ratio gives a picture of how many times debtors made payments to the firm. Creditors Turnover Ratio = Credit Purchases / Average Creditors & Bills Payable This ratio focuses light on how many times credit facility is allow to the firm. The lower the ratio the higher the facility of credit. Working Capital Turnover Ratio = Sales (or) Cost of Sales / Working Capital To know the relationship between working capital and sales. Fixed Assets Turnover Ratio = Sales (or) Cost of Sales / Fixed Assets To know the effective utilization of fixed assets in production. Total Assets Turnover Ratio = Sales / Capital Employed To test the managerial efficiency and business performance. This ratio measures how efficiently assets are employed overall. Ratio: The relationship between two financial values. Gross Profit: Sales Cost of Goods Sold Equity: Proprietary Funds Debt: Long term and short term liabilities Operating exp.: The aggregate of office and administrative expenses, selling & distribution and financial expenses. Financial Leverage: The use of fixed rate of sources along with owners equity is described as financial leverage. Amalgamation : When two or more companies carrying one similar business taken over by a newly formed company for the progress in business, it is called amalgamation. Absorption : It one or more companies are taken over by a company already in existence, it is called absorption. Reconstruction : It means reorganization of companys financial structure.

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Finance Material Purchase Consideration : Purchase consideration means the purchase price agreed upon, which is paid by the purchasing company inorder to pay to the Vendor Company. Lump sum Method : Lump sum amount is paid to Vendor. HOLDING COMPANIES: It is obvious that Holding Companies can nominate the majority of directors in other companies which are known as subsidiary companies and therefore a holding company usually holds the majority of paid up equity share capital. When a company reaches the stage of floating another company holding majority of shares, it becomes a parent company. The existing companies in order to avoid competition float a company which holds a majority of their shares. Sec. 4 of the Companies Act, 1956 defines a Holding Company and Subsidiary Company by their relation to each other. A company shall be deemed to be a subsidiary of another if, but only if, The other company controls the composition of its Board of Directors; or The other company a) holds more than half of the nominal value of its equity capital, or b) if it is an existing company (i.e., a company formed before 1st April 1956) with both equity and preference shareholders, having equal voting rights, the other company controls more than half of the total voting power; or It is a subsidiary of any company which is the other companys subsidiary. To make it clear a company is termed to be the holding company of another only when the other is its subsidiary. Therefore a holding company is one which has control over one or more other companies. It is to be noted that there is no liquidation of subsidiary company. Moreover, its separate legal entity cannot be disturbed. The point is only acquisition of shares in the subsidiary company but not its assets or liabilities. Preparing consolidated Balance Sheet is common. Goodwill or Capital Reserve: When the Holding Company purchases the shares of subsidiary company by paying more than face value, the excess paid is treated as Goodwill. When the holding company purchases shares from the subsidiary company, less than the face value, the difference between face value and the amount paid is treated as capital reserve. Capital Profits: The profits and reserve in the subsidiary company on the date of shares acquired by the holding company is treated as capital profits.

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Finance Material Revenue Profits: Profits earned by subsidiary company after acquiring the shares by holding company are called Revenue Profits. Minority Share Holders Interest: The amount related subsidiary company is treated as minority shareholders interest. Contingent Liabilities: Contingent Liability is a liability which may or may not arise. Inter company Transactions: Transactions between the holding company and the subsidiary company are known as inter company transactions. VALUATION OF SHARES: Net Assets Method: In this method valuation of shares is based on asset valuation. Net Tangible Assets: (Assets - Liabilities) - Intangible Assets Yield Method: This is also known as earning capacity or Market Value Method. Investors in general and small investors in particular pay for the shares on the basis of the income or yield expected. Therefore, the expected dividends are taken as the basis in this method. Fair Value Method: this is also called earning capacity valuation method or dual method. This is geared to rectify one of the limitations of the earlier method that the value of the share is based on the dividend but not on the earnings. This method relates the value of the share to the earning efficiency in terms of profitability of the company as the market price of the share is based on the earnings of the company rather than the dividend declared. Intrinsic value: Means the potential price of a companys common stock. Liquidation: Winding up of the company. Net Worth: Means the sum of paid up share capital plus reserves plus the preference share capital. VALUATION OF GOODWILL: Goodwill is the reputation and image built up which places the business in position to have long run survival, success and growth, success and growth besides positively influencing the earnings. Factors affecting goodwill: Profitability of Business, Brand Equity, Product of Service Quality, Customer Acceptance, Business Location and Access etc. 75

Finance Material

Average Method: In this method which takes into account the average profits for the past few years and the value of goodwill is calculating as some years purchase of this amount. Super Profit Method: The excess of actual profits over the normal profit is known as super profit. A business unit may posses some advantages which enable it to earn extra profits over and above the amount that would be normally earned, if the same capital is employed elsewhere in a business of same risk class. Annuity Method: Under this method goodwill is calculated by taking the average super profit as the value of an annuity over a certain number of years. An annuity is a series of equal periodic payments occurring at equal intervals of time. In other words goodwill is calculated by finding the present value of an annuity discounted at a given rate of interest which is usually the normal rate of return. Value Added Statements: The Statements which show changes in value added which are created by production. Historical Cost Accounting: The accounting statements which are prepared on the basis of past transactions. Inflation Adjusted Statements: Accounting statements are adjusted on the basis of established price index. Replacement Cost: It is the cost of replacing an existing employee. Opportunity Cost: The actual or assumed rate for capitalization of the differential earnings expected to be earned by an employee. Annuity: A series of receipts or payments of a fixed amount for a specialized number of years. Present Value: The value of sums received in future being discounted by an appropriate capitalization rate.

FINANCIAL MANAGEMENT
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Finance Material

Financial Management: Concerns the acquisition, management of assets with some overall goal.

financing,

and

Future Value: The value at some future time of a present amount of money, or a series of payment, evaluated at a given interest rate. Net Present Value: The Present Value of an investment projects net cash flows minus the projects initial cash outflow. Present Value: The current value of a future amount of money, or a series of payments, evaluated at a given interest rate. Price / Earning Ratio: The market price per share of a firms common stock divided by the most recent 12 months of earnings per share. Risk: The variability of returns from those that are expected. Capital Structure: The mix of a firms permanent long - term financing represented by debt, professed stock, and common stock equity. Compound Interest: Interest paid on any previous interest earned, as well as on the principal borrowed. Funds: Funds include not only cash but also the total current assets or financial resources. Profit Maximisation: It is a criterion for economic efficiency as profits provide a yard stick by which economic performances can be judged under condition of perfect competition. Wealth Maximisation: It stands that the management should seek to maximize the present value of the expected returns of the firm. Discounting: A reduction of some further amount of money to a present value at some appropriate rate in accordance with the concept of the time value of money. Sole Proprietorship: A sole proprietorship is a firm owned by an individual. He owns all assets and owes all liabilities of the business. Partnership Firm: A partnership firm is a business unit carried on by two or more persons with an intention to share profits or losses. The limitations are 77

Finance Material i) Unlimited liability ii) Limited life iii) difficulty in transferring ownership and iv) Limitations in raising funds. Joint Stock Company: A joint stock company is a legal entity created under the law and empowered to own assets, to incur liabilities, and to engage in business. It is an artificial person created by the law. The capital of a company is divided into small portions and each portion is called a share. Investors who buy these share are shareholders and they are the owners of the company. Co-operatives: Cooperative societies are associations formed voluntarily by the people to render service to the members of their society. They are formed to protect and safeguard the economic interest of the weaker sections of the society from the exploitation of stronger sections of the society. SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI) The SEBI Act, 1992 was promulgated after withdrawing the Capital Issues (Control) Act. SEBI is broad in its application covering wide ranging issues. The powers and functions of SEBI Act are: Regulating the business of stock exchanges Registering and regulating the working of Stock Brokers, Sub Brokers, Share Transfer Agents, Bankers to the Issue, Trustees of Trust Deeds, Registrars to an issue, Merchant Bankers, Underwriters, Portfolio Mangers, Investment Advisors. Registering and regulating the working of Depositors, Custodians of Securities, Credit Rating Agencies Registering and regulating the working of Venture Capital Fund, Collective Investment Schemes, Mutual Funds Promoting self regulating organizations. Prohibiting fraudulent and unfair trade practices Promoting investors education Prohibiting insider trading Regulating substantial acquisition of shares, takeover of companies.

Accountancy: The method of identifying, arranging and passing on the required financial information to the decision makers is business

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Book-Keeping: It is the process of recording business transactions and submitting statements of accounting information to the decision makers by summarizing and analyzing these transactions. Accounting Principles (It is classified into two categories)

Accounting Concepts

Accounting Conventions

ACCOUNTING CONCEPTS 1) Business entity concept: while recording the business transactions, only those transactions which have a bearing on the profit/loss of the firm (Concern) should be taken into account from the view point of business. 2) Money measurement concept: Accounting records only transactions that are expressed in terms of money. From the business point of view services of employees and depreciation on fixed assets like furniture, machinery should be measured in terms of money only but not in any other terms. 3) Cost concept: generally the business transactions are recorded at cost in the books of accounts. Eg: A firm purchases a machine for Rs 100000 only though The machine Plays very important role in the Production activity. 4) Going concern concept: Accounts are recorded assuming that the business will continue for a long time. While selling goods to outsiders or purchasing goods from outsiders business concern presumes that they will stay in the business for longer period. In absence of this view there is no need to maintain books of account. The concept is also useful to determine the value of fixed assets. Eg: While taking a properly on lease basis the going concern Concept is Useful to assess the intangible assets like Goodwill.

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5) Realization concept: According to this concept imaginary profits should not be recorded at all 6) Dual Aspect concept: As per this concept, every transaction should have two aspects, one is receiving aspect and the other is giving aspect. The receiving aspect is called debit and the giving aspect is called credit. Therefore, for every debit, there is an equal corresponding credit. Eg: If a machine is purchased for 50,000 Increase in the machine account Increase in the cash account both are Equal ACCOUNTING CONVENTIONS 1) Consistency 2) Conservation 3) Disclosure 4) Relevance 5) Feasibility ACCOUNTING TERMINOLOGY Business Transaction:Every business Operation deals with exchange of cash, goods and services. This results in change in the financial position of the business concern. Hence, a business transaction may be defined as an activity that brings a change In the aspects of the business. It is also transfer of may or moneys worth between two parties. Event like purchase an sale of goods, receipts and payments of cash etc, Business: It is an activity which involves exchange of goods/services with the intention of earning income and profit. Assets: Assets refer to any properties or things owned by a business concern including the amount due to it from others. Eg: Building Machinery Stock Cash and Bank Balance Investment etc..,
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Fixed Assets: It is permanent assets it is also provide long-term benefits for running the business. Change in the value of these assets is minimum. Eg: Land, Building, Plant, Machinery, Vehicles, and Furniture Floating Assets: In these assets dedicate their benefits for running the business and which change in value with in a short span of time. Values of those assets always change. Eg: Goods, Debtors, Cash & Investment etc.., Current Assets: Cash and other short term assets or circulating assets like debtors, stock, bills receivable , cash etc, Eg: Investment, debtors, Closing Stock, Cash at Bank, Cash in hand, prepaid expenses, accrued incomes Fictitious Assets: It is also called intangible assets. In these assets are types of peculiar assets whose existence in invisible but whose benefit is enjoyed. Eg: Good will, Copy rights, Patents. Unabsorbed portion of Differed revenue expenses like advertisement, preliminary Exp, samples can also be shown under this heading. Cash transactions: when payment for business activity in made immediately, it is called cash transaction. Credit Transactions: when the payment is postponed to a future data it is called credit transaction. Non-Cash Transaction: A non-cash transaction is a business transaction where these is no payment or receipt of cash either immediately or at a future date. Eg: Depreciation, bad Debts etc.., Proprietor: The owner of business is called proprietor he invests capital in the business with the intention of earning profit. Capital: It is the Amount invested by the proprietor in the business. It is always equal to (Assets-Liabilities) it is also called owners equity i.e. Owners claim against the Assets.

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Assets = Capital + Liabilities Capital = Assets Liabilities Liabilities = Assets - Capital Drawings: it is the value of cash or goods withdrawn from the business by the owner for his personal use. Goods: It refers to commodities, articles or things in which a trader deals. Goods refer to commodities or things intended for resale. Unsold goods lying in a business concern on any given date are called stock. Debtor: A debtor is a person who owes money to the business. Creditor: A Creditor is a person to whom the business owes money. Liabilities: it is refer to debits or amount due from a business to other either for money borrowed or for goods or assets purchased on credit or services received without making immediate payment. This includes (Bank Loan, or Over Draft, Trade Creditors, Outstanding Expenses) etc., Fixed liabilities: Fixed or long term liabilities are the loans payable after a reasonable long term durations say 5 to 10 years. Eg: Debentures, long term lones, Mortgage loans etc, Current liabilities: Current liabilities are the Repayment obligation payable from one year to three years. These are no hard and fast rules for this. Eg: Sundry creditors, Bills payable, Bank loans etc.., Contingent Liabilities: It is the liabilities which may arise in future depending on happening of an uncertain event. Eg: Damages payable but still under dispute. Bills Discounted But likely to dishonored etc.., Liquid Liabilities: which are to be paid at very short notice can be included in this category. Eg: Outstanding expenses, Income Received in Advance, Bank Overdraft etc..,

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Equity: All claims against the assets of business are called equity the claim of outsider is called creditors Equity or liability. The claim of the proprietor in called owners Equity or capital. Book Debt or Debt: the amount due form a debtor is called debt. Book debt is nothing but debt. It is called Book Debt because it is the amount due from debtor as per the books of account. Good Debt: It is a debt which is fully recoverable. Bad Debt: A Debt which is irrecoverable is called Bad debt. Revenue: It refers to the earnings of a Business. It includes the sale proceeds of goods, receipts for services rendered and earnings from interest, Commission etc.., Expense: It is the amount spent in conducting business activities. It is the expenditure, in return for some benefit. Eg: Salary paid to staff. Rent paid to landlord etc..,

DEBIT

CREDIT

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To debit an account means to enter the transaction on the debit side of that account. It means left hand side of the account. (Incoming benefit or receiving benefit is called Debit)

To Credit an account means to enter the transaction on the credit side of that account. It means right hand side of an account. (Out going benefit or giving benefit in called credit)

Entry: The record of a transaction in a journal is called entry. In practice the term is used for record made in any book of account. Posting: Posting is the process of entering in the ledger the information already recorded in journal or subsidiary books. Books of Accounts: Books of account refer to suitable ruled account books in which business transactions are recorded. These are mainly two sets of books of accounts maintained by a concern. They are: a) Journal or subsidiary Books b) Ledger. Journal: It is an account Book. Where business transactions are first recorded. It is a book of original entry. Every business transactions recorded in a chronological order. And day to day transactions are to be recorded in a journal. This book also called daily recorded or day book and also book of prime entry Eg: Sales Returns, purchase rate, C/R and payment, loans & advances Ledger: It is a book in which various accounts are opened. It is also called Book of final entry Brought Down (b/d): This term is written in the ledger to show the opening balance in any account. It suggests that the account has been brought down from the previous period. Carried down (c/d): this is written in the ledger account at the time of closing the account.

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Accounting: it is the art of recording, classifying and summarizing in a significant and In terms of money, transactions and events which are in part at least, of a financial character and interpreting the results there of. AICPA: American Institute of Certified Public Accountants. Account: It is a summarized statement of Debit & Credit. These are two parts for every account. The left hand side of the part is called Debit side and the right hand side of the is known as Credit side. Expenditure: Amount spent for acquiring goods or services for running business is known as expenditure. It may be Capital expenditure Revenue expenditure Capital expenditure: The amount spent for the acquisition of fixed asset which have long life and which are useful for the long term benefit of the business is known as capital expenditure. Eg: Machinery, furniture, fixtures, land, building Revenue Expenditure: All expenses incurred for running the business for the current year is known as Revenue Expenditure Eg: Salaries, Rent, Interest, Manufacturing and selling goods etc.., Income: The amount earned by a firm out of its business transaction during a period is called income. Particular Income is of two types. Capital gains, Revenue Income. Capital gains: Capital gains are the excess amount received over the book value of the asset owned by the firm. Eg: Profit earned over sale of building. Revenue Income: Revenue income is the income received during business transactions or sale and purchase of goods or on services rendered to outsider. Eg: Interest and commission received Journal Entry: The process of recording the business transaction in the journal is known as journalizing. To divide business a transaction into two aspects and recording in the journal is called journal entry the first one is debt aspect and the second one is credit aspect.
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Cheque: A cheque is an instrument, by means of which a depositor can order the bank to pay a certain sum of money only to the order of a person or to the bearer of the instrument. Invoice: it is a statement sent by the seller to the purchaser which contains the details of the quantity of goods sold and price of the goods/product, terms and conditions of payment particulars. Loss: Loss refers to money or moneys worth given up without any benefit in return. It is an expenditure in return for which no benefit is received. Loss of goods by fire, damages paid to others is examples of losses. Loss is different form an expense. An expense brings some benefit, a loss does not bring any benefit, Rent paid is an expense but a goods destroyed by fire is a loss. It is two types 1) Normal Loss 2) Abnormal Loss Normal Loss: Loss of stock is said to be normal loss when it is of unavoidable nature and due to inherent characteristics of commodity. Such loss may be arise due to loading and unloading of goods, cutting the bulk material into small parts evaporation, drying etc.., Abnormal Loss: Abnormal Loss is that loss which is avoidable and which does not arise due to the nature of goods. Such loss is caused due to fire, theft, pilferage etc.., A business man records the business transactions in two ways. They are 1) Single entry system:This Method is unscientific an incomplete. Some experts in accountancy revealed that single entry system is not at all a system of accountancy. In this system only one side aspect of the transaction (Either Debit or Credit) is to be recorded instead of two aspects. Hence this system is called Single entry system. In this method the accountant maintain only personal account and cash book and also maintain real account and leaves the nominal account. This method is known as incomplete double entry system. According to Indian companies act 1956 the single entry system of accounts should not be followed by Joint Stock Companies.

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2) Double Entry System: The double entry system was invented by a Trader called LUCI PACIOLO in Italy he wrote about this system in his first book DE COMPUTISET SCRIPTURIS In the year 1434. According to him every transaction takes place between either two persons or two firms/enterprises. When such a transaction takes place one person receives benefit and the other person gives benefit. These two benefits are inseparable. Hence, we can not think of one transaction leaving the other. If one person is receiving the benefit, it indicates that some other person is giving that benefit. In accountancy the receiving benefit in called Debit aspect and giving benefit is called Credit aspect. This, the procedure of recording both the receiving and giving aspects related to business transaction is called Double entry system. CLASIFICATION OF ACCOUNTS
(Golden Rules of accounting nothing but personal & Real & Nominal a/cs)

(It is two types)

Personal Accounts

Impersonal Accounts

Real Accounts Capital type Accounts Assets Accounts

Nominal Accounts

Revenue Type Accounts Income Accounts

Liabilities Accounts Expenses Accounts

Principles of Double entry Personal Accounts Real Accounts Nominal Accounts

Debit

Credit

Debit

Credit

Debit

Credit

ReceiverGiverwhat what Expenses Incomes Comes in goes out & losses & gains

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Personal Accountants: Personal accountants are accounts of persons with whom a concern carries on business.

When the Account Holder Receives Benefit When the Account Holder Gives benefit ( Debit the Receiver ) (Credit the Giver ) Eg: - Names of persons, Company etc..,

Debit Credit

Real Accountants: Accounts relating to properties or assets of a trader are known as real accounts. It includes tangible assets such as buildings, furnitures cash etc.., and also intangible assets such as goodwill, Trade marks etc,

When Assets comes into the firm Debit When Assets goes out of the firm Credit (Debit what comes in) (Credit what goes out ) Eg: - Machinery, Furniture, goods Nominal Accountants: Accounts dealing with expenses, losses, gains and incomes are called nominal accountants. Eg: Salaries, rents, Commission etc..,

When the firm receives benefit Debit When the firm gives benefit Credit (Debit all losses and expenses) (Credit all gains and incomes)
Dr Date Particulars J.F.No. Account Amo. Date Particulars J.F.No. Cr Amo.

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Compound Entry: Whenever two or more transactions of the same nature (i.e. transactions where either the account to be debited of the account to be credited is common) take place on the same date a composite or compound or combined journal entry may be passed for them instead of passing a separate journal entry for each of them. It should be noted that the amount in debt column equals to the amount in credit column, based on double entry system of book-keeping. One amount in the debit column must be equal to two or more amounts in the credit column or one amount in the credit column equals to two or more amounts in the debit column. Opening Entry: At the time of beginning of a new accounting year, every businessman has to write and keep a new set of books of accounts. The accounts not closed in the previous accounting period are recorded in a new set of books with an entry called Opening entry. All the assets accounts are debited and liabilities accounts are credited. The difference between the assets and liabilities is to be credited to the capital Account. Capital type Accounts:the capital type accounts are those accounts whose effect is not limited to a particular financial year but carries over to future financial years also. Revenue type accounts:When the effect of income and expenditure is limited to a particular financial year, it is known as Revenue type of account. Eg:Commission Received, Interest Received, rent paid, Salaries paid etc.., its classified two types 1) Income A/C 2) Expenses A/C Personal Accounts: a) Sold goods to sukumar for Rs.900 Sukumar a/c ..Dr To goods a/c ..Cr b) Received cash from Ravisankar Rs.2000 Cash a/c Dr To Ravisankar...Cr c) Paid cash to Subramanyam Rs.1000 This transaction is influenced by two a/cs Real & Personal a/cs Subramanian a/cDr To Cash a/cCr Real Accounts: a) Received cash from Sivaram Rs.1600
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This transaction is influenced by two a/cs Real & Personal a/cs Cash a/c ..Dr To Sivaram a/cCr b) Purchased furniture from Sumalatha traders for Rs.30000 This transaction is influenced by two a/cs Real & Personal a/cs Furniture a/c.Dr To Sumalatha traders a/cCr c) Purchases machinery for cash Rs. 16000 This transaction is influenced by two Real a/cs Machinery a/cDr To Cash a/c.Cr d) Cash paid to Sivaramakrishna & Company, for Rs.900 This transaction is influenced by Real & Personal a/cs Sivaramakrishna & Company a/cDr To Cash a/c.Cr

Nominal Accounts: a) Paid wages Rs.10000 Wages a/c .Dr To Cash a/c..Cr b) Received Commission Rs.430 Cash a/c..Dr To Commission a/c.Cr c) Received Interest Rs.600 This transaction is influenced by Real & Nominal a/cs Cash a/c ..Dr To Commission a/c ..Cr Personal Accounts Real Accounts Nominal Accounts

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1) Sivaram a/c 2) Sangita a/c 3) ICICI Bank a/c 4) National Insu. Co. a/c 5) Kumar Cotton co. a/c 6) Venugopal & co. a/c 7) Salaries to be paid a/c 8) Comm. to be paid a/c 9) Rent rec in advn a/c 10)Insu. paid in advn a/c 11) Capital a/c

1) Machinery a/c 2) Building a/c 3) cash a/c 4) goods a/c 5) furniture a/c 6) investment a/c 7) good will a/c 8) patents a/c 9) loose tools a/c 10) Office furniture a/c

1) Rent a/c 2) salaries a/c 3) interest a/c 4) commission a/c 5) insurance a/c 6) stationery a/c 7) printing a/c 8) traveling exp. a/c 9) advertisement a/c 10) discount a/c

KINDS (CLASSIFICATIONS) OF LEDGER ACCOUNTS 1) Debtors ledger Accounts: When customer purchases goods on credit basis from the business concern, they becomes the Debtors of the firm. When all their accounts are recorded in one book that book is known as Debtors ledger. All the accounts in the Debtors ledger show only debit balances. The total balances of these accounts indicate the total amount to be received from the customers. 2) Creditors Ledger Accounts: When the firm purchase goods on credit basis from the Suppliers, the suppliers become Creditors to the firm. When all the accounts of creditors are recorded in one book, that book is known as Creditors Ledger. All the accounts in the creditors ledger show only credit balances. The Total balance of these accounts indicates the total amount to be paid by the company to the supplier. 3) General Ledger: The business firm acquires many assets for successful operation of the business similarly it makes different types of expenditure in the process of business. The business gets income out of its business transactions. When the company records all these accounts that means accounts related to the assets, income and expenditure in one book, that book is known as General Ledger Assets a/c = Goods, Cash, Machinery etc, Expenses a/c = Wages, Salaries, freights, etc.., Income a/c = Commission received, discount received etc..,
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Are recorded in general, ledger accounts related to real accounts and the balance of all types of accounts related to nominal accounts always show only debit balance. On the other hand, all the accounts related to incomes show only credit balances. 4) Self Ledger: When all accounts which indicate the relationship between proprietor and the business firm are recorded is one book, that book is known as Self Ledger this is called Private Ledger Eg: Capital Account, Drawing Accounts, Profit and Loss a/cs etc.., This ledger is highly confidential. SUBSIDIARY BOOKS In this Book maintained separate books to record each kind of transaction. As all the similar kind of transactions is recorded in separate book, it becomes easier post all such transactions in ledger at a time. It is overcome such problems the posting of journal entries in ledger can be avoided at every time a transaction occurs. This, the different Transactions are classified into various groups and relevant transactions are recorded in a separate journal. Such journals are called Subsidiary Journals or Books of original entry or Subsidiary Books. Kinds of Subsidiary Books: 1) Purchases Book: Only the credit purchases of goods are recorded in this book cash purchases and purchase of asset are not recorded in this book. It is also known as Invoice Book it is posted to the debit of Purchase account. 2) Sales Book: The credit sales of goods are recorded in the sales book. Cash sales and sales of assets are not recorded in this Book. It is also know as Sales day Book. 3) Purchases returns Book: This book keeps a record of the returns outwards: that is, return of goods to the supplier. When goods are purchases on credit basis and returned to the supplier for some reasons the transaction related to the return outwards are recorded in this book Return outward book. 4) Sales Returns Book: This book is kept for recording returns inwards. When goods are sold on credit basis and returned by the customer due to some reasons, Transactions related to returns inwards are recorded in the sales returns book Returns inward Book.

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5) Cash Book: The cash book in maintained to record all cash transactions. All the cash receipts and payments are recorded in the book. 6) Bills Receivable Book:The bills on which the amount is yet to be received and promissory notes drawn by the seller or creditors are recorded in the bills receivable book. 7) Bills payable Book: All bills and promissory notes accepted by the buyer or debtor are recorded in the bills payable book. 8) Journal Proper:This book is used for recording only those transactions which can not be recorded in any of the above mentioned subsidiary books. Debit Note: While Returning the goods. It is prepared by the purchaser. Net amount is debited to the suppliers account. Two copies of the debt note are prepared. One is sent to the suppliers and the other one is retained by the firm. It is recorded in purchases return book. It is mainly contain name and address of the supplier. It is Reason for returning the goods should be mentioned. Credit Note: When goods are sold on credit, on account is opened under the customers name and the total amount of goods sold is noted in the debit side of his account. When goods are returned by him, his account should be credited with the exact amount of the goods returned. It is maintained two copies. One is given to the customer and the other is retained by the firm. This is entered in the sales return book. CASH BOOK It is customary to every businessman to have cash transactions, i.e. cash receipts and payments, regardless of the size of the business organization. If the size of the firm is small, the cash transactions are in small amounts. In case of large organizations, the transactions will be in big amount. If cash receipts and payments are recorded in a separate book, it is known as Cash Book. The person who maintains this book is called a cashier. There are chances for fraud and manipulation of cash. In order to avoid the probable fraud, all the cash transactions are recorded in the cash book, through which the closing balance of cash is known. Importance: Usually there are two types of transactions in every business organizations, cash transactions and credit transactions. Credit transactions are recorded in the
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respective subsidiary books. Cash transactions are recorded in the cash book. Cash transactions are or two types: 1) Cash receipts 2) Cash Payments Cash receipts should be shown on the debit side & Cash payments on the credit side of the cash book. Cash received and paid pertaining to previous transactions are also recorded. The difference between the debit total and the credit total reveals the cash balance available with in the firm, no business concern can pay more than what is receives. It means the payments should not exceed receipts. Sometimes, the debit and credit may figure the same. When the amounts of receipts equal the payments, the cash balance with the firm is nil. Cash book can be used either as a book of original entry or a ledger. It plays the role of both a ledger and subsidiary book. As cash transactions are first recorded in this book, it is also called the Book of final Entry. Transactions recorded in the cash book need not be posted in the ledger again. That is way, it is also called Book of final Entry. Cash book should be prepared and maintained with minimum errors. Cash book helps the firm to have a proper control on cash. Characteristics of Cash Book 1) It can also be treated as a subsidiary book. 2) Like ledger, there are the debit and the credit columns is cash book. 3) Only cash transactions are recorded. 4) It always shows debit balance but it never shows the credit balance. 5) The balance of cash can be known at any point of time. Types of Cash Book Cash book mainly four types 1) Simple cash book 2) Double column cash book a) Containing cash and discount columns b) Containing bank and discount columns 3) Triple column cash book 4) Petty cash book 1) Simple Cash book The simple cash book is maintained, usually, by newly started business firms, whose trade activities are limited. Only cash transactions are recorded in this book. So, it is called single column cash book. Credit transaction (credit purchases & credit sales) does not recorded in this book. 2) Double Column Cash Book a) Cash book with cash and discount column
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In this book pertaining to cash and cash discounts are also recorded. That is way; it is called Double column cash Book. In this book expressly various types of discounts are offered. 1) Trade discount 2) Cash discount. Trade Discount: The discount offered by the seller to the buyer on the price of the goods purchased is called Trade discount. It is shown in the Invoice. It is prepared with the net amount. It is does not appear either in the cash book or any other Book. Cash Discount:If a debtor clears his debt before or on the date specified, he may receive some rebate in the form of cash form the creditor. This is treated as cash discount received by the debtor. This rebate given by creditors is treated by him as discount allowed. This discount always recorded in the cash book. Along with the cash column, discount column is maintained on both the debit and credit sides of the book. Hence this book is called double column cash book. The discount column of the debit side is called discount allowed and the discount column of the credit side is called is called discount received. b) Cash Book with Bank and Discount Columns The modern business concerns, for safety reasons, do not, usually carry out their transactions only in the form of cash. The transactions are usually carried out through banks. The payments and receipts are usually made through cheques. Every day the cash and cheques deposited in the bank are recorded on the debit side and the cheques drawn are shown on the credit side. The discount obtained regarding these transactions is shown on the credit side and the discount allowed is recorded on the debit side. Usually, the bank column shows a debit balance, but sometimes it can show a credit balance also. If it shows a credit balance, we call it an overdraft. 3) Triple column Cash Book (Cash Book with discount, cash and bank columns) The modern organizations, in which the cash transactions are made amounts, deal with banks regularly to gain the following advantage. Cheques received can be deposited in their bank accounts. All payments can be made through cheques. Interest can be earned by depositing the cash balance in the bank.
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As the business firms deal largely with banks. They prepare a cash book containing cash, discount and bank columns. So, this book is called Triple column cash book. As we include a bank column in the cash book itself, there is no need of opening a bank account in the ledger. By adding a bank column on both the debit and credit side of a double column cash book a triple column cash book is obtained. This book is thus, a mixed record of three accounts. The three accounts are. Discount account as Nominal A/c Cash A/c as Real A/c Bank A/c as personal A/c Dr. Proforma of Triple Column Cash Book
cash Bank Date particulars Received LF Discount Cash

Cr.
Bank

Date Particulars LF no discount Allowed

Important points to be noted while recording the transactions in the triple column cash book. a) When opening cash and bank balances are given, they should be recorded on the debit side of the cash and bank columns when opening bank balance is given as an overdraft, it should be recorded on the credit side bank column of the cash book. b) When cash is received by the firm, it should be recorded on the debit side cash column of the cash book. In the same way, cash payments made by the firm are shown in the cash column on the credit side of the cash book. c) When cash or cheque is received from debtors through cash sales or any other sources, it is recorded in the cash column on the debit side of the cash book. If the cheque Is deposited into bank on the same day or assumed to be deposited on the same day, it is recorded in the bank column on the debit side. d) If any payment is made or a debt is cleared in the form of cheques, it is recorded in the bank column on the credit side.
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e) If discount is involved in cash/bank transactions, it should be treated as under: If discount is allowed by the firm, it is recorded in the discount column, on the debit side of the cash book. If discount is received, it is recorded on the discount column on the credit side of the cash book. f) If the cheques sent to bank for collection are dishonored, these should be recorded in the bank column on the credit side of the cash book. Similarly, if we receive any information that the cheques issued by us are dishonored, it should be promptly noted in the bank column on the debit side. g) If cash is withdrawn from the bank for the business use, it should be recorded in the cash column an its debit side and bank column on the credit side of the cash book. Similarly if we deposit cash into bank it should be recorded in the bank column and credit the cash column of the cash book. This type of entry is called contra entry. h) The cash and the bank columns are balanced periodically. But, the discount column will not be balanced. These columns are totaled and the amounts are carried forward to ledger accounts. i) Contra entry: If a transaction requires entries on both the debit and the credit sides simultaneously, it is called Contra entry. Here, both the sides are affected. Example: when the cheques previously rare deposited now in the bank, they should be recorded in the bank column on the debit side and he cash column on the credit side of the cash book. Contra entries do not have ledger folio. To indicate that in is a contra entry, the alphabet C is mentioned in the ledger folio column on both the debit and the credit sides. C means contra entry. Note:if cash is withdrawn from the bank for the proprietors personal use, then it is not a contra entry. Usually, the contra entries will appear in the following occasions. When an account is opened with a bank. The firms cash is deposited in the bank. The cash is withdrawn from bank for office use. The cheques received from debtors, are deposited in the bank. In transactions a & b, the cash balance available with the firm is decreased, the cash in bank is increased. In transaction C, the cash in the bank is decreased and the cash in the firm is increased. Note:
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1)When cheque received from a debtor is deposited in the bank on the same day, the entry will be as under: Bank A/c Dr. To Debtor A/c (Being the cheque received from the debtor is treated as cash) 2) When the cheque received from a debtor is not deposited into bank on the same day, two entries are recorded. When the cheque is received: Cash A/c Dr. To debtor A/c (Being the cheque received from the debtor is treated as cash) When the cheques are sent to the bank next day for collection. (this entry is called contra entry) Bank a/c Dr. To Cash A/c (Being the cheque deposited in the bank) Problem: prepare a triple column cash book in Vijay & Co., Books. 1996 July 1 Commenced business with cash Rs.19, 000 2 Deposited in Bank of India Rs. 10,000 4 furniture purchased by cheque payment Rs. 5,000 6 Electricity deposit paid in cheque Rs. 3,500 9 Credit purchases from shyam lal Rs. 20,000 13 wages paid in cash Rs. 6,500 15 Credit Sales to Ratan Rs. 14,000 16 Transport expenses paid Rs.60 18 Cash sales Rs. 6,000 19 Received from Ratan by cheque of Rs. 13,850 21 Paid to Shyanlal by cheque Rs. 19,900 22 Ratanlal cheque deposited in bank 24 cash brought into business on cheque Rs.10, 000 25 withdraw from bank for office use Rs. 2,500 28 Rent paid by cheque Rs. 2,000 29 wages paid Rs. 4,000 29 cash sales Rs. 15,600 31 Electricity bill paid Rs.250
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31 Rent received by cheque Rs.6000 Cheque deposited in bank on the same day. Petty Cash Book:in a business where there are large numbers of small payments the entries are not made in cash book, but in petty cash book. The petty cashier is given a certain sum of money and all small payments below a certain limit are made by him. The petty cash book is maintained just like cash book generally petty cash book is maintained on Imprest system. Imprest System:under this system a rough estimate of the small payment for a period of month or week is made and the head cashier gives the petty cashier the estimated amount. Petty cashier makes payment and records the transactions in the petty cash book. At the end of the period the petty cashier balances his book. Then the chief cashier pays him the amount which he spent, so that original amount of petty cash with which he started is restored. Imprest System is very useful especially if an analytical petty cash book is used. Under this method a separate column is provided to record each head of petty expense along with a total column. Every payment is entered in the concerned head of petty expense and in total column. All the payments made are analyzed in the column of petty cash book itself, under the different heads of expenses. Hence it is called analytical petty cash book. It will be on the following lines.
Receip Vouch Total Date Parti Analysis of Payment Conveyance CartagStatione Postage

Journal proper
This book is used for recording only those transactions which can not be recorded in any of the above mentioned subsidiary books. It is one kind of Subsidiary book Example: In the event of purchase of furniture for Rs. 10,000/- from Mr. Srinivas, the transaction cannot be recorded in the purchase book because it is not the purchase of goods. So, we record it in the journal proper as under:
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Furniture a/c Dr 10000 To Mr. Srinivas a/c 10000 (Being the furniture brought from Mr. Srinivas on Credit) Note:If the purchase is made for cash, it must be recorded in the cash Book. Example:The firm owes to Mr. Rama Chandra a rent of Rs. 3000/- this entry will be as follows: Rent a/c Dr 3000 To Mr. Rama Chandra a/c (Being rent to be paid to Mr. Rama Chandra) Note:Had the rent been paid earlier, it would have been recorded in the cash book. As it is not paid, it is viewed as a liability of the firm. Ledger Postings:The sum total of all the subsidiary books is posted to the relevant ledger accounts. We know that we have recorded all the purchase of goods in different amounts in the purchase book and while posting on the debit side of the purchase account the total amount is shown as a single item. Similarly, the sum total of the sales book is credited to the sales account. The ledger postings are also necessary for the entries in the journal proper. Advantages of Journal proper: As business transactions are classified and recorded in their respective subsidiary books, the following entries are recorded in the journal proper. a) Opening Entries:The assets or capital brought in should be recorded first in the journal proper and then, it must be posted to the respective accounts in the ledger. Thus, students must remember that before posting any entry in the ledger, it must be recorded first in the journal proper. The entries recorded in this manner are called the opening entries. Such entries should be recorded only in the journal proper. Example:Suppose Kumar commenced business on January 1st, 1998 with the assets Rs.10, 000/- in cash, furniture worth Rs. 5,000/-, Machinery worth Rs.4, 000/- and stock worth Rs. 3000/-, He writes journal entries as under. Solution: Date Particular Ledger Debit Credit a/c Folio a/c

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1998 Jan. 1St

Cash a/c...Dr Furniture a/cDr Machinery a/c.Dr Stock a/c..Dr To Capital a/c (Being assets brought into the business as capital along with cash)

10,000 5,000 4,000 3,000 22,000

Example:The balance sheet of Mr. Ramu as on 31st December, 1997 is as under shows the opening entries in his book as on 01-01-1998. Balance sheet of Mr. Ramu as on 31-12-1997 Liabilities Amount Assets Amount Bills Payable Sundry Creditors Capital 15,000 Cash 24,000 Sundry Debtor 41,000 Furniture Stock 80,000 Solution: Date
1998 Jan 1st

25,000 15,000 20,000 20,000 80,000 LF Debit

25,000 15,000 20,000 20,000 15,000 24,000 41,000

Particulars
Cash a/c..Dr Sundry Debtors a/c Dr Stock a/c.. Dr Furniture a/c . Dr To Bills Payable a/c To Sundry Creditor a/c To Rams Capital a/c (Being the balance of the previous year brought into the current year books)

Credit

Example: The ledger balance of the accounts of Sunitha and Co as on December 31st, 1998 is as under. You are required to show the opening entries in their book as on January 1st, 1999. Cash Rs. 8,000; Cash at Bank Rs. 10,000; Debtors Rs. 20,000 Furniture Rs.12,000; Machinery Rs. 21,000; Bills Receivable Rs. 11,000; Building Rs.15,000; Creditors Rs. 12,000; Stock Rs. 5,000; Bills Payable Rs.6,000; Capital- Rs.84,000/Solution: Date Particular LF Debit credit

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Cash a/c.Dr 8,000 Bank a/c.Dr 10,000 Debtor a/c..Dr 20,000 Furniture a/c..Dr 12,000 Bills Receivable a/cDr 11,000 Machinery a/c.Dr 21,000 Building a/cDr 15,000 Stock a/c Dr 5,000 To Creditors a/c 12,000 To Bills Payable a/c 6,000 To Capital a/c 84,000 (Being the balance of previous year brought into the current year books) Note: 1) in the entry of the journal proper, if two or more debit or credit items are shown, they are called compound entries. 2) It should be noted that in order to facilitate the recording of the opening entries cash items are included in the journal proper. 1999 Jan 1st b) Rectification Entries:Some times, errors may occur while recording transactions, posting them into the ledger or while balancing the ledger accounts. In such cases, certain entries should be passed in order to rectify the errors. Such entries are called Rectification Entries. When there is an error in passing an entry, another entry (rectification entry) should be passed to nullify the effect of the previous incorrect entry. Example:Let us imagine that the firm has paid Rs. 9,500 as Salaries. Let us presume the accountant wrote Rs.5, 900. This is an error. In order to rectify this error. (This entry must now be posted in the ledger) Sol: Salaries a/c Dr 3,600 To Cash a/c 3,600 (Being the error in noting down the salaries amount, now rectified) Example: Rama paid Rs. 100. This was erroneously credited to Bheemas a/c the rectification entry will be as follows: Sol: Bheemas a/c Dr 100 To Ramas a/c 100 (Being the wrong credit given to Bheemss a/c, now rectified) Example:A businessman, instead of debiting the salary a/c with Rs. 10,000 debited the insurance a/c. Correct this entry.

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Sol:In order to rectify this error, we should debit the salary a/c with Rs. 10,000 and credit the insurance a/c. (Which was mistakenly debited) by Rs.10, 000. The entry will be as follows: Salary a/cDr 10,000 To Insurance a/c 10,000 (Being wrong debit given to insurance a/c, now rectified) c) Adjustment Entries: The value of the assets at the beginning of the year is not equal to that of the end of the year. It is because the constant use of assets throughout the year reduces their value. So, the value of an asset is either decreased (Depreciation) or increased (Appreciation) at the end of the year. To provide for these changes in the value of assets, adjustment entries are passed. In order to write an entry for appreciation in the value of an asset, there should be an increase in the cash inflows as a result of the increase in the value of an asset. These adjustment entries should be first recorded in the journal proper and only then it should be posted in the ledger, these entries which are passed in the journal proper for adjusting the increase/decrease in the value of assets are called Adjustment Entries. Example: Suppose a machinery costing Rs. 30,000/- is to be depreciated at the rate of 10%. The adjustment entry for this will be as follows: Sol:Depreciation a/c.Dr 3000 To Machinery a/c 3000 (Being the Machinery is depreciated by 10%) Similarly, interest on capital, outstanding expenses, income receivable, and bad debts provision require certain adjustments. If such adjustment entries are not passed. d) Closing Entries:In order to know the net result of his business i.e., in order to know whether he has obtained profit or incurred losses, every businessman prepares final accounts. Final a/cs are prepared in three parts. a) Trading a/c b) Profit and Loss a/c c) Balance Sheet. At the end of every financial year, the balances of all the nominal accounts are computed and transferred to the trading and profit and loss accounts. These transferred entries will become the closing entries. These nominal accounts include accounts pertaining to both expenses and revenues. The accounts pertaining to revenue expenditure a/c are balanced and the totals are debited to trading or profit
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and loss accounts. The accounts pertaining to revenue or income are balanced and the totals are credited to the trading or profit and loss accounts. These closing entries are recorded in the journal proper. The following the closing entries. e) Other Entries: The transactions which should not occur in the journal are recorded in the journal proper. Some of them are as under: Goods taken from the business by the proprietor for his personal use. Goods lost due to theft, fire accident etc., Goods sent on consignment for sale purpose. Interest on capital, interest on drawings, provision for doubtful debts, Provision for depreciation etc..,

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Finance Material ACCOUNTING MATERIAL

1. Accounting: Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least of financial character and interpreting the results there of. 2. Book Keeping: It is mainly concerned with recording of financial data relating to the business operations is significant and orderly manner. 3. Branches of Accounting: Financial Accounting and Management Accounting 4. Concepts of Accounting: a. Separate entity concept b. Going concern concept c. Money measurement concept d. Cost concept e. Dual aspect concept f. Accounting period concept g. Periodic matching of costs and revenue concept h. Realization concept 5. Conventions of Accounting: 1. Conservatism 2. Full disclosure 3. Consistency 4. materiality 6. Systems of book keeping: a) Single entry system, b) Double entry system 7. Systems of Accounting: a) Cash system accounting, b) Mercantile system of accounting 8. Principles of accounting: a. Personal a/c --- Debit the receiver and credit the giver b. Real a/c -- debit what comes in and credit what goes out c. Nominal a/c -- Debit all Expenses and losses and Credit all gains and incomes 9. Meaning of Journal: Journal means chronological record of transactions 10. Meaning of Ledger: Ledger is a set of accounts. It contains all accounts of the business enterprise whether real, nominal, personal. 11. Posting: It means transferring the debit and credit items from the journal to their respective accounts in the ledger. 12. Trial Balance: Trial balance is a statement containing the various ledger balances on a particular date. 13. Credit Note: The customer when returns the goods get credit for the value of the goods returned. A credit note is sent to him intimating that his account has been credited with the value of the goods returned. 14. Debit Note: When the goods are returned to the supplier, a debit note is sent to him indicating that his account has been debited with the amount mentioned in the debit note. 15. Contra Entry: Which accounting entry is recorded on both the debit and credit side of the cash book is known as the contra entry. 16. Petty cash Book: Petty cash is maintained by business to record petty cash expenses of the business, such as postage, cartage, stationery etc. 17. Promissory note: As instrument in writing containing an unconditional undertaking signed by the maker, to pay certain sum of money only to or to the order of a certain person to the barer of the instrument

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18. Cheque: A bill of exchange drawn on a specified banker and payable on demand 19. Stale Cheque: A stale cheque means not valid of cheque that means more than six months the cheque is not valid. 20. Bank Reconciliation statement: It is a statement reconciling the balance as shown by the bank pass book and the balance as shown by the Cash Book. OBJ: to know the difference and pass necessary correcting, adjusting entries in the books. 21. Matching concept: Matching means requires proper matching of expense with the revenue. 22. Capital Income: The term capital income means an income which does not grow out of or pertain to the running of the business proper. 23. Revenue Income: The income which arises out of and in the course of the regular business transactions of a concern 24. Capital expenditure: It means an expenditure which has been incurred for the purpose of obtaining a long term advantage for the business. 25. Revenue Expenditure: An expenditure that incurred in the course of regular business transactions of a concern 26. Differed revenue expenditure: An expenditure which is incurred during an accounting period but is applicable further periods also 27. Bad Debts: Bad debts denote the amount lost from debtors to whom the goods were sold on credit. 28. Depreciation: Dep denotes decrease in the value of asset due to wear and tear, laps of time and accident. 29. Fictitious assets: Fictitious assets are type of peculiar assets whose existence is invisible but whose benefit is enjoyed. 30. Prepaid expenses: those expenses which have been paid in advance for future. 31. Accrued Income: It means the trader may earn the income by rendering some service but the income has not been realized in terms of money but definitely comes in near future. 32. Classification of errors: Errors of omission, Errors of commission, Errors of principle, Compensating errors 33. Suspense A/c: The suspense account is an account to which the difference in the trial balance has been put temporarily. 34. Depletion: It implies removal of an available but not replaceable source, such as extracting coal from a coal mine. 35. Amortization: The process of writing of tangible assets is term as amortization. 36. Dilapidations: The term dilapidations to damage done to a building or other property during tenancy. 37. Capital employed: The term capital employed means sum of total long term funds employed in the business. i.e. share capital + Reserves & surplus + long term loans - (non business assets + fictitious assets) 38. Equity shares: Those shares which are not having pref. rights are called the equity shares. 39. Pref. Shares:Those shares which are carrying the pref.rights is called pref.shares. a. Pref.rights in respect of fixed dividend., b. Pref.right to repayment of capital in the event of company winding up. 40. Leverage: It is a force applied at a particular point to get the desired result. 41. Operating Leverage: The operating leverage takes place when a changes in revenue greater changes in EBIT. 42. Financial Leverage: It is nothing but a process of using debt capital to increase the rate of return on equity.

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43. Combine Leverage: It is used to measure of the total risk of the firm = operating risk + financial risk. 44. Joint Venture: A joint venture is an association of two or more the persons who combined for the execution of a specific transaction and divide the profit or loss their of an agreed ratio. 45. Partnership: Partnership is the relation b/w the persons who have agreed to share the profits of business carried on by all or any of them acting for all. 46. Factoring: It is an arrangement under which a firm (called borrower) receives advances against its receivables, from a financial institutions (called factor). 47. Capital reserve: The reserve which transferred from the capital gains is called capital reserve. 48. General reserve: The reserve which is transferred from normal profits of the firm is called general reserve. 49. Free cash: The cash not for any specific purpose free from any encumbrance like surplus cash. 50. Minority Interest: Minority interest refers to the equity of the minority shareholders in a subsidiary company. 51. Capital Receipts: Capital receipts may be defined as "non-recurring receipts from the owner of the business or lender of the money crating a liability to either of them. 52. Revenue Receipts: Revenue receipts may defined as "A recurring receipts against sale of goods in the normal course of business and which generally the result of the trading activities". 53. Meaning of Company: A company is an association of many persons who contribute money or money's worth to common stock and employs it for a common purpose. The common stock so contributed is denoted in money and is the capital of the company. 54. Types of Company: a. Statutory companies b. Government company c. Foreign company, d. Registered companies Companies limited by shares, Companies limited by guarantee, Unlimited companies Private company, Public company 55. Private Company: A private co is which by its AOA: Restricts the right of the members to transfer of shares Limits the no. of members 50. Prohibits any Invitation to the public to subscribe for its shares or debentures. 56. Public company: A company which is not a private company is called public company. 57. Characteristics of a company: Voluntary association, Separate legal entity, Free transfer of shares, Limited Liability, Common Seal, Perpetual existence 58. Formation of company: Promotion, Incorporation, Commencement of business 59. Equity Share Capital: The total sum of equity shares is called equity share capital. 60. Authorized share capital: It is the maximum amount of the share capital which a company can raise for the time being. 61. Issued Capital: It is that part of the authorized capital which has been allotted to the public for subscriptions. 62. Subscribed Capital: It is the part of the issued capital which has been allotted to the public. 63. Called up capital: It has been portion of the subscribed capital which has been called up by the company. 64. Paid up capital: It is the portion of the called up capital against which payment has been received. 65. Debentures: Debenture is a certificate issued by a company under its seal acknowledging a debt due by it to its

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Finance Material
holder. 66.Cash Profit: Cash Profit is the profit it is occurred from the cash sales. 67. Deemed public Ltd. Company: A private company is a subsidiary company to public company it satisfies the following terms/ conditions sec 3(1)3: 1. Having minimum share capital 5 lakes, 2. Accepting investments from the public 3. No restriction of the transferable of shares, 4. No restriction of no. of members 5. Accepting deposits from the investors 68. Secret reserves: Secret reserves are reserves are reserves the existence of which does not appear on the face of balance sheet. In such a situation, net assets position of the business is stronger than that disclosed by the balance sheet. These reserves are crated by: 1. Excessive dep. of an asset, excessive over-valuation of a liability. 2. Complete elimination of an asset, or under valuation of an asset. 69. Provision: Provision usually means any amount written off or retained by way of providing depreciation, renewals or diminutions in the value of assets or retained by way of providing for any known liability of which the amount can not be determined with substantial accuracy. 70. Reserve: The provision in excess of the amount considered necessary for the purpose it was originally made is also considered as reserve * provision is charge against profits while reserves is an appropriation of profits * Creation of reserve increase proprietor's fund while creation of provisions decreases his funds in the business. 71. Reserve fund: The term reserve fund means such reserve against which clearly investment etc., 72. Undisclosed reserves: Sometimes a reserve is created but its identity is merged with some other account or group of accounts so that the existence of the reserve is not known such reserve is called an undisclosed reserve. 73. Finance management: Financial management deals with procurement of funds and their effective utilization in business. 74. Objectives of financial management: Financial management having two objectives that Is: 1. Profit maximization: The finance manager has to make his decisions in a manner so that the profits of the concern are maximized. 2. Wealth maximization: Wealth maximization means the objective of a firm should be to maximize its value or wealth, or value of a firm is represented by the market price of its common stock. 75. Functions of financial manager: 1. Investment decision 2. Dividend decision 3. Finance decision 4. Cash management decisions 5. Performance evaluation 6. Market impact analysis 76. Time value of money: The time value of money means that worth of a rupee receive today is different from the worth of a rupee to be received in future. 77. Capital structure: It refers to the mix of sources from where the long-term funds required in a business may be raised; in other words, it refers words, it refers to the proportion of debt, preference capital and equity capital. 78. Optimum capital structure: Capital structure is optimum when the firm has a combination of equity and debt so that the wealth of the firm is maximum. 79. Wacc: It denotes weighted average cost of capital. It is defined as the overall cost of capital computed by reference to the proportion of each component of capital as weights. 80. Financial break even point: It denotes the level at which a firm's EBIT is just sufficient to cover interest and preference dividend.

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81. Capital budgeting: Capital budgeting involves the process of decision making with regard to investment in fixed assets. Or decision making with regard to investment of money in long term projects. 82. Pay back period: Payback period represent the time required for complete recovery of the initial investment in the project. 83. ARR: Accounting or average rate of return means the average annual yield on the project. 84. NPV: The net present value of an investment proposal is defined as the sum of the present values of all future cash in flows less the sum of the present values of all cash out flows associated with the proposal. 85. Profitability Index:Where different investment proposal each involving different initial investments and cash inflows are to be compared. 86. IRR: Internal rate of return is the rate at which the sum total of discounted cash inflows equals the discounted cash out flow. 87. Treasury management: It means it is defined as the efficient management of liquidity and financial risk in business. 88. Concentration banking: It means identify locations or places where customers are place and open a local bank account in each of these locations and open local collection centre. 89. Marketable securities: Surplus cash can be invested in short term instruments in order to earn interest. 90. Ageing schedule: In an ageing schedule the receivables are classified according to their age. 91. Maximum permissible bank finance (MPBF): It is the maximum amount that banks can lend a borrower towards his working capital requirements. 92. Commercial paper: A commercial paper is a short term promissory note issued by a company, negotiable by endorsement and delivery, issued at a discount on face value as may be determined by the issuing company 93. Bridge finance: It refers to the loans taken by the company normally from a commercial banks for a short period pending disbursement of loans sanctioned by the financial institutions. 94. Venture capital: It refers to the financing of high risk ventures promoted by new qualified entrepreneurs who require funds to give shape to their ideas. 95. Debt securitization: It is a mode of financing, where in securities are issued on the basis of a package of assets (called asset pool). 96. Lease financing: Leasing is a contract where one party (owner) purchases assets and permits its view by another party (lesee) over a specified period. 97. Trade Credit: it represents credit granted by suppliers of goods, in the normal course of business. 98. Over draft:Under this facility a fixed limit is granted within which the borrower allowed to overdraw from his account. 99. Cash Credit:It is an arrangement under which a customer is allowed an advance up to certain limit against credit granted by bank. 100. Clean Overdraft:it refers to an advance by way of overdraft facility, but not back by any tangible security. 101. Clean Overdraft:It refers to an advance by way of overdraft facility, but not back by any tangible security. 102. Funds flow statement:-

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It is the statement deals with the financial resources for running business activities. It explains how the funds obtained and how they used. 103. Sources of funds:There are two sources of funds internal sources and external sources. Internal source: - Funds from operations is the only internal sources of funds and some important points add to it they do not result in the outflow of funds. a. Depreciation of fixed assetsb. Preliminary expenses or goodwill written off, Loss on sale of fixed assets. Deduct the following items as they do not increase the funds. Profit on sale of Fixed assets, Profit on revaluation of fixed assets. External Sources:- 1. Funds from long term loans, 2. Sale of fixed assets. 3. Funds from increase in share capital 104. Application of funds : a. Purchase of fixed assets. b. Payment of dividend . c. Payment of tax liability. d. Payment of fixed liability. 105. ICD (Inter corporate deposits) :Companies can borrow funds for a short period. For example 6 months or less from another company which have surplus liquidity. Such deposits made by one company in another company are called ICD. 106. Certificate of deposits :The CD is a document of title similar to a fixed deposit receipt issued by banks there is no prescribed interest rate on such CDs it is based on the prevailing market conditions. 107. Public deposits :it is very important source of short term and medium term finance. The company can accept PD from members of the public and shareholders. it has the maturity period of 6 months to 3 years. 108. Euro Issues :The euro issues means that the issues is listed on a European stock Exchange. The subscription can come from any part of the world except india. 109. GDR (Global depository receipts) :A depository receipt is basically a negotiable certificate, dominated in us dollars that represents a non - US company publicly traded in local currency equity shares. 110. ADR ( American depository receipts) :Depository receipt issued by a company in the USA are known as ADRs. Such receipts are to be issued in accordance with the provisions stipulated by the securities exchange commission (SEC) of USA like SEBI in India. 111. Commercial banks :Commercial banks extend foreign currency loans for international operations, just like rupee loans. The banks also provided overdraft. 112. Development banks: It offers long-term and medium term loans including foreign currency loans. 113. International agencies:International agencies like the IFC, IBRD, ADB, IMF etc. Provide indirect assistance for obtaining foreign currency. 114. Speed capital assistance:The seed capital assistance scheme is desired by the IDBI for professionally or technically qualified entrepreneurs and persons possessing relevant experience and skills and entrepreneur traits.' 115. Unsecured loans:It constitutes a significant part of long-term finance available to an enterprise. 116. Cash flow statement:It is a statement depicting change in cash position from one period to another. 117. sources of cash: Internal sources. a. Depreciation. b. Amortization. c. Loss on sale of fixed assets. d. Gains from sale of fixed assets. e. Creation of reserves external sources :- a. Issue of new shares. b. Raising loan term loans. c. Short-term borrowings. d. Sale of fixed assets, investments. 118. Application of cash:a. Purchase of fixed assets . b. Payment of long term loans. c. Decrease in deferred payment liabilities. d. Payment of tax, dividend. e. Decrease in unsecured loans and deposits. 119. Budget:It is a detailed plan of operations for some specific future period. It is an estimate prepared in

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advance of the period to which it applies. 120. Budgetary control:It is system of management control and accounting in which all operations are forecasted and so for as possible planned ahead, and the actual results compared with the forecasted and planned ones. 121. Cash budget:It is a summary statement of firm's expected cash inflow and outflow over a specified time period. 122. Master budget: A summary of budget schedules in capsule form made for the purpose of presenting in one report the highlights of the budget forecast. 123. Fixed budget: It is a budget which is designed to remain unchanged irrespective of the level of activity actually attained. 124. Zero-base-budgeting: It is a management tool which provides a systematic method for evaluating all operations and programmes, current of new allows for budget reductions and expansions in a rational manner and allows reallocation of source from low to high priority programs. 125. Goodwill: The present value of firm's anticipated excess earnings. 126. BRS: It is a statement reconciling the balance as shown by the bank pass book and balance shown by the cash book. 127. Objective of BRS: The objective of preparing such a statement is to know the causes of difference between the two balances and pass necessary correcting or adjusting entries in the books of the firm. 128. Responsibilities of accounting: It is a system of control by delegating and locating the responsibilities for costs. 129. Profit centre: A centre whose performance is measured in terms of both the expense incurs and revenue it earns. 130. Cost centre: A location, person or item of equipment for which cost may be ascertained and used for the purpose of cost control. 131. Cost: The amount of expenditure incurred on to a given thing. 132. Cost accounting: It is thus concerned with recording, classifying, and summarizing costs for determination of costs of products or services planning, controlling and reducing such costs and furnishing of information management for decision making. 133. Elements of cost: (A) Material (B) Labour (C) Expenses (D) Overheads 134. Components of total costs: (A) Prime cost (B) Factory costs (C) Total cost of production (D) Total cost 135. Prime cost: It consists of direct material direct labour and direct expenses. It is also known as basic or first or flat cost. 136. Factory cost: It comprises prime cost, in addition factory overheads which include cost of indirect material indirect labour and indirect expenses incurred in factory. This cost is also known as works cost or production cost or manufacturing cost. 137. Cost of production: In office and administration overheads are added to factory cost, office cost is arrived at. 138. Total cost: Selling and distribution overheads are added to total cost of production to get the total cost or cost of sales. 139. Cost unit: A unit of quantity of a product, service or time in relation to which costs may be ascertained or expressed. 140. Methods of costing:(A) Job costing (B) Contract costing (C) Process costing (D) Operation costing (E) Operating costing (F) Unit costing (G) Batch costing

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141. Techniques of costing: (a) marginal costing (b) direct costing (c) absorption costing (d) uniform costing. 142. Standard costing: standard costing is a system under which the cost of the product is determined in advance on certain predetermined standards. 143. Marginal costing: it is a technique of costing in which allocation of expenditure to production is restricted to those expenses which arise as a result of production, i.e., materials, labour, direct expenses, and variable overheads. 144. Derivative: Derivative is product whose value is derived from the value of one or mose basic variables of underlying asset. 145. Forwards: a forward contract is customized contracts between two entities were settlement takes place on a specific date in the future at today's pre agreed price. 146. Futures: a future contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Future contracts are standardized exchange traded contracts. 147. Options: an option gives the holder of the option the right to do some thing. The option holder option may exercise or not. 148. Call option: a call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price. 149. Put option: a put option gives the holder the right but not obligation to sell an asset by a certain date for certain price. 150. Option price: option price is the price which the option buyer pays to the option seller. It is also referred to as the option premium. 151. Expiration date: the date which is specified in the option contract is called expiration date. 152. European option: It is the option at exercised only on expiration date its self. 153. Basis: Basis means future price minus spot price. 154. Cost of carry: The relation between future prices and spot prices can be summarized in terms of what is known as cost of carry. 155. Initial margin: The amount that must be deposited in the margin a/c at the time of first entered into future contract is known as initial margin 156. Maintenance margin: This is some what lower than initial margin. 157. Mark to market: In future market, at the end of the each trading day, the margin a/c is adjusted to reflect the investors gains or loss depending upon the futures selling price. This is called mark to market. 158. Baskets: Basket options are options on portfolio of underlyibng asset. 159. Swaps: Swaps are private agreements between two parties to exchange cash flows in the future according to a pre agreed formula. 160. Impact cost: impact cost is cost it is measure of liquidity of the market. It reflects the costs faced when actually trading in index. 161. Hedging: Hedging means minimize the risk. 162. Capital market: Capital market is the market it deals with the long term investment funds. It consists of two markets

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1.primary market 2.secondary market 163. Primary market: those companies which are issuing new shares in this market. It is also called new issue market. 164. Secondary market: secondary market is the market where shares buying and selling. In India secondary market is called stock exchange. 165. Arbitrage: it means purchase and sale of securities in different markets in order to profit from price discrepancies. In other words arbitrage is a way of reducing risk of loss caused by price fluctuations of securities held in a portfolio. 166. Meaning of ratio: Ratios are relationships expressed in mathematical terms between figures which are connected with each other in same manner. 167. Activity ratio: A mutual fund is a pool of money, collected from investors, and is invested according to certain investment objectives. 169. characteristics of mutual fund: 1.Ownership of the MF is in the hands of the of the investors 2.MF managed by investment professionals 3.The value of portfolio is updated every day 170. Advantage of MF to investors: 1.Portfolio diversification, 2.Professional management, 3.reduction in risk, 4.reduction of transaction casts 5.Liquidity, 6.Convenience and flexibility 171. Net asset value: The value of one unit of investment is called as the Net Asset Value 172. Open-ended fund: open ended funds means investors can buy and sell units of funnd, at NAV related prices at any time, directly from the fund this is called open ended fund. 173. Close ended funds: Close ended funds means it is open for sale to investors for a specific period, after which further sales are closed. Any further transaction for buying the units or repurchasing them, happen, in the secondary markets. 174. Dividend option: Investors who choose a dividend on their investments, will receive dividends from the MF, as when such dividends are declared. 175. growth option: Investors who do not require periodic income distributions can be choose the growth option. 176. Equity funds : Equity funds are those that invest pre-dominantly in equity shares of company. 177. Types of equity funds : Simple equity funds, Primary market funds , Sectoral funds, Index funds 178. Sectoral funds : Sectoral funds choose to invest in one or more chosen sectors of the equity markets. 179. Index funds : The fund manager takes a view on companies that are expected to perform well, and invests in these companies. 180. Debt funds : The debt funds are those that are pre-dominantly invest in debt securities. 181. Liguid funds : The debt funds invest only in instruments with maturities less than one year. 182. Gilt funds : Gilt funds invests only in securities that are issued by the GOVT. and therefore does not carry any credit risk. 183. Balanced funds : Funds that invest both in debt and equity markets are called balanced funds. 184. Sponsor : Sponsor is the promoter of the MF and appoints trustees, custodians and the AMC with prior approval of SEBI. 185. Trustee :

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Trustee is responsible to the investors in the MF and appoint the AMC for managing the investment portfolio. 186. AMC : The AMC describes Asset Management Company, it is the business face of the MF, as it manages all the affairs of the MF. 187. R & T Agents : The R & T agents are responsible for the investor servicing functions, as they maintain the records of investors in MF. 188. Custodians : Custodians are responsible for the securities held in the mutual fund's portfolio. 189. Scheme take over : If an existing MF scheme is taken over by the another AMC, it is called as scheme take over. 190. Meaning of load : Load is the factor that is applied to the NAV of a scheme to arrive at the price. 192. Market capitalization : Market capitalization means number of shares issued multiplied with market price per share. 193. Price earning ratio : The ratio between the share price and the post tax earnings of company i called as price earning ratio. 194. Dividend yield : The dividend paid out by the company, us usually a percentage of the face value of a share. 195. Market risk : It refers to the risk which the investor is exposed to as a result of adverse movements in the interest rates. It also referred to as the interest rate risk. 196. Re-investment risk : It the risk which an investor has to face as a result of a fall in the interest rates at the time of reinvesting the interest income flows from the fixed income security. 197. Call risk : Call risk is associated with bonds have an embedded call option in them. This option hives the issuer the right to call back the bonds prior to maturity. 198. Credit risk : Credit risk refers to the probability that a borrower could default on a commitment to repay debt or band loans. 199. Inflation risk : Inflation risk reflects the changes in the purchasing power of the cash flows resulting from the fixed income security. 200. Liquid risk : It is also called market risk, it refers to the ease with which bonds could be traded in the market.

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Finance Material Revenue: Revenue is the value of out put supplied to customers Gross inflow of assets or the gross decrease in liabilities Operating revenue: Arising from the main operations or business (sale of products manufactured by a company) Non-operating revenue: Indirect to the main operations of the firm (sale of an old equipment similarly dividend and interest from temporary investments) Expenditure: The cost of earning revenue. When assets or consumed or liabilities are increased. Operating expenses: Relating to the main operations (manufacturing expenses) Non-operating expenses: Which are indirect to the main operations (legal expenses) Capital expenditure: Money spent to acquire physical assets, which are buildings, machinery, and land. Company: Is a voluntary and autonomous association of certain persons which capital divided into numerous transferable shares formed to carry out a particular purpose. Company formed and registered under the companys act 1956. Kinds of companies: Charted companies: East India company Statutory companies: RBI, IFC Registered companies: Incorporated under companys act 1956. Difference between Private limited company and Public limited company: 1. Minimum number of its members Private: (2), Public (7) 2. Maximum number of its members Private: (50), Public: unlimited 3. Issue of prospects: a private company cannot invite public to subscribe to its shares or debentures by issue of prospects. Public company must issue the prospects. 4. Transfer of shares: restrict to private company, freely transferable to public company. 5. Number of Directors: Private (2), Public (5) 6. Use of the word Limited 7. Restriction regarding managerial remuneration, public limited company not more than 11% of the net profit. 8. Legal formalities 9. Commencement of business Equity shares: Represent the ownership position in a company; equity shareholders will get dividend and repayment of capital after meeting the claims of preference shareholders. Equity shareholders have the voting right. Preference shares: Preference shareholders will get dividend and repayment of capital in the winding up of the company over the equity shareholders Types: Cumulative preference shares, Non-cumulative preference shares Redeemable preference shares (usually non-redeemable) 115

Finance Material Participating and non-participating preference shares (on surplus profits) Debentures: Acknowledgement of debt, certificate issued by a company under its seal as an evidence of a debt due from the company Types: Naked or simple debentures (no security) Mortgage debentures (security) Redeemable, Irredeemable debentures Convertible, Non-convertible debentures Share premium: Value greater than its face value Bank account Dr To share application account (Being application money along with premium received) Share application account Dr To share capital account To share premium account (Share application money transferred to share capital account) Share allotment account Dr To share capital account To share premium account (The allotment money and share premium money due on shares) Bank account Dr To share allotment account (Share allotment money received) Share discount: Value less than its face value Share discount account Dr Discount on the issue of share account Dr To share capital account Primary market: Initial public offering of securities (IPO), newly floated shares, first issue of shares Secondary market: Buying and selling of securities (shares) is traded in secondary market OTCI: Over the counter exchange of India (no particular place to buy and selling of shares) Memorandum of association: It determines the scope of the activities of the company and defines the relations of the Company with out side world. Registered office, company name, objectives, 7 members have to promise to take at least one share each, their names and addresses. Articles of association: Rules and regulations of the internal management of the company and very important to the Shareholders, because they determine the relation between the company and its members. Subsidiary company: A company that is completely control by the company 116

Finance Material Holding company: A company that has control over other companies through ownership of a sufficient portion Of those companies common stock. A company that owns enough voting stock in another Firm to control management EX: CAPITLA IQ is subsidiary of S & P (standard and poor, credit rating company) S & P is holding company of CAPITLA IQ. Stock exchanges in India and abroad: Place where buying and selling of shares takes place is stock exchange EX: BSE, NSE, NYSE, NASDAQ, London stock exchange, Toronto stock exchange Depreciation: Reduction in the value of asset due to wear tear and laps of time, depletion and obsolesce Convert the cost of asset into cost of operation Methods: Straight-line method Diminishing balance method or declining balance method or accelerated method Sinking fund method Depletion method Accrued expenses: Represent a liability that a firm has to pay for the services which has already receive, Obligations payable by the firm. Ex: wages, salaries outstanding. Deferred income: Represent funds received by the firm for goods and services, which it has agreed to supply in Future Ex: advanced payments by the customers SEBI: Securities and Exchange Board of India (12th April 1988) To promote fair dealing. To provide a degree of protection To regulate and develop a code of conduct, register and working of stock brokers Provision: Preparatory action of measure, money kept aside for a specific work Reserve: Some amount of profit kept aside to meet contingent expenses, put aside for future purpose Minority interest: The ownership interest in a company held by the person other than the parent company and Its subsidiary undertakings General reserve: It can be used for any purpose including distribution of dividend Capital reserve: For specific purpose Dividend: Shareholders will expect some return from their investments by them in the share capital Are generally paid in cash Dividend declared by the board of directors in the AGM (annual general meeting) Interim dividend: Dividend declared for 6 months is called interim dividend Final dividend: Declared at the end of the financial year 117

Finance Material Theories: Relevance: Walters model, Gardens model, Bird in a hand argument Irrelevance: Modigliani and Millers Hypothesis Marginal cost: Aggregate amount of variable cost Variable cost: One which various directly with changes in the level of output over a defined period of time Fixed cost: One which is not affected by changes in the level of out put over a defined period of time Semi-variable cost: Which does not vary proportionally but simultaneously cannot remain stationary at all times Ex: Depreciation, repairs Partnership: A business relationship where two or more persons carry on a business with a view to make a profit. Joint-venture: A foreign company joins hands with local company for local interest to carry out a single project pr a limited number of projects, in specific period of time. Non-recurring items in P & L account (Profit and loss account): Sale of investments Non-cash expenditure in P & L account: Depreciation Depletion: Used of oil wells, mines or deposits for depreciation Amortization: For long term investments such as patens copyrights, paying of debt gradually Capital profits: Sale of fixed assets Revenue profits: From main operation of the firm (sale of goods and services) Mutual fund: An open-ended fund operated by an investment company, which arises money from shareholders and investments in a group of assets Raise money by selling shares of the fund to the public (income fund, growth fund) Trade discount: Which is not shown in the books Cash discount: 50% out of MRP like that Trade credit: To the credit that a customer gets from supplier of goods in the normal course Duties of Finance Manager: Raising of funds, allocation of funds, profit planning, understanding capital markets Interim audit and statutory audit: Chairman: One of the person elected by the directors in the board of directors meeting. Who is the Director: one of the shareholders becomes director CEO: chief executive officer, top officer in the company in the executive cadre 118

Finance Material Who can appoint CEO: board of directors AGM: shareholders annual general meeting Quorum: attend the minimum number of members in the meeting Statutory books: Register of investment holders and their names, register of earnings, register of debenture and shareholders, register of directors and their shares Financial books: Cash book, general ledger, return outwards and return inwards, invoice, bills payable, bills receivables Resolution: solving the problem Who can appoint auditor: board of directors Minute books: recording of the board of directors meeting Agenda: the meeting, which is discussed by the board of directors Duties of director: to appoint officers and auditors, to take policy decisions. Contribution: sales variable cost Role of stock exchange: to regulate the share trading in India Corporation: Business firm whose articles of incorporation have been approved in some state A business, which is a completely separate entity from its owners Difference between Corporation and Company: Company: an institution created to conduct business He only invest in large well established company He can start the company in his garage Principles of accounting: Policies: prudent, materiality, consistency Assumptions: continuing, consistency, accrual (revenue and cost) Proxy: it includes every proxy consensus and authorization with in the meaning of section 14 (a) of the act (representative) Consignment: Auction are quite simple A consignor brings merchandise for you to sell online Consignor owner Consignee agent Debt & Credit: every account has two sides left side Debit and right side Credit Open market: a market, which is widely accessible to all investors or consumers Annual report: (10 K) Audited document required by the SEC and send to the public companys or mutual funds share at the end of each fiscal year (balance sheet, income statement, cash flow statement and description of company operations, auditors report, summary of operations, chairmans speech) contain in annual report. Quarterly report: (10 Q) Un audited document required by the SEC of all us public companies reporting the financial results for the quarter and noting any significant changes and events in the quarter (financial statements, discussion from the management, list of material events) Merger: two or more companies combine into one company they may form a new company Absorption: two or more companies combine into an existing company 119

Finance Material Consolidation: is a combination of 2 or more companies into a new company Acquisition: As an act of acquiring effective control by one company over the assets or management of another company without any combination of companies. Take over: as obtaining of control over management of a company by another Types of merger: horizontal, vertical, and conglomerate Reverse acquisition: One way of a company to become publicly traded by acquiring a public company and then installing its own management team and renaming the acquiring company. Reverse merger: The acquiring of a public company by a private company allowing the private company to bypass the usually lengthy and complex process of going public. ADR: American depository receipts, a negotiable certificate issued by a U.S Debt: a liability or economic obligation in the form of bonds, loans Equity: ownership interest in a company in the form of common stock or preferred stock Shareholders equity: total assets total liabilities Depression: a period during which business activity drops significantly Portfolio: A collection of investments allowed by the same individual or organization (equity, bonds, debentures, preferred stock) Portfolio Management: Choosing and maintaining appropriate investments and allocating funds accordingly Security analysis: the entire process of estimating return and risk for individual securities Portfolio analysis: To determine the future risk and return in holding various blends of individual securities Prospects: A legal document offering securities for sale required by the securities section act 1933 it must explain the offer including the terms, issuer, objectives, historical financial statements Private placement: The sale of securities directly to institutional investors such as banks, mutual funs, LIC Bad debt reserve: an amount set aside as reserve for bad debts Listing: The acceptance of securities for trading in a registered stock exchange (at least 49 % offer to public) total paid up capital should not be less than 3 crore GDR: global depositary receipts (CITI Bank 1990 introduced) Underwritings: The procedure by which an underwriter brings a new security issue to the investing public in an offering. The process of insuring someone or something Inventory: raw material, work-in-progress, finished goods not at been sold Affiliate: A company in which another company has a minority interest related to another company Venture capital: Funds made available for startup firms small business with exceptional growth potential Capital: cash or goods used to generate income

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Finance Material Capital budgeting: Firms decision to invest its current funds most effectively in the long-term assets in anticipation of an expected flow of benefits over a series of years Blue chip: Stock of large, national company with a solid record of stable earnings and/or dividend growth and reputation for high quality management, (first class equity shares) Board of directors: Individuals elected by a corporations shareholders to over the management of the company Strategic alliance: An agreement between two or more individuals to achieve a common goal Stock split: To attract the potential investors changing the shareholders equity announcing two or one split of common stock to reduce the face value of the share (pare value) Securitization: The process of aggregating similar investment such as loan mortgage into negotiable securities, SENSEX: An index composed of 30 largest and most actively trading stock companies in BSE, NSE Cost of capital: Minimum acceptable rate of return that a firm must earn on its investments for the market value. Short selling: Trader sells the shares with a small profit a short period by gaining limited returns in a short period. ABC analysis: Statistical tool used over inventory that a firm should not excuse some degree of control over its items which are most costly as compared to less costly items. EOQ: (economic order quantity) Refers to the order size that will result in the lowest total of orders and carrying of an item of an inventory. Leverage: Meeting a fixed cost or paying a fixed return for employing resources or funds, Describe the firms ability to use fixed cost assets or funds to magnify the returns to its owners. Operating leverage: Defined as tendency of operating profit to vary disproportionately with sales High operating leverage fixed cost more than the variable cost Formula: Contribution/operating profit Degree of operating leverage: % of change in EBIT/ %change in sales EBIT: earning before interest and tax, Contribution: sales variable cost Financial leverage: Defines as tendency of the residual income to vary disproportionately with operating profit Formula: operating profit (EBIT)/ PBT Degree of financial leverage: %change in EPS/ %change in EBIT EPS: earnings per share, PBT: profit before tax Combination of operating and financial leverage: %Change in EPS/ % change in sales Discounted cash flow technique: time value of money concept NPV, IRR, PI Bankruptcy: becoming insolvent 121

Finance Material IRR: Is that the rate of which the sum of discounted cash inflow equals the sum of discounted cash outflow. Where NPV is 0 Shareholder: one who owns share of stock in a corporate or mutual funds Liquidate: To convert into cash (or) to sell all of a company assets pay outstanding debts and distribute the remaining to shareholders and then go out of business. Savings account: A deposit account at a bank or savings and loan which pays interest but cannot be withdrawn by check writing Transaction: An agreement between a buyer and a seller to exchange an asset for payment Credit: the borrowing capacity of an individual or company Accounts payable: Money which is owned to vendors for products and services purchased on credit Accounts receivables: Money which is owned to a company by a customer for products and services provided on credit. Broker: An individual or firm acting as intermediary between a buyer and seller, usually charging a commission. Dual trading: The practice by a broker of acting as an agent and simultaneously acting as a dealer (buying and selling of ones own account) Loan-value ratio: The amount borrowed dividend by the appraised value of the collateral (securities) in % Common-stock ratio: A companys common stock divided by its total capitalization Tax: A fee charged (levied) by a government on a product, income or activity If tax is levied directly a personal or corporation income its called as direct tax. If tax is levied on price of goods or services is called as indirect tax Income Tax: Annual tax levied by the federal government on an individual or corporations net profit Earnings report: An official quarterly or annually final document published by a public company Shows earnings, expenses and net profit Net profit: gross sales (taxes + interest + depreciation + other expenses) Retail price: price charged to retail customers Whole sage: the purchase of goods in quantity for resale purpose Retail: selling directly to consumers or customers Credit card: Any card that may be used repeatedly to borrow money or buy products and services on credit issued by bank Debit card: A card, which allows customer to access their funds immediately electronically Profit: the positive gain from an investment or business operations 122

Finance Material Face value: the nominal $ amount assigned to a security by the issuer AMEX:(American stock exchange) Second largest stock exchange in the US after NYSE (Newyork stock exchange) largest representation of stock and bonds issued by smaller companies than the NYSE In 1998 the NASDAQ purchased the AMEX Compound interest: Interest which is calculated not only on the initial principal but also the accumulated interest of prior period. Capitalization: the sum of corporations long-term debt stock and retained earnings ADS: American depositary shares the share issued under American depositary agreement, which is actually traded GATT: General agreement on tariffs and trade affiliate with the United Nations, to facilitate international trade Tariff: A tax imposed on a product when it is imported into a country or company EBITDA: earning before interest tax dividend and amortization Exchange ratio: The number of shares of the acquiring company that shareholders will receive for one share of the acquired company Form S 1: a registration statement used in the initial public offering of securities Pooling of interest: In which the balance sheet of the two companies combined line by line without a tax impact Capital budgeting decisions: operating, administration and strategic Decision tree: Define investment, identify decision alternatives, draw decision tree, and analyze data Concept of cash flow: Initial investment, annual net cash flow, terminal cash flow Investment evaluation: Estimation of cash flow, estimation of required rate of return decision rule for making the choice. Financial analysis: It is the process of identifying the financial strength and weakness of the firm by properly establishing relationship between the items of the balance sheet and the profit and loss a/c Liquidity: Refers to the firms ability to pay debts as they mature Solvency: refers to the firms ability to meet eventually all its long-term and short-term debt Accounting system: A source of financial information of a firm should know the financial implications of its operations Treasurer: auditing cost control Controller: planning and budgeting, inventory management, accounting Finance: Is the conversion of accumulated funds to productive use Finance aptly been called as science of money Finance functions: 123

Finance Material Investment decision Dividend decision Liquidity decision Financing decision Scope: finance, production and marketing Finance management: Is that managerial activity which is concerned with the planning and controlling of the firms financial resources Forfeiture of shares: when a shareholder fails to pay calls Dividend: Profit and loss a/c Dr To proposed dividend a/c (Being dividend proposed by the directors) Preliminary expenses: Are those expenses which are incurred on the formation of the company Cost: the amount of expenditure incurred on attributable to a specific thing or activity Short-term finance: Trade credit, bank credit, public deposits, advances, personal loans, retained earnings, accrued expenses, and provision for tax, depreciation Commerce: business Calls in erriers will be disclosed in balance sheet: Deduction from subscribed capital Father of scientific management: F.W Tayler Espit Decorps: Employee at all levels should be given the opportunity to take initiative and exercise judgment Government Company: Central government or state government holds 51 % more of the total paid up capital Entrepot trade: import of foreign goods view to re export Calls in advances will be disclosed in balance sheet: Deduction from subscribed capital Under share premium disclosed in B/S: reserves and surplus Net profit on reissue of forfeited shares will be transferred to: capital reserve Condition for issue of shares at discount: After one year from the date of certificate of commencement of business Discount on issue of shares will be disclosed in B/S: miscellaneous expenses Purpose of preparing receipts and payment account: To know balance of cash and bank at the end of the year Tangible assets: which are having physical existence (Fixed assets) Intangible assets: which does not having physical existence (patents, copyrights, and trademarks, franchises, intellectual property rights) Not a negotiable instrument: deed of partnership Unclaimed dividend: dividend paid out not yet claimed by the shareholder Deferred revenue expenditure: Expenditure whose benefits lasts for more than one accounting period (advertisement exp) Right issue: issue of shares to existing shareholders

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Finance Material Which how many days the minimum subscription amount should be received by a company: 90 days A public company needs the business to start: Certificate of commencement of business Fundamental analysis: To find out the intrinsic value of a security, true economic worth of a financial asset (It contains economic analysis, industry analysis, and company analysis) Technical analysis: Based on past information prices of stock depends on supply and demand Dow theory: Raising trend line no single individual or buyer can influence the major trend of the market Flat trend line market discounts natural calamities can influence the market Falling trend line it is provided way to understand it Bull market: up ward Bear market: down ward NSDL: national securities depository limited Random walk theory:

Strong efficient market all information is reflected on prices big one Semi strong all public information is reflect on security prices second one Weakly efficient market all historical market influence the security prices small one Markwitz theory: the effect of combining two securities CAPM: (capital asset pricing model) The relationship between expected return and UN avoidable risk Combine risk free securities with risk securities Derivatives: A financial derivative is a product that derives its value from an underlying asset Tools for better financial and risk management Confer on the financial system are well known Options: Types of contract between two parties Put option: to sell the securities to fixed amount Call option: to purchase securities for fixed amount Futures: Is an agreement to pay or sell an asset at a certain time in the future for a certain price Types Organized exchange which are traded in over the counter (OTCI) Standardization, clearing house, margins Risk: 125

Finance Material Foregoing of money (systematic, unsystematic, business risk, market risk, financial risk) Trading system: Through brokers and dealers Commission brokers, floor brokers, odd-lot dealers, Taravaniwala, bundiwalars, arbitrager, security dealers Accounting: It records business transactions takes place during the accounting period with a view to prepare financial statements Accounting is art of recording classifying and summarizing in a sufficient manner in terms of money, (to communicate quantitative information) Objectives: To measure the profit of the company, to ascertain the financial position of the company Accounting cycle: Recording transaction in subsidiary books Classifying data by posting them from subsidiary books to accounts Closing the books and preparing of final accounts Accounting concepts: Entity concept: Scope of what is to be recorded or what is being excluded from the accounting books (ex: drawings account) important to the accountant Corporate capital paid out only at the time of winding up of the company Dual aspect concept: It is transaction based purchase, sales, payments, receipts total amount debit is equal total amount credited capital + liabilities = assets Going concern: The enterprise will continue to exist in the foreseeable future continuing in operation for the foreseeable future Accounting period concept: The time interval is called accounting period, natural business year 12 months Money measurement concept: Transaction is recorded in terms of money ex: purchase of building Matching concept: Profit = revenue expenses Cost concept: (historic) Asset is recorded at the price paid to acquire it purchase land 80,000 (whether it is 1,75,000 at the time of preparation of balance sheet) will not be considered Revenue recognition concept: The amount received (receivables) sale of out put are called revenue Revenue is the gross inflow of cash (sale of goods manufactured by the company) Accrual concept: Cost or recognized when they are incurred and not when paid until cash is received Objectivity concept: (evidence) Transaction should be supported by verifiable document asset is shown by replacement cost Accounting conventions: Convention of disclosure: 126

Finance Material Accounts must be honestly prepared and all material information must be disclosed there in Contingent liabilities appearing as a note, market value of investments appearing as a note Convention of materiality: Material and immaterial matters Value of stock: loss of markets due to competition or government regulations, increase in wage bill Allocation of cost: allocated to every one of the three years Convention of consistency: Important conclusions regarding the working of a company over a number of years, accounting procedures, and policies should be consisting. Convention of conservatism: (playing sage) Considering of all prospective losses but leaves all prospective profits Make the provision of all prospective losses but leaves all prospective profits Make the provision for doubtful debts Valuation of stock, provision for fluctuation of investments Amortization Financial accounting: To ascertain the financial results Profit & loss in the operations of the business during the accounting period Cost accounting: To analyze the expenditure To ascertain the cost of various products manufacture by the company Management accounting: To assist the management in taking rational policy decisions Financial statements: It contains summarized information of the firms financial affairs organized systematically Financial statements are prepared from the accounting records maintained by the firm Generally accepted accounting principles (GAAP) and procedures are followed to prepare those statements It presents firms financial situation to users Preparation for the purpose of external reporting to owners investors and creditors Objective: For decision making To provide reliable financial information about economic resources and obligations of business enterprise. For estimating the earnings potential of the enterprise Types of financial statements: Income statement (P & L a/c): Periodic statement FPO (for the period of) It presents the summary of revenues, expenses and net income or net loss of a firm Measure the firms profitability; it is a scoreboard for a period of time Operating expenses: Office salary, wages, insurance, rent, rates, taxes, stationary, printing, post office, repairs Selling expenses: Sales man salary, traveling exp, advertising, discount paid, bad debts, commission for sales 127

Finance Material Distribution expenses: Sales traveling, wear housing rent, insurance Financial expenses: Bank charges, bank commission, and bank overdraft interest, interest on capital Non-debiting expenses in P & L account: Drawings, income tax, life insurance P & L account credit items: Interest received, discount received, rent received, and collection of bad debts Balance sheet: Pointed statement Portrays an exact picture of the financial position of the enterprise About economic resources and obligations of a business entity and about it owners as a specific date, it is a measure of the firms liquidity and solvency What is business owns (assets) and owes (liability) the difference is capital or owners equity all its contain in balance sheet Uses: communicating to the users, for raising further capital Statement of retained earnings: It means the accumulated excess of earnings over losses and dividends the balance shown by the income statement is transferred to the valance sheet through this statement after making necessary appropriations Statement of changes in financial position: (cash flow statement) It is essential to identify the movement of working capital or cash in and out of the business Changes in the firms working capital Changes in the firms cash position Changes in the firms total financial position Income: Increase in the net worth of the business arising out of business operations Cost of goods sold: Opening stock + purchases + direct expenses closing stock Assets = liabilities + share holders equity Assets: Any owned physical object (tangible) or right (intangible) having economic value to its owners Fixes assets: A substantial part of its capital in acquiring what are known as fixed assets 80% - 90% of longterm funds used to acquire fixed assets Valuation of fixed assets: Historical cost method, discounted cash flow method, replacement cost method Goodwill: Means that old customer will resort to the old place, name fame and reputation of the company, goodwill arises when a new partner admitted, acquire by another, spent on R & D Methods of calculating goodwill: Average method, super annuation method, capitalization method Other assets: Preliminary expenses, share issuing expenses, discount on issue of shares and debentures, these should be written of from out of profits 128

Finance Material Contingent assets: Un called share capital of the company, not shown in the balance sheet because principal of conservatism Current assets: Are those, which are realized within the operating cycle of the business Investments: Idle funds of a business are invested in marketable securities Objective: convert them into cash with in a period of one year Investments in government securities Immovable properties Capital of partnership business Liability: Economic obligation of an enterprise Current liability: Which are paid within one year (paid out of current assets) Long-term liabilities: Which do not become due for payment in one year Contingent liabilities: Uncalled liability on investments in another companies Erriers of fixed cumulative dividend Bills discount (if drawee doesnt pay the bill amount to bank) Owners equity: equal to net worth Subsidiary books: Special books: Sales book purchase book Returns book sales, purchases Bills book payable receivables Cashbook General books: Opening entries adjusting and closing post entries, correcting entries Personal accounts: Proprietors, suppliers, creditors Artificial persons limited company a/c, insurance company a/c, government company a/c Representative persons common title, salaries outstanding, rent prepaid Real accounts: Tangible land, buildings, machinery Intangible goodwill, patents, intellectual properties, Nominal accounts: Salaries, rent, commission, discount, insurance

Debit credit Personal accounts: the receiver the giver Real accounts: what comes in what goes out Nominal accounts: all losses and exp all gains Ledger: is a set of accounts, ledger is the important book of the double entry system 129

Finance Material Posting: process of entering in the ledger Journal entry: The book of first entry (original entry) chronological record Trail balance: All the accounts of a concern are thus balanced off then they are put in a list Debit side trail to credit side Debit side: losses, expenses, and assets Credit side: gains, revenues, liabilities To find out the figures arithmetically correct or not Trading account: To find out the gross profit Debit side: wages, carriage, and royalties if it is used for production Factory expenses, package goods are incomplete such as biscuits consumable stores (cotton waste, grease, engine oil) factory rent salaries Gross profit: sales cost of goods sold Inventories: Raw materials, work in progress, finished goods Need for holding inventories: Transaction motive smooth production Precautionary motive risk, unpredictable changes Speculative motive price fluctuations Methods: First-in first-out method (FIFO) Last-in first-out method (LIFO) Weighted average method Specific identification method Ordering cost: entire cost of acquiring raw materials Carrying cost: incurred for maintaining storage, insurance, taxes Capital structure: Refers the mix of long-term sources of funds, preference capital and equity capital and retained earnings BEP: (break-even-point) Total revenues equals to total cost Behavior of profits in response to the changes in volume, cost and prices Need: What minimum level of sales need be achieved to avoid losses What should be the sales level to earn a target profit Make or buy decision, production planning BEP (units): total fixes cost/ selling price variable cost per unit BEP (rupees): total fixed cost/ 1- variable cost per unit/ selling price P/V ratio: sales variable cost/ sales BEP (rupees): fixed cost/ p/v ratio (or) contribution ratio Angle of 45: The vertical and horizontal lines are spaced equally with the same distance Intersection between sales line and total cost line is the break-even point Margin of safety: The excess of actual sales (or) budgeted sales over the break even sales is known as M.S 130

Finance Material Ratio: budgeted sales break-even sales/ budgeted sales Target sales: fixed cost + desired profit/ contribution ratio (or) p/v ratio Budget: Is a detailed plan of operations for some specific future period Corporate finance: It is concerned with the raising and administration of funds used in business Deals with practices and policies Deals with financial problems Marketable securities: Are the temporary short-term investments in shares, debentures and bonds Commercial papers, UTI units, inter corporate lending Bad debts: debts, which will never be collected, are called Bills receivables: Represents the promises made in writing by debtors to pay definite some of money after some specific period of time Loans and advances: due from employees and associates Patents: Right granted by the government enabling the holder to control the use of an invention Copy right: Exclusive right to reproduce and sell literacy musical and artistic works Franchises: Contracts giving exclusive right to perform certain functions or to sell certain products or services Other assets (preliminary exp, deferred revenue expenditure): Prepayments for services or benefits for period longer than the accounting period Ex: advertising, preliminary exp Relation ship between B/S and P & L a/c: Revenue is an inflow of assets (or outflow of liabilities) Expenses is an outflow of assets (or inflow of liabilities) Bills of exchange: The seller draws a bill of exchange for a specific amount payable at a specified date in future It is accepted by the customer or by a bank Brawer: who write the bill Drawee: who accepted the bill Purchase or discount of bills: The amount provided under this agreement is covered within the overall cash credit or overdraft limit implies that the bank becomes owner of the bill Banks holds the bill as a security for the credit Banks charge discount charges Over draft: The borrower is allowed to withdraw funds in excess of the balance in his current account Up to a certain specified limit during a stipulated period, interest charged on daily basis operates the account through cheques Cash credit: Borrower is allowed to withdraw funds from the bank up to the sanctioned credit limit Funds flow statement: (statement of sources and uses of funds) 131

Finance Material The statement of changes in financial position prepared to determine only the sources and application (or uses) of working capital between the dates of two balance sheets Banks and financial institutions required it when a company approaches them for loans Increase in assets is use of funds Increase in liabilities and net worth (shareholders equity) is source of funds Decrease in assets is source of funds Decrease in liabilities and retained earnings is use of funds Fund: Its a financial product, change in cash only, Change in working capital, change in financial resources Working capital: Fund required to run the day-to-day business activities cannot be overemphasized Finance provided to support the short-term assets of the business Sources: Over draft, cash credit, purchase or discounting of bills What is the need to invest funds in current assets How much funds should be invest in each type of current assets Gross working capital: current assets Net working capital: current assets current liabilities (net current assets) Need: To run the day to day operations of the business Fixed working capital: Minimum level of current assets is referred to as permanent or fixed working capital Degree of excessive working capital: Chances of inventory mishandling, waste, losses increase Defective credit policy, stock collection period Higher incident of bad debts, managerial inefficiency Inadequate working capital: Difficult to implement operating plan, operating inefficiency, Fixed assets are not efficiently utilized, losses its reputation Working capital cycle: Acquiring raw materials resources Manufacturing the products finished goods Accounts receivables through sales if credit sales book debts Use of working capital: Adjusted net loss from operations Purchase of non-current assets Repayment of long-term debt Redemption of redeemable preferred shares Payment of cash dividend Determinants: Nature and size of business Manufacturing cycle Sales growth Production policy Price level changes Operating efficiency and performance 132

Finance Material Firms credit policy Availability of credit Estimating working capital: Current assets holdings period Ratio of sales Ratio of fixed investments Cash flow statements: Summarizes the causes of changes in cash position between dates of two B/S Only cash transactions depreciation is not considering It is useful for short-term planning Statements of changes in financial statements on cash basis Sources: Profitable operations of the firm Decrease in assets (except cash) Increase in liabilities Comparative statement analysis: To find out the periodic changes in the financial performance of a company, at least for two years, changes: income or decrease aggregate changes Common-size statements: Vertical analysis Take sales as 100 Take total assets and total liabilities as 100 Trend analysis: (time series analysis) The direction of changes over a period of years Applicable to the items of P & L a/c Trends of sales and net income Ratio analysis: The relationship between two or more things Benchmark for evaluating the financial position and performance of a firm To make large quantitative of financial data and to make qualitative judgment about the firms financial performance Standards of comparison: Past ratios from the past reports, project ratios, competition ratios Industry ratios ratios of the industry to which the firms belongs Uses of ratio analysis: The ability of the firm to meet its current obligations Long-term solvency by borrowing funds The efficiency utilizing assets in generating sales revenue Overall operating efficiency and performance of the firm Financial ratios as predicators of failure Types: liquidity, leverage, activity, and profitability Liquidity ratios: Essential for a firm to be able to meet its obligations as they become due Measure the ability of the firm to meet its current obligations Firm should not suffer from lack of liquidity will result in a poor credit worthiness Loss of creditors confident 133

Finance Material A very high degree of liquidity is also bad idle assets earn nothing Current ratio: current assets/ current liabilities Standard is 2 to 1 (or) 2:1 For measuring short-term solvency It represents a margin of safety for creditors Quick ratio: current assets inventories/ current liabilities Standard is 1 to 1 (or) 1:1 Converted into cash without any loss of value Cash is the most liquid asset Inventories less liquidity fluctuate Cash ratio: cash + marketable securities/ current liabilities Internal measure: current assets inventory/ average daily operating expenses Total operating expenses/360 A firms ability to meet its regular cash expenses is internal measure Operating exp: expenses + cost of goods sold + selling & administrative expenses + general expenses depreciation Net working capital (NWC): NWC/ net assets Current liabilities exclude short-term borrowings Leverage ratios: For bankers - firms current debt paying ability For firms long-term financial strength The firm has a legal obligation to pay interest to debt holders irrespective of the profit made or loss incurred by the firm Total debt ratio: total debt/ total debt + net worth (or) TD/ NA TD: total debt, NA: net assets For long term solvency of a firm Capital employed = net assets (or) Shareholders equity + long term debt Net worth = shareholders equity Debt equity ratio: external equity/ internal equity or TD/NW (net wroth) A high ratio shows that claims of creditors are greater than those of owners A low ratio implies greater claims of owners than creditors Capital employed to net worth ratio (CE): CE/ NW By lenders and owners contribution Total liabilities to total assets ratio: TL/ TA Financial risk: preference capital include in net worth Lease payment = debt Debt ratio: TD + value of lease/ TD + value of lease + net worth Coverage ratios: Interest coverage ratio: EBIT/ interest (or) EBIDT/ interest Whether the business would earn sufficient profits to pay periodical the interest charges Standard is 6 to 7 times Debt service coverage ratio: EBIT/ interest + principle payment installment/ 1 tax rate Whether the company to make payment of principle amount Activity ratios: Funds of creditors and owners are invested in various assets to generate sales and profits 134

Finance Material The better the management of assets the larger the amount of sales Turnover ratios: balance between sales and assets Inventory turnover ratio: cost of goods sold/ average inventory The ratio indicates the efficiency of the firm in selling its product Days of inventory holdings: 360/ inventory turnover How rapidly the inventory is turning into receivable through sales Debtors turnover ratio: credit sales/ average debtors (or) sales/ debtors Average debtors: opening balance + closing balance/ 2 Collection period: 360/ debtors turnover Average collection period measures the quality of debtors speed of their collection Creditors turnover ratio: credit purchases/ average creditors (not important) Assets turnover ratio: sales/ net assets Assets used to generate sales Ex: Sales of one rupee of capital employed in net assets Total assets: sales/ TA Fixed assets: sales/ net F.A (fixed assets) Working capital turnover ratio: sales/ net CA Ex: The one rupee of sales the company need as 0.31 of net current assets Profitability ratios: The company should earn profits to serve and grow over a long period of time Profitability in relation to sales Profitability in relation to investment Gross profit margin: sales cost of goods sold/ sales Efficiency which management produces each unit of product Contribution ratio: sales variable exp/ sales (or) 1 variable exp/ sales Net profit margin: profit after tax (PAT)/ sales It indicates management efficiency in manufacturing and administrative and selling the products (or) EBIT (1 T)/ sales T: tax Operating expenses ratio: operating expenses/ sales For changes in the profit margin (EBIT) A higher operating expenses ratio is unfavorable Cost of goods sold ratio (CGS): CGS/ sales Return on investment (ROI): Return on total assets: EBIT (1 T)/ TA (or) EBIT/ TA Return on net assets: EBIT (1 T)/ NA (or) EBIT/ NA Return on equity (ROE): PAT/ NW Earnings per share (EPS): PAT/ number of common shares outstanding Dividend per share (DPS): earnings paid to shareholders/ no. Of ordinary shares out Dividend payout ratio: DPS/ EPS Dividend yield ratio: DPS/ market value of the share Price earning ratio P/E ratio: market value of the shares/ EPS Market value of book value: Market value/ book value Other ratios: Fixed assets ratio: fixed assets/ long-term funds Standard 0.67 135

Finance Material This ratio should not be more than 1 If less than 1 it shows that a part of the working capital has been financed through long-term funds Proprietary ratio: shareholders funds/ total tangible assets Standard 0.05 Importance to creditors High proprietary ratio will indicates relatively little danger to the creditors Wasting assets; Oil wells (lease) coal mines Pre incorporation profit are transferred to capital reserve Section 210 to 220 of the companies act 1956 legal position relating to the final accounts of joint stock company Section 210 preparation and presentation of final accounts Section 211 balance sheet and P & L a/c Profit and loss appropriation a/c To transfer for reserves By last years balance b/d To income tax for previous year By net profit for the year b/d Not provided for To interim dividend By amount withdraw from general reserve or any other To proposed dividend By provision such as income tax To surplus carried to B/S By provision no longer required Divisible profits: dividend to shareholders Transfer to reserve: not exceed 10% of the PAT should not less than 2.5% Interest on dividend: 23% Creditors: Are those persons who have already advanced some money or moneys worth to the business Conflicts of accounting principles: Valuation of stock: some years market value Some years cost, because of principle of conservatism But the principle of consistency will controversy Feasibility: assets are recorded at cost less depreciation Petty cash book: Small amounts and high frequency Ex: payment of stationary, postage, telegrams, and carriage Errors not disclosed by Trail Balance: Omission in recording the transaction in the books of original entry debit and credit side both Wrong recording in the original books Posting to wrong account with correct amount and no correct side Compensatory error: forgetting to post Error of principle Errors disclosed by trail balance: Error in casting of subsidiary books (make total) Error in carrying forward the one page to another page Error in posting to ledger Error in balancing the amount Preparation of debtors and creditors schedule How to find out the errors: 136

Finance Material Divide the difference by 2 and find out the equal figure appear in the trail balance If the difference is evenly divisible by 9 error the trans position (847 treated as 987) If the amount is net round figure its mistake in posting If the amount is round figure mistake in casting or carrying forward If the difference is large amount compare this year trail balance to previous year Free samples: debit to advertisement a/c and credited to purchase a/c Closing entry: In an account is having debit balance that is credited either trading a/c or P & L a/c similarly like the way to credit Debit sales a/c debit p & l a/c Credit trading a/c credit salaries a/c Post closing trail balance: In order to see whether the amount in the ledger are still in balance, which are still open Mercantilist system: period taken into account Stock destroyed: deducted from closing stock loss is shown in debit side of P & L a/c When not insured: P & L a/c Dr To Trading a/c When fully insured: Insurance claim a/c Dr To Trading a/c When partially insured: Insurance claim a/c Dr P & L a/c Dr To Trading a/c Expenses out standing: Debit expenses (p & l a/c) Credit expenses out standing a/c (liability) Expenses paid in advance: Prepaid expenses (asset) Credit expenses (p & l a/c) Out standing or accrued income: (asset) Like interest on securities, dividend on shares, commission are earned but not received It has to credited to insurance a/c Debit accrued income (asset) Credit income (p & l a/c credit side) Income received in advance: Debit income (p & l a/c) Credit income received in advance (liability) Depreciation: Debit depreciation a/c (p & l a/c) Credit asset (B/S) Bad debts: Debit bad debt (p & l a/c) Credit debtors (B/S) 137

Finance Material Bad debt provision: Balancing of debtors (objective) Debit p & la/c Credit bad debts provision Provision for discount on debtors and creditors Discount on debtors: debit p & l a/c Credit provision of discount on debtors Discount on creditors: debit provision for discount on creditors Credit p & l a/c Interest on capital Debit p & l a/c Credit capital a/c Interest on drawings: Debit capital a/c Credit p & l a/c Cash paid allowed discount: Cash a/c Dr X a/c Dr Discount a/c Dr To cash a/c To X a/c To discount a/c Advance tax payment: Advance tax a/c Dr Tax a/c Dr To Bank a/c To advance tax a/c To bank a/c Life insurance premium: paid on life it is add to drawings Insurance premium: If shop p & l a/c If goods purchased, factory building, factory machine Trading a/c Loss or gain on asset sold: p & l a/c Discount received and allowed: P & L a/c Stock at the end appear in trail balance: Opening stock: Debit purchase a/c Credit stock a/c Closing stock: Debit stock a/c Credit purchase a/c Bank reconciliation statement (BRS): Two sources to find out the balance at bank Bank columns of the cash book (or) bank account in the ledger Pass book (copy of bank column in cash book) Passbook: credit balance favorable Cashbook: debit balance favorable Purpose of preparing BRS: To reconcile the two balances which often differ for various reasons The statement show the difference between two balances Reasons: 138

Finance Material Cheques deposited for collection but not yet collected Cash book debit Passbook - credit If the cash book balance is given - less to the If the pass book balance is given add to the Cheques issued but not yet presented for payment: Cashbook credit Pass book debit If the cash book balance is given add to the If the pass book balance is given lee to the Credits in the pass book only: Interest on favorable balance Interest on fixed deposits Dividend and interest on securities collected Sales proceeds of securities behave of the cash Bills promises notes collected Amount remitted to the account of the customer by the debtors (deposit) In all cases cashbook shows the high balance than cashbook If the cash book balance is given add to the If the pass book balance is given less to the Debits in the pass book: payment as per LIC premium, subscription to club Interest on unfavorable balance (overdraft) Bank charges Purchase of investments In all cases passbook balance shows less balance than cashbook If the cash book balance is given less If the passbook balance is given add Error in passbook and cashbook Payment side of the cashbook is undercast by 200 in case of favorable balance add to the passbook In case of un favorable balance reduce from the passbook A cheque for Rs 100 paid to a party entered error in the cashbook the passbook balance is more by 100 Sa cheque for 600 draws no 1 a/c wrongly charged by the bank to no 2 a/c No 1 a/c pass book balance increase 600 reduce the pass book balance no 2 Bookkeeping: Recording of business transactions by following accounting procedures Accounting: following the rules and procedures Manufacturing account: It shows the expenditure in an activity or product it will transfer to trading account

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1. Accrued Interest: The interest earned on a bond between interest payment periods (generally twice a year). 2. Acquisition: One company taking control of another by purchasing a majority or all of the target company's outstanding shares. An "unfriendly" or "hostile" acquisition attempt is usually characterized by an offer far in excess of the market value of the shares, which is meant to induce current stockholders into selling. 3. Ask" Price: In the context of the over-the-counter market, the term "ask" refers to the lowest price at which a market maker will sell a specified number of shares of a stock at any given time. The term "bid" refers to the highest price a market maker will pay to purchase the stock. The ask price (also known as the "offer" price) will almost always be higher than the bid price. Market makers make money on the difference between the bid price and the ask price. That difference is called the "spread". 4. Annual Report: A publication that is issued yearly by all publicly held corporations and freely available to all shareholders. It reveals the company's assets, liabilities, revenues, expenses, and earnings for the past year, along with other financial data. 5. Audit Committee: Appointed by the Board of Directors and charged with monitoring the internal and external reviews of the finances of the Exchange and its subsidiaries, and of the Exchanges information technology systems. 6. Balance Sheet: A condensed financial statement showing the nature and amount of a company's assets, liabilities and capital on a given date. In dollar amounts the balance sheet shows that the company owned, what it owed, and the ownership interest in the company of its stockholders. 7. Bear: For generations, bulls and bears on Stock exchanges have referred to two decidedly different types of investors - the bulls being those who expect stock prices to rise, the bears being those who believe prices are about to decline. 8. Bear Market: A term to describe a market of declining prices. 9. Blue Chip:A company known nationally for the quality of its products or services, its reliability, and its ability to operate profitably in good and bad economic times. 10.Bankruptcy: Its a position where the liabilities of the company exceeds the assets of the company and the company is not in a position to pay its debts and unable to run the business.

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11."Bid" Price: In the context of the over-the-counter market, the term "bid" refers to the highest price a market maker will pay at any given time to purchase a specified number of shares of a stock. The term "ask" refers to the lowest price at which a market maker will sell the stock. The ask price (also known as the "offer" price) will almost always be higher than the bid price. Market makers make money on the difference between the bid price and the ask price. That difference is called the "spread". 12.Blank Cheque Company:A blank check company is a development stage company that has no specific business plan or purpose or has indicated its business plan is to engage in a merger or acquisition with an unidentified company or companies, other entity, or person. These very small companies typically involve speculative investments and often fall within the SECs definition of "penny stocks" or are considered "microcap stocks." 13.Bond:A debt secured by a specific asset of the issuing corporation. The term bond, debenture and note are often used interchangeably. All three represent debt obligations of the issuing entity. 14.Stock and Bond Certificates, Old :. An old stock or bond certificate may still be valuable even if it no longer trades under the name printed on the certificate. The company may have merged with another company or simply changed its name. You can use the resources below to find out if an old stock or bond certificate has value. Even if you learn that a certificate has no value, you may find that the certificate itself has value as a collectable 15.Book Entry The "book entry" form of ownership allows you to own securities without a certificate. Stock in direct investment plans, Treasury securities purchased directly from the U.S. Department of the Treasury, and recently issued municipal bonds are held in book entry form. 16.Buying and Selling Stock When you call your broker to buy or sell a stock or hit "enter" when placing an order through your online brokerage account that's only the beginning of the transaction. Your broker's firm must then send your order to a market center to be executed. This process of filling your order is known as "trade execution." 17.Your broker generally has a choice of market centers to execute your trade:

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Exchange An exchange is a marketplace where traders can buy or sell stocks and bonds. For a stock that's listed on an exchange, such as the New York Stock Exchange (NYSE), your broker may direct the order to that exchange, to another exchange (such as a regional exchange), or to a firm called a "third market maker." Market Maker A "market maker" is a firm that stands ready to buy or sell a stock at publicly quoted prices. Market makers in exchange-listed stocks are known as "third market makers." Market makers in stocks that trade in over-the-counter (OTC) markets, such as the Nasdaq, are known as "Nasdaq market makers" or simply "market makers." Electronic Communications Network (ECN) An electronic communications network (ECN) is an electronic trading system that automatically matches buy and sell orders at specified prices. 18.Bull For generations, bulls and bears on Stock exchanges have referred to two decidedly different types of investors - the bulls being those who expect stock prices to rise, the bears being those who believe prices are about to decline. 19.Bull Market A condition of the stock market when prices of stocks are generally rising. 20.Call Option A contract that gives the holder the right to buy the underlying stock at a specified price (the strike price) within a fixed period of time. 21.Capital Stock All shares representing ownership of a business, including common and preferred. 22.Cash Flow Reported net income of a corporation plus amounts charged for depreciation, depletion, amortization, extraordinary charges to reserves, which are bookkeeping deductions and not paid out in actual dollars and cents. 23.Closed-end Fund
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Closed-end funds have a fixed number of shares outstanding. Following an initial public offering, those shares trade throughout the day on an exchange between investors. Share prices are determined by the forces of supply and demand and can be more or less than the fund's net asset value (NAV). This differs from open-end funds, which continuously offer their shares to investors and whose share prices are based on their NAV, determined at the close of each business day. 24.Commercial Paper Very short term IOUs written by reputable blue chip companies in need of short-term financing. 25.Commodities Articles of commerce or products that can be used for commerce. In a narrow sense, products traded on an authorized commodity exchange. Types of commodities include agricultural products, metals, petroleum, foreign currencies, financial instruments and indexes to name a few. 26.Common Stock Securities that represent an ownership interest in a corporation. If the company has also issued preferred stock, both common and preferred have ownership rights. Common stockholders assume the greater risk, but generally exercise the greater control and may gain the greater award in the form of dividends and capital appreciation. The terms common stock and capital stock are often used interchangeably when the company has no preferred stock. 27.Conglomerate A corporation that has diversified in operations usually by acquiring enterprises in widely varied industries. 28.Consolidated Balance Sheet A balance sheet showing the financial condition of a corporation and its subsidiaries. 29.Convertible Bond A debt issue that may be exchanged, or converted, by the owner for a fixed number of common shares, or other securities, usually of the same company, in accordance with the terms of the issue. Companies also issue convertible preferred shares. 30.Credit Rating An evaluation of a debt issuer by a rating agency such as Moodys and Standard and Poors. The evaluation is based on the issuers credit history and its ability to pay its obligations. 31.Current Assets
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Those assets of a company that are reasonably expected to be realized in cash, or sold, or consumed during one year. These include cash, Government bonds, receivables and money due usually within one year, and inventories. 32.Current Liabilities Money owed and payable by a company, usually within one year. 33.Capital Gains and Losses Investors contact the SEC asking about the tax consequences when they sell securities. In particular, investors want to know whether they will have to pay a capital gains tax or can take a capital loss. The SEC does not regulate this area. The Internal Revenue Service does instead 34.Central Registration Depository or CRD The Central Registration Depository, called the CRD, is a computerized database that contains information about most brokers, some investment advisers, their representatives, and the firms they work for. For instance, you can find out if brokers are properly licensed in your state and if they have had run-ins with regulators or received serious complaints from investors. You'll also find information about the brokers' educational backgrounds and where they've worked before their current jobs. 35.Executive Compensation The federal securities laws require clear, concise and understandable disclosure about compensation paid to CEOs and certain other high-ranking executive officers of public companies. Several types of documents that a company files with the Commission include information about the company's executive compensation policies and practices. You can locate information about executive pay in: (1) the company's annual proxy statement; (2) the company's annual report on Form 10-K; and (3) registration statements filed by the company to register securities for sale to the public. The easiest place to look up information on executive pay is probably the annual proxy statement. 36.Forex - Foreign Currency Transactions The foreign exchange markets are sometimes referred to as "forex." Operating 24 hours a day, the forex market is highly liquid and most of the trading is conducted electronically or over the phone. Banks, insurance companies, large corporations and other large financial institutions all use the forex markets to
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manage the risks associated with fluctuations in currency rates. In recent years, retail investors have also looked to the forex markets as yet another possible investment opportunity. The Commodity Futures Trading Commission cautions investors to be wary of websites that purport to offer high yield investment opportunities in forex transactions, because this is a common area of internet fraud. 37.Convertible Securities A "convertible security" is a security - usually a bond or a preferred stock - that can be converted into a different security - typically shares of the company's common stock. In most cases, the holder of the convertible determines whether and when a conversion occurs. In other cases, the company may retain the right to determine when the conversion occurs.Companies generally issue convertible securities to raise money. Companies that have access to conventional means of raising capital (such as public offerings and bank financings) might offer convertible securities for particular business reasons. 38.Agent A person who buys or sells for the account and risk of another. Generally, an agent takes no financial risk and charges a commission for his services. 39.American Depositary Receipt (ADR) A receipt that is issued by a U.S. depositary bank which represents shares of a foreign corporation held by the bank. Because ADRs are quoted in U.S. dollars and trade just like any other stock, they make it simple for investors to diversify their holdings internationally. 40.American Stock Exchange (Amex) An open auction market where buyers and sellers compete in a centralized marketplace. The Amex typically lists small to medium cap stocks of younger or smaller companies. Until 1921 it was known as the New York Cumulative Exchange. 41.Arbitration Arbitration often allows you to resolve disputes more quickly and cheaply than by going to court. Instead of judges or juries, arbitrators decide if wrongdoing occurred and how to correct or compensate you for it.

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When the arbitration is over, the decisions of the arbitrators are final. If you are unhappy with the result, you cannot go to court to try again. The arbitrators' decisions can only be appealed under very limited circumstancesfor example, if you can demonstrate that an arbitrator was biased. If you want to appeal an arbitrator's decision you must do so within three months or less in a "motion to vacate 42.Cumulative Voting Cumulative voting is a type of voting process that helps strengthen the ability of minority shareholders to elect a director. This method allows shareholders to cast all of their votes for a single nominee for the board of directors when the company has multiple openings on its board. In contrast, in "regular" or "statutory" voting, shareholders may not give more than one vote per share to any single nominee. 43.Derivatives Derivatives are financial instruments whose performance is derived, at least in part, from the performance of an underlying asset, security or index. For example, a stock option is a derivative because its value changes in relation to the price movement of the underlying stock. 44.Employee Stock Options Plans Many companies use employee stock options plans to compensate, retain, and attract employees. These plans are contracts between a company and its employees that give employees the right to buy a specific number of the companys shares at a fixed price within a certain period of time. Employees who are granted stock options hope to profit by exercising their options at a higher price than when they were granted. 45.Employee Stock Ownership Plans (ESOPs) An employee stock ownership plan (ESOP) is a retirement plan in which the company contributes its stock to the plan for the benefit of the companys employees. With an ESOP, you never buy or hold the stock directly. This type of plan should not be confused with employee stock options plans, which are not retirement plans. Instead, employee stock options plans give the employee the right to buy their companys stock at a set price within a certain period of time.
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46.Debenture Debt not secured by a specific asset of the corporation, but issued against the issuers general credit. 47.Director Person elected by shareholders, usually during an annual meeting, to serve on the Board of Directors of a corporation. The directors appoint the president, vice president and all other operating officers. Directors decide, among other matters, if and when dividends shall be paid. 48.LOAN SYNDICATION The process of involving numerous different lenders in providing various portions of a loan. Mainly used in extremely large loan situations, syndication allows any one lender to provide a large loan while maintaining a more prudent and manageable credit exposure because they aren't the only creditor. 49.TRUSTEES One, such as a bank, that holds legal title to property in order to administer it for a beneficiary. A member of a board elected or appointed to direct the funds and policy of an institution. A country responsible for supervising a trust territory. 50.Does a banker sign the annual report who has sanctioned loan to the Company? NO, the banker doesnt sign the annual report but he sees the documents are charged in favour of him. 51.What is synergy? The idea that the value and performance of two companies combined will be greater than the sum of the separate individual parts This term is used mostly in the context of mergers and acquisitions. For example, if Company A has an excellent product but lousy distribution whereas Company B has a great distribution system but poor products, the companies could create synergy with a merger. 52.What is meant by liability and Contingent Liability?
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Liability -legal debt or obligation estimated via accrual accounting Contingent Liability-An asset in which the possibility of ownership depends solely upon future events uncontrollable by the company. An example might be a settlement from a lawsuit 53.Who is a general partner? partner in a business who has unlimited liability. 54.What is limited Liability Company? A corporate structure whereby the shareholders of the company have a limited liability to the company's actions Basically, an LLC is a hybrid between a partnership and a corporation 55.Who is Merchant Banker? A bank that deals mostly in (but is not limited to) international finance, longterm loans for companies and underwriting. Merchant banks do not provide regular banking services to the general public. 56.What is public float? The total number of shares publicly owned and available for trading. The float is calculated by subtracting restricted shares from outstanding shares. For example, a company may have 5 million outstanding shares, but only 3 million are trading on the stock market. So, the float would be 3 million. 57.Secondary Market A market on which an investor purchases an asset from another investor rather than an issuing corporation. good example is the New York Stock Exchange. Here all stock exchanges are part of the secondary market, as investors buy securities from other investors instead of an issuing company. 58.What is balance of trade? The largest component of a country's balance of payments. It is the difference between exports and imports. Debit items include imports, foreign aid, domestic spending abroad and domestic investments abroad. Credit items include exports, foreign spending in the domestic economy and foreign investments in
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the domestic economy. A country has a trade deficit if it imports more than it exports, and the opposite scenario is a trade surplus. 59.What is balance of payments? A record of all transactions made by one particular country during a certain period of time. It compares the amount of economic activity between a country and all other countries. This includes trade balance, foreign investments, and investments by foreigners among other things. 60.What is corporate governance? The relationship between all the stakeholders in a company. This includes the shareholders, directors, and management of a company, as defined by the corporate charter, bylaws, formal policy, and rule of law. 61.Who is a factor? financial intermediary that purchases receivables from companies 62.what is W.T.O An international organization dealing with the global rules of trade between nations. Its main function is to ensure that trade flows as smoothly, predictably, and freely as possible. 63.What is dumping? In international trade, this occurs when one country exports a significant amount of goods to another country at prices much lower than in the domestic market. 64.What is globalization? The tendency of investment funds and businesses to move beyond domestic and national markets to other markets around the globe, 65.Diversification Spreading investments among different types of securities and various companies in different fields. 66.Depreciation Charges against earnings to write off the cost, less salvage value, of an asset over its estimated useful life. It is a bookkeeping entry and does not represent any cash outlay nor are funds earmarked for the purpose. 67.Dividend

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The payment designated by the Board of Directors to be distributed pro rata among the shares out-standing. For preferred shares, the dividend is usually a fixed amount. For common shares, the dividend varies with the fortunes of the company and the amount of cash on hand, and may be omitted if business is poor or if the directors determine to withhold earnings to invest in plants and equip-ment. 68.Dow Jones Industrial Average (DJIA) The Dow Jones Industrial Average (DJIA) is an index used to measure the performance of the U.S. financial markets. Introduced on May 26, 1896 by Charles H. Dow, it is the oldest stock price measure in continuous use. Over the past century "the Dow" has become the most widely recognized stock market indication in the U.S. and probably in the entire world. Most of the stocks included in the index are listed on the New York Stock Exchange, and are all large blue-chip companies that reflect the health of the U.S. economy. All but a handful of these have major business operations throughout the world, thus providing some insight into the economic well-being of the global economy 69.Income Statement A report on a company's financial status over a period of time. It totals profits, subtracts expenses and pinpoints how much money the company can reinvest. 70.Market Order Processing Super Dot's market order system is designed to process member firms' market orders of up to 30,099 shares. The system provides for rapid execution and reporting of market orders. In 1994, market orders were executed and reported back to the originating member firm on average within 24 seconds. 71.Market Price The last reported price at which the stock or bond sold, or the current quote. 72.Going Private A company "goes private" when it reduces the number of its shareholders to fewer than required and is no longer required to file reports with the SEC. A number of transactions can result in a company going private, including: Another company or individual makes a tender offer to buy all or most of the companys publicly held shares;
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The company merges with or sells the companys assets to another company; or The company can declare a reverse stock split that not only reduces the number of shares but also reduces the number of shareholders. In this type of reverse stock split, the company typically gives shareholders a single new share in exchange for a block10, 100, or even 1,000 sharesof the old shares. If a shareholder does not have a sufficient number of old shares to exchange for new shares, the company will usually pay the shareholder cash based on the current market price of the companys stock.

73.Face Value The value of a bond that appears on the face of the bond, unless the value is otherwise specified by the issuing company. Face value is ordinarily the amount the issuing company promises to pay at maturity. Face value is not an indication of market value. Sometimes referred to as par value. 74.Fiscal Year Any consecutive 12-month period of financial accountability for a corporation or government. For example, because of the Christmas rush many department stores find it easier to wind up their yearly accounting on January 31 instead of December 31. Fiscal year is often abbreviated FY with a date. For example, FY May 31 means that the company's fiscal year goes from June 1 to May 31 of the following year. 75.Fixed Charges A company's fixed expenses, such as bond interest, which it has agreed to pay whether or not earned, and which are deducted from income before earnings in equity capital are computed. 76.General Mortgage Bond A bond that is secured by a blanket mortgage on the issuing company's property, though it may be outranked by one or more other mortgages. 77.Going Public: When a company sells shares of itself to the public to raise capital. 78.Government Bonds Obligations of the Government, regarded as the least risky, highest-grade securities issues. The major types of debt instruments issued by the government are: Treasury Bills, Saving Bonds, Treasury Notes, and Treasury Bonds. 79.Hedging

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The purchase or sale of a derivative security (such as options or futures) in order to reduce or neutralize all or some portion of the risk of holding another security. 80.Holding Company A corporation that owns a large number of shares in other companies. Holding companies use the voting rights that come with their shares to exert influence over the companies under them. 81.Initial Public Offering (IPO) An issue of new stock by a once private company to transform itself into a publicly held one. IPOs are usually done to raise cash for growing young companies that need larger sources of capital than the private sector can provide. The new shares are sold to one or more investment banks, which then sell them to the public. 82.Institutional Investors Organizations whose primary purpose is to invest their own assets or those entrusted to them by others. The most common are employee pension funds, insurance companies, mutual funds, university endowments, and banks. 83.Investment Banker One whose principal business consists of acting as investment adviser and rendering investment supervisory services. 84.Investment Counsel One whose principal business consists of acting as investment adviser and rendering investment supervisory services. 85.Issuer A corporation, government, or other authority, that borrows money through the sale of bonds or notes. 86.Insider Trading "Insider trading" is a term that most investors have heard and usually associate with illegal conduct. But the term actually includes both legal and illegal conduct. The legal version is when corporate insidersofficers, directors, and employeesbuy and sell stock in their own companies. When corporate insiders trade in their own securities, they must report their trades to the SEC. 87.Examples of insider trading cases that have been brought by the SEC are cases against:

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Corporate officers, directors, and employees who traded the corporation's securities after learning of significant, confidential corporate developments; Friends, business associates, family members, and other "tippees" of such officers, directors, and employees, who traded the securities after receiving such information; 88.Leverage Any means of increasing value and return by borrowing funds or committing less of one's own. For corporations, it refers to the ratio of debt (in the form of bonds and preferred stock outstanding) to equity (in the form of common stock outstanding) in the company's capital structure. 89.Listed Companies: Companies whose shares of stock trade on a securities market. 90.Locked In: Investors are said to be "locked in" when a security they own is trading at a higher price than they paid for, but they choose not to sell in order to avoid having their profit become subject to the capital gains tax. 91.Margin The amount paid by the customer when using a broker's credit to buy or sell a security. Under Federal Reserve regulations, the initial margin required since 1934 has ranged from 40% of the purchase price up to 100%. Since 1974 the current rate of 50% has been in effect. 92.Margin Call A demand upon a customer to put up money or securities with the broker. The call is made when a purchase is made; also if a customer's equity in a margin account declines below a minimum standard set by the Exchange or by the firm. 93.Market Data System (MDS) Captures and displays, worldwide, trade and volume information continuously generated by trading floor activity. MDS is the core of the NYSE international communications network. 94.New Issue or IPO A stock or bond sold by a corporation for the first time. Proceeds may be used to retire outstanding securities of the company, for new plants or equipment, for additional working capital, or to acquire a public ownership interest in the company for private owners.
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95.New York Stock Exchange (NYSE) The NYSE marketplace blends public pricing with assigned dealer responsibilities. Aided by advanced technology, public orders meet and interact on the trading floor with a minimum of dealer interference. The result is competitive price discovery at the point of sale. Liquidity in the NYSE market is provided by individual and institutional investors, member firms trading for their own accounts, and assigned specialists. The NYSE is linked with other markets trading listed securities through the Intermarket Trading System (ITS). 96.Nominating & Governance Committee Appointed by the NYSE Board of Directors and charged with (i)recommending to the Board candidates for the Board of Directors, the Board of Executives and for Trustees of the Gratuity Fund, (ii) reviewing the Exchanges governance principles and practices, (iii) establishing and overseeing self-assessment by the Board and the Board of Executives, (iv) recommending director compensation, and (v) succession planning for the Chairman and Chief Executive Officer of the Exchange. 97.Notes: Generally, a bond issue maturing in more than two years but no more than ten years. 98.NYSE Composite Index The NYSE Composite Index is designed to measure the performance of all common stocks listed on the NYSE, including ADRs, REITs and tracking stocks. Under its methodology, all closed-end funds, ETFs, limited partnerships and derivatives are excluded from the index. It is a measure of the changes in aggregate market value of all NYSE-listed common stocks, adjusted to eliminate the effects of capitalization changes, new listings and delistings. The index is weighted using free-float market capitalization and calculated on both price and total return basis. 99.NYSE Hybrid Market The NYSE Hybrid Market is the NYSEs new market model, integrating into one venue the best aspects of both the auction market and automated trading while providing customers with the broadest choice of trade-execution preferences. 100. Net Asset Value

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"Net asset value," or "NAV," of an investment company is the companys total assets minus its total liabilities. For example, if an investment company has securities and other assets worth $100 million and has liabilities of $10 million, the investment companys NAV will be $90 million. Because an investment companys assets and liabilities change daily, NAV will also change daily. NAV might be $90 million one day, $100 million the next, and $80 million the day after. Mutual funds and Unit Investment Trusts (UITs) generally must calculate their NAV at least once every business day, typically after the major U.S. exchanges close. A closed-end fund, whose shares generally are not "redeemable"that is, not required to be repurchased by the fundis not subject to this requirement. 101. Market Performance Committee (MPC) Focuses primarily on evaluating and seeking to strengthen the performance of NYSE specialist organizations, administering trading procedures, and recommending to the QOMC ways to improve NYSE markets' quality and competitiveness. Members include specialists, non-specialist floor members, allied members, and institutional traders. Hypothecation The pledging of securities as collateral for example, to secure the debit balance in a margin account. 102. Market Value The current resale value of a security. The market value of an issue is easily computed as the closing price multiplied by the shares outstanding. 103. Market-On-Close (MOC) Order A market order, which is to be executed in its entirety at the closing price, on the Exchange, of the stock named in the order, and if not so executed, is to be treated as cancelled. The term "at the close order'' shall also include a limit order that is entered for execution at the closing price, on the Exchange, of the stock named in the order pursuant to such procedures as the Exchange may from time to time establish. 104. Merger: Combination of two or more corporations. 105. Money Market Account An account in which your money is reinvested in short-term securities by the bank or investment firm managing the account. 106. Municipal Securities Rulemaking Board (MSRB) The organization responsible for rules regulating dealers who deal in municipal bonds, municipal notes, and other municipal securities. 107. Mutual Fund

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A portfolio of stocks, bonds, or other securities administered by a team of one or more managers from an investment company who make buy and sell decisions on component securities. Capital is contributed by smaller investors who buy shares in the mutual fund rather than the individual stocks and bonds in its portfolio. The return on the fund's holdings is distributed back to its contributors, or shareholders, minus various fees and commissions. This system allows small investors to participate in the reduced risk of a large and diverse portfolio that they could not otherwise build themselves. They also have the benefit of professional managers overseeing their money who have the time and expertise to analyze and pick securities. There are two types of mutual funds, open and closed-ended. Shares in closedend funds, some of which are listed on the New York Stock Exchange, are readily transferable in the open market and are bought and sold, like other stock. These funds do not accept new contributions from investors, but only reinvest the return on the existing portfolio. Open-end funds sell their own new shares to investors, stand ready to buy back their old shares, and are not listed on exchanges. Open-end funds are so called because their capitalization is not fixed; they issue more shares as people want them. Many open-ended funds allow contributors extra perks, such as the ability to write checks with their portion. 108. Mergers Mergers are business transactions involving the combination of two or more companies into a single entity. Most state laws require that mergers be approved by at least a majority of the company's shareholders if the merger will have a significant impact on the company. The proxy or information statement will describe the terms of the merger, including what you will receive if the merger is approved. If you believe the amount you will receive is not fair, check the statement for information on appraisal or dissenter's rights under state law. You must follow the procedures precisely or your rights may be lost. 109. Mortgage-Backed Securities Mortgage-backed securities (MBS) are debt obligations that represent claims to the cash flows from pools of mortgage loans, most commonly on residential property. Mortgage loans are purchased from banks, mortgage companies, and
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other originators and then assembled into pools by a governmental, quasigovernmental, or private entity. The entity then issues securities that represent claims on the principal and interest payments made by borrowers on the loans in the pool, a process known as securitization.

110. Mutual Funds A mutual fund is a company that pools money from many investors and invests the money in stocks, bonds, short-term money-market instruments, or other securities. Legally known as an "open-end company," a mutual fund is one of three basic types of investment company. The two other basic types are closed-end funds and Unit Investment Trusts (UITs). 111. NASDAQ An automatic information network that provides brokers and dealers with price quotations on securities traded over-the-counter. 112. National Securities Clearing Corporation (NSCC) Facilitates trade processing, clearance, delivery and settlement of equities, and corporate and municipal bonds. NSCC is owned equally by the New York and American Stock Exchanges and the National Association of Securities Dealers. 113. Negotiable: Refers to a security title that is transferable by delivery. 114. Net Asset Value Usually used in connection with investment companies to mean net asset value per share. An investment company computes its assets daily, or even twice daily, by totaling the market value of all securities owned. All liabilities are deducted, and the balance divided by the number of shares outstanding. The resulting figure is the net asset value per share. 115. Odd Lots: Stock transactions that involve less than 100 shares. 116. Off-Board: This term may refer to transactions over-the-counter in unlisted securities or to a transaction of listed shares that is not executed on a national securities exchange. 117. Offer: The price at which a person is willing to sell a security. 118. Open Interest: In options and futures trading, the number of outstanding option contracts at any given time which have not been exercised and have not yet reached expiration. 119. Open-End Investment Company
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A company or trust that uses its capital to invest in other companies. There are two principal types: the closed end and the open end, also known as mutual fund. Shares of closed-end investment companies, most of which are listed in the NYSE, are readily transferable in the open market and are bought and sold like shares of stock. Capitalization of these companies remains the same unless action is taken in change, which is rare. Open-end funds sell their own new shares to investors, stand ready to buy back their old shares, and are not listed. Open-end funds are so called because their capitalization is not fixed; they issue more shares as people want them. 120. Opening Automated Reporting System (OARS) OARS, a feature of the Super Dot system, is designed to accept member firms' pre-opening market orders for all stocks up to 30,099 shares for rapid, systematic execution and immediate reporting. OARS automatically and continuously pairs buy and sell orders and presents the imbalance to each specialist up to the opening of a stock, thus assisting the specialist as he or she determines the opening price. 121. Options Options are derivative securities that give the holder the right to buy (call) or sell (Puts and Calls) a specified amount of the underlying security at a specific "strike price" and within a specified timeframe. The NYSE withdrew from the options trading business in 1997. 122. Out-of-the-Money A call option is out-of-the-money when the strike price is above the price of the underlying security. Likewise, a put option is out-of-the-money when the exercise price is below the price of the underlying security. An out-of-themoney option is one that has no intrinsic value. 123. Over-the-Counter (OTC) A market for securities made up of dealers who may or may not be members of a securities exchange. OTC firms conduct business over the telephone and act either as principals or dealers (buying and selling stock from their own inventory and charging a markup) or as a broker or agent and charging a commission. 124. Stock and Bond Certificates, Old An old stock or bond certificate may still be valuable even if it no longer trades under the name printed on the certificate. The company may have merged with
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another company or simply changed its name. You can use the resources below to find out if an old stock or bond certificate has value. Even if you learn that a certificate has no value, you may find that the certificate itself has value as a collectable. These resources may be found on the Internet, at public libraries, stock exchanges, or stockbrokers' offices. But please note that the SEC cannot recommend or endorse any of these entities, their personnel, or their products or services. 125. Online Trading Although you may save time and money trading online, it does not take the homework out of making investment decisions. To avoid costly mistakes, investors who trade online should understand how our securities markets work and their options in placing trades in fast-moving markets when slow downs occur. Our publication, What You Need to Know About Trading In FastMoving Markets, provides useful tips for online traders. 126. Paper Profit (Loss) An unrealized profit or loss on a security still held. Paper profits and losses become realized only when the security is sold. 127. Par Value Par value is ordinarily the amount the issuing company promises to pay, per bond, at maturity, typically $1,000. Par value is not an indication of market value. Also referred to as Face Value. 128. Passed Dividend: The omission by a company's board of a regular or scheduled dividend payment. 129. Penny Stocks Low-priced issues, often highly speculative, selling at less than $1 a share. Frequently used as a term of disparagement, although some penny stocks have developed into investment-caliber issues. 130. Portfolio The collection of different investment instruments owned by one individual or institution. A portfolio can consist of any combination of stocks, bonds, derivatives and such. 131. Preferred Stock A type of stock that pays a fixed dividend regardless of corporate earnings, and which has priority over common stock in the payment of dividends. However, it carries no voting rights, and should earnings rise significantly the preferred
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holder is stuck with the same fixed dividend while common holders collect more. The fixed income stream of preferred stock makes it similar in many ways to bonds. 132. Premium For bonds and preferred stock, the premium is the amount by which the price exceeds the face, or par, value. For options markets, the premium is synonymous with the option's price. See also Discount. 133. Price Improvement When a buy order is executed at a price lower than the current quoted offer, or when a sell order is executed at a price higher than the current quoted bid. In addition to quoting the best prices more than 90 percent of the time, the NYSE continuous auction market typically improves upon these quoted prices, allowing investors to get a better price for their shares. 134. Price/Earnings Ratio A popular measure for comparing stocks selling at different prices in order to single out over- or under-valued issues. The P/E ratio is simply the price per share divided by the company's earnings per share. However, P/E is not always an accurate guide to a stock's quality. Some people tend to think that a stock is inflated and drastically overvalued if its price is many times its earnings. Yet that same stock may be quite accurately valued to reflect the company's rapid growth and potential for high future earnings. When comparing P/Es it is therefore important to choose stocks in the same industry that are likely to face the same earnings prospects. 135. Pricing Bond prices may be stated in dollar or yield terms. In dollars, the price is expressed as a percent of par value. Thus, a price of 90 means that the value of the bond is equal to 90% of the (usually) $1,000 face amount of the bond, or $900. Yield pricing expresses the price in terms of yield to maturity. 136. Primary Market The process by which a corporation's stock is issued for the first time. It is then sold to the public on the secondary market. 137. Prime Rate The lowest interest rate charged by commercial banks to their most creditworthy and largest corporate customers; other interest rates such as personal, automobile, commercial and financing loans are often pegged to the prime. 138. Profit-Taking
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Selling stock that has appreciated in value since purchase, in order to realize the profit. The term is often used to explain a downturn in the market following a period of rising prices. 139. Prospectus The issuer must provide according to SEC regulations, the official documents to potential purchasers of a new securities issue. It highlights the much longer registration statement filed with the Commission that gives information on the financial well being of the issuer and the specifics of the issue itself. Potential investors can consult this information before buying. 140. Proxy A ballot by which stockholders can transmit their votes on corporate matters without needing to attend the actual shareholders meeting. A proxy could also state the stockholder's intention to transfer voting rights to someone else. A company's shareholders are commonly asked to vote on such matters as electing a board of directors, approving mergers and acquisitions, and sometimes on proposals that other stockholders have submitted to management. One share generally equals one vote. 141. Primary Distribution The sale of a new issue of securities by a company. Initial public offerings (IPOs) are primary distributions by companies that were not publicly traded prior to the offering. 142. Put Option A contract that gives the holder the right to sell the underlying stock, to the writer of the put, at a specified price (the strike price) within a fixed period of time. 143. Quote: The highest bid to buy and the lowest offer to sell any stock at a given time. 144. Rate of Return In stocks and bonds, the amount of money returned to investors on their investments. Also known as yield. 145. Record Date The date on which you must be registered as a shareholder of a company in order to receive a declared dividend or, among other things,to vote on company affairs. 146. Redemption Price The price at which a bond may be redeemed before maturity, at the option of the issuing company. Redemption value also applies to the price the company must pay to call in certain types of preferred stock. 147. Registered Representative (RR)
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Also known as account executive, customers' broker, or similar title. Describes full-time NYSE member organization sales persons who have met the NYSE's background and industry knowledge requirements. 148. Registrar Usually a trust company or bank charged with the responsibility of keeping a record of the owners of a corporation's securities and preventing the issuance of more than the authorized amount. 149. Retained Earnings: Profits a company keeps for its operations, after paying taxes and dividends. 150. Right to Vote The right of common stockholders to vote on matters of corporate policy at an annual stockholder's meeting. The impact of a stockholder's vote is proportionate to the amount of stock owned. 151. Rights When a company wants to raise more funds by issuing additional securities, it may give its stockholders the opportunity, ahead of others, to buy the new securities in proportion to the number of shares each owns. The piece of paper evidencing this privilege is called a right. Because the additional stock is usually offered to stockholders below the current market price, rights ordinarily have a market value of their own and are actively traded. In most cases they must be exercised within a relatively short period. Failure to exercise or sell rights may result in monetary loss to the holder. 152. S&P 500 A capitalization weighted index of 500 stocks. Standard and Poor's 500 index represents the price trend movements of the major common stock of U.S. public companies. It is used to measure the performance of the entire U.S. domestic stock market. 153. Sarbanes-Oxley Act The Sarbanes-Oxley Act of 2002 addresses a wide range of corporateaccountability issues. Key provisions of the legislation, which apply to both U.S. and foreign private issuers, will: Create a Public Company Accounting Oversight Board to establish auditing standards and regulate accountants who audit public companies; Prohibit auditors from providing non-audit services to audit clients, except with oversight board pre-approval;

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Require CEOs and CFOs to certify their companies annual and quarterly financial reports, subject to civil and criminal penalties; Require CEOs and CFOs to forfeit bonuses, incentive compensation or gains from the sale of company securities during the 12-month period after the initial publication of financial statements that have to be reinstated as a result of misconduct; Demand real-time disclosure, in plain English, of material changes to an issuers financial condition or operations; Require public companies to have an audit committee composed entirely of independent directors; Require public companies to disclose the adoption of, and any changes to, corporate codes of ethics; Prohibit issuers from extending new personal loans to directors and executive officers; Accelerate the reporting of insider transactions to within two business days; Prohibit directors and executive officers from trading company stock during company benefit plan blackout periods; Provide criminal penalties for destroying audit records or falsifying documents; Enhance criminal penalties for violations of antifraud rules, federal securities laws and other white-collar crimes; Protect employees of public companies against retaliation for whistle-blowing; Increase the frequency of SEC reviews of public-company filings to at least once every three years.

154. Secondary Market

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When stocks or bonds are traded or resold, they are said to be sold on a secondary market. The majority of all securities transactions take place on a secondary market. 155. Securities and Exchange Commission (SEC) A watch-dog agency created by the U.S. Congress to monitor the securities industry and enforce punishments of those that violate the industry's regulations. 156. Seller's Option A special transaction that gives the seller the right to deliver the stock or bond at any time within a specified period, ranging from not less than two business days to not more than 60 business days. 157. Shares Outstanding The number of authorized shares in a company that are held by investors, including employees and executives of that company. Unissued shares or treasury shares are not included in this figure. 158. Short Position Stock options, or futures contracts sold short and not covered as of a particular date. On the NYSE, a tabulation is issued once a month listing all issues on the Exchange in which there was a short position of 5,000 or more shares and issues in which the short position had changed by 2,000 or more shares in the preceding month. Short position also means the total amount of stock an individual has sold short and has not covered, as of a particular date. 159. Sinking Fund Money regularly set aside by a company to redeem its bonds, debentures or preferred stock from time to time as specified in the indenture or charter. 160. Slow Market The Market becomes slow or converts temporarily from a Hybrid Market to an Auction Market only mode so as to enable specialists, floor brokers, and customers to interact with Quotes and Orders manually, with the objective of enhancing liquidity and reducing volatility. Certain market conditions temporarily trigger a Slow Market including Gap Quotes, Trading Halts or reaching LRPs. The Slow Market can be traded through. 161. Sole Proprietorship Any business that is owned and operated by a single individual. 162. Speculation The employment of funds by a speculator. Safety of principal is a secondary factor. 163. Spin-Off The separation of a subsidiary or division of a corporation from its parent by issuing shares in a new corporate entity. Shareowners in the parent receive
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shares in the new company in proportion to their original holding and the total value remains approximately the same. 164. Split The division of the outstanding shares of a corporation into either a larger or smaller number of shares, without any immediate impact in individual shareholder equity. For example, a 3-for-1 forward split by a company with 1 million shares outstanding results in 3 million shares outstanding. Each holder of 100 shares before the split would have 300 shares worth less, although the proportionate equity in the company would stay the same. A reverse split would reduce the number of shares outstanding and each share would be worth more. 165. Stock Index A basket of stock used to track the market. Typically, this is used for long-term evaluation. The performance of a group of stocks is averaged, and over time, that average serves as an indicator of the market's general movement. 166. Stock Split When a company increases the number of shares outstanding by splitting existing shares. A 2-for-1 split means every stockholder gets two new shares for each one they own, and a 3-for-2 split means they get three shares for every two they own. The price of an individual share falls, but stockholders do not lose money because they are being given the equivalent number of new shares. In a reverse stock split, a company reduces the number of the shares outstanding by consolidating existing shares. A 1-for-5 reverse split for example, means that for each five shares owned one receives a single new share instead. The price of the new shares is five times higher, but only to reflect the shortened supply. If a company's stock is trading at a very low price, this process makes the company look more attractive to investors 167. Stockholder Record A stockholder whose name is registered on the books of the issuing corporation. 168. Swapping Selling one security and buying a similar one at almost the same time to take a loss, usually for tax purposes. 169. Tick The tick is the direction in which the price of a stock moved on its last sale. An up-tick means the last trade was at a higher price than the one before it and a down-tick means the last sale price was lower than the one before it. A zeroplus tick means the transaction was at the same price as the one before, but still higher than the nearest preceding different price. The tick becomes especially

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important when large market movements trigger the implementation of certain circuit breakers meant to stabilize the market. 170. Ticker A telegraphic system that continuously provides the last sale prices and volume of securities transactions on exchanges. Information is either printed or displayed on a moving tape after each trade. 171. Ticker Symbol A three or four letter abbreviation used to identify a security whether on the floor, a TV screen, or a newspaper page. Ticker symbols are part of the lore of Wall Street. They were originally developed in the 1800s by telegraph operators to save bandwidth. One-letter symbols were therefore assigned to the most active stocks. Railroads were the dominant issues at the time, so they retain a majority of the one-letter designations. Ticker symbols today are assigned on a first-come, first-served basis. Each marketplace -- the NYSE, the American Stock Exchange, and others -- allocates symbols for companies within its purview, working closely to avoid duplication. A symbol used for one company cannot be used for any other, even in a different marketplace. 172. Transfer The legal change in ownership after the sale of a security. This task may involve the physical delivery of a stock certificate or the change of ownership on the books of the corporation by the transfer agent. 173. Transfer Agent A transfer agent keeps a record of the name of each registered shareowner, his/her address, the number of shares owned, and sees that the certificates presented for transfer are properly cancelled and new certificates issued in the name of the new owner. 174. Transparency: Accurate and timely information regarding stock prices and volume. 175. Treasuries: Debt obligations of the U.S. government. Treasuries are among the safest investments, since the full faith and credit of the government secure them. The interest of Treasuries is exempt from state and local taxes but is subject to federal income tax. There are three types of treasuries: Treasury Bills, with maturities of one year or less; Treasury Notes, with maturities ranging from one

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to 10 years; and Treasury Bonds, long-term instruments with maturities of 10 years or more. 176. Treasury Stock Shares, formerly outstanding, that were repurchased by the issuing company. Companies often repurchase stock to benefit existing shareholders. Those who sell receive a premium price from the company for their shares, thus substituting a large capital gain for future dividends. This ploy is used when dividend taxes are higher than capital gains taxes. Remaining investors who keep their shares benefit from a tightened supply, which raises the share price. Companies may later resell treasury stock, or retire it according to a shareholder vote. 177. Trustee A bank designated by the issuer as the custodian of funds and the official representative of the bond holders. 178. Turnover Rate The volume of shares traded in a year as a percentage of total shares listed on an Exchange, outstanding for an individual issue or held in an institutional portfolio. 179. Underlying The security that one has the right to buy or sell according to the terms of an option contract. 180. Voting Right The common stockholders' right to vote their stock in the affairs of a company. Preferred stock usually has the right to vote when preferred dividends are in default for a specified period. The right to vote may be delegated by the stockholder to another person. 181. underwriter for options A person who assumes the obligation to sell (call) or buy (put) the underlying security at an options exercise

182. Yield In stocks and bonds, the amount of money returned to investors on their investments. Also known as Return. For bonds, also see: Current Yield; Yieldto-Maturity; and Yield-to-Call. 183. Yield to Call A yield that would be realized on a callable bond, if the bond was redeemed on the next call date. 184. Yield to Maturity
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A yield calculated on the combination of the annual coupon (interest) payments to maturity, the realized difference between the (discount or premium) acquisition price of the issue and the par value at maturity. For interest bearing issues, the calculation includes the assumption that interest is earned on the interest received is at the same rate as the calculated yield to maturity. 185. Zero-Coupon Bonds Bonds that pay no interest but are priced, at issuance, at a discount from their redemption par value, which usually is $1,000. The longer the term of the issue the greater the discount at issuance. 186. Proxy Statement The SEC requires that shareholders of a company whose securities are registered under Section 12 of the Securities Exchange Act of 1934 receive a proxy statement prior to a shareholder meeting, whether an annual or special meeting. The information contained in the statement must be filed with the SEC before soliciting a shareholder vote on the election of directors and the approval of other corporate action. Solicitations, whether by management or shareholders, must disclose all important facts about the issues on which shareholders are asked to vote. 187. Reverse Stock Splits A reverse stock split reduces the number of shares and increases the share price proportionately. For example, if you own 10,000 shares of a company and it declares a one for ten reverse split, you will own a total of 1,000 shares after the split. A reverse stock split has no affect on the value of what shareholders own. Companies often split their stock when they believe the price of their stock is too low to attract investors to buy their stock. Some reverse stock splits cause small shareholders to be "cashed out" so that they no longer own the companys shares. 188. Short Sales A short sale is generally the sale of a stock you do not own. Investors who sell short believe the price of the stock will fall. If the price drops, you can buy the stock at the lower price and make a profit. If the price of the stock rises and you buy it back later at the higher price, you will incur a loss.

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When you sell short, your brokerage firm loans you the stock. The stock you borrow comes from either the firms own inventory, the margin account of another of the firms clients, or another brokerage firm. 189. Spin-Offs In a "spin-off," a parent company distributes shares of a subsidiary on a pro rata basis to the parent company's shareholders. As a result, the subsidiary becomes a separate company. State law and the rules of the stock exchanges determine whether a company must seek shareholder approval for a spin-off. A subsidiary does not have to register the shares of the spin-off under the Securities Act of 1933 if it meets certain conditions. One of the conditions requires the parent company to provide adequate information about the spin-off to its shareholders and the trading markets. But when registration is required, the subsidiary must file a registration statement with the SEC. 190. Spread The "spread" is the difference between the "bid" price and the "ask" price on over-the-counter market securities. The term "bid" refers to the highest price a market maker will pay at any given time to purchase a specified number of shares of a stock. The term "ask" refers to the lowest price at which a market maker will sell the stock. 191. Stock and Bond Certificates, Old An old stock or bond certificate may still be valuable even if it no longer trades under the name printed on the certificate. The company may have merged with another company or simply changed its name. You can use the resources below to find out if an old stock or bond certificate has value. Even if you learn that a certificate has no value, you may find that the certificate itself has value as a collectable. 192. Stock Splits When a company declares a stock split, the price of the stock will decrease, but the number of shares will increase proportionately. For example, if you own 100 shares of a company that trades at $100 a share and it declares a two for one stock split, you will own a total of 200 shares at $50 a share after the split. A stock split has no effect on the value of what shareholders own. If the
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company pays a dividend, your dividends paid per share will also fall proportionately. 193. Stop Order A stop order is an order to buy or sell a stock once the price of the stock reaches a specified price, known as the stop price. When the specified price is reached, your stop order becomes a market order. Buy Stop Order Investors typically use a stop order when buying stock to limit a loss or protect a profit on short sales. The order is entered at a stop price that is always above the current market price. Sell Stop Order A sell stop order helps investors to avoid further losses or to protect a profit that exists if a stock price continues to drop. A stop order to sell is always placed below the current market price. 194. Bond Swaps A bond swap occurs when an investor sells one bond and uses the proceeds to purchase another bond, often at the same price. Investors engage in bond swaps for a variety of reasons. For example, investors may want to take a tax loss by selling one bond at a loss but then preserve their investment by simultaneously buying a similar bond. At other times, investors swap bonds to obtain a higher yield and return on their bond investments 195. Capital Gains and Losses Investors contact the SEC asking about the tax consequences when they sell securities. In particular, investors want to know whether they will have to pay a capital gains tax or can take a capital loss. The SEC does not regulate this area. The Internal Revenue Service does instead. 196. Treasury Securities Treasury securitiesincluding Treasury bills, notes, and bondsare debt obligations issued by the U.S. Department of the Treasury. Treasury securities are considered one of the safest investments because they are backed by the full faith and credit of the U.S. government. The income from Treasury securities is exempt from state and local taxes, but not from federal taxes.

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197. Zero Coupon Bonds Zero coupon bonds are bonds that do not pay interest during the life of the bonds. Instead, investors buy zero coupon bonds at a deep discount from their face value, which is the amount a bond will be worth when it "matures" or comes due. When a zero coupon bond matures, the investor will receive one lump sum equal to the initial investment plus interest that has accrued. The maturity dates on zero coupon bonds are usually long-termmany dont mature for ten, fifteen, or more years. These long-term maturity dates allow an investor to plan for a long-range goal, such as paying for a childs college education. With the deep discount, an investor can put up a small amount of money that can grow over many years. 198. FORMS 10-Q 10-QSB Quarterly report pursuant to sections 13 or 15(d) Optional form for quarterly and transition reports of small business issuers under section Annual report pursuant Optional form for annual and transition reports of small business issuers Current report filing Annual and transition report of foreign private issuers Annual reports filed by certain Canadian issuers

10-K 10KSB

8-K 20-F

40-F

Forms S-1 & S-3 -

Registration statement for face-amount certificate companies

Forms N1 & N-1A

Registration statement for open-end management investment companies

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Form NCSR -

Certified annual shareholder report of registered management investment companies

199. ANNUAL MEETING meeting of shareholders that the law requires a corporation to hold each year for the election of directors and the transaction of other business 200. SPECIAL MEETING A meeting held for a special and limited purpose; specify A corporate meeting held occasionally in addition to the annual meeting to conduct only business described in a notice to the shareholders 201. STOCKHOLDER: One who owns a share or shares of stock in a company. Also called stockowner 202. STAKEHOLDER : One who has a share or an interest, as in an enterprise. 203. STOCK CERTIFICATE: A certificate establishing ownership of a stated number of shares in a corporation's stock. 204. CLASS DIRECTORS The Directors are appointed with specified tenure in the office. For instance, if three directors are appointed for a period of three years and two more directors appointed for period of two year, each of the group will be classified as two different classes. 205. VOTING SECURITIES (RECORD DATE CAN BE FIXED TO DETERMINE THE ELIGIBLE STOCK HOLDERS) The Board of Directors will fix a record date to list certain securities holders who are eligible to vote in an Annual Meeting or Special meeting. Those securities that are on record date are called voting securities. 206. BENEFICIAL OWNER : A person who enjoys the benefits of ownership even though title is in another name. 207. BYE LAWS OF A COMPANY 1. A law or rule governing the internal affairs of an organization. 2. A secondary law.
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208. INDEPENDENT DIRECTORS A director who does not have any other material pecuniary relationship with the company apart from drawing his remuneration. 209. EXECUTIVE AND NON EXECUTIVE DIRECTORS An Executive Director is a person who is Member of the Board of Directors and also part of the company's management team. He looks after the Management functions apart from being the Member of the Board of Directors. A non Executive Director is a person who is Member of the Board of Directors and is not part of the management team. The purpose of having Non-Executive Directors is to provide unbiased and impartial perspectives on issues brought to the board. He does not hold any Executive positions in the company. 210. EXECUTIVE AND NON EXECUTIVE CHAIRMAN He is one of the BOD The presiding officer of a meeting, committee, or board He could be Executive Chairman or Non Executive Chairman An Executive Chairman is an employee of the Company but not the Non Executive Chairman It is his or her responsibility to determine the final agenda for each meeting and to conduct the Board Meetings and General Meetings The chairman has to be fair to all A good listener and a good communicator Next to Chairman is Co- Chairman and Vice Chairman Co- Chairman or Vice Chairman shares the duties along with the chairman 211. INTERNAL AUDITORS Internal auditor is a person appointed as per statutory requirements and audits the day to day financial and accounting transactions of the Company. 212. DIRECTOR NOMINEE He is a person whose name is proposed for the directorship of the company and his chances of becoming director depend upon the election in the meeting
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He is not a director and only a proposed candidate for future Directorship in the company. 213. NOMINEE DIRECTOR A nominee director is a person appointed by the financial institution or banks or such other government bodies to protect in their interest. Such person would be employee of those organizations. 214. WHO IS A PROXY A person authorized to act for another; an agent or substitute. The authority to act for another. The written authorization to act in place of another. 215. GENERAL COUNSEL A lawyer at the head of a legal department (as of a corporation or government agency) 216. COMMITTEES A group of people officially delegated to perform a function, such as investigating, considering, reporting, or acting on a matter. 217. NON MANAGEMENT DIRECTORS Non executive directors 218. LISTING STANDARDS The norms specified the concerned stock exchange to get a company listed. 219. INDEPENDENT PUBLIC ACCOUNTANTS The independent public accountants are the external auditors to the company who shall report to the shareholders of the Company 220. ANNUAL FINANCIAL STATEMENTS Balance sheet, Profit and loss account, cash flow statement are the annual financial statements. They are prepared to once in a year to find out the net profit and to list out the assets and the liabilities of a company. 221. CASH FLOW STATEMENT One of the quarterly financial reports any publicly traded company is required to disclose to the SEC and the public. The document provides aggregate data regarding all cash inflows a company receives from both its ongoing operations and external investment sources, as well as all cash outflows that pay for business activities and investments during a given quarter. 222. QUARTERLY REPORT
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A quarterly report is a document required by all public companies, reporting the results for the quarter 223. EMPLOYMENT AGREEMENT OF A DIRECTOR An employment contract is an agreement entered into between an employer and an employee at the commencement of the period of employment and stating the exact nature of their business relationship, specifically what compensation the employee will receive in exchange for specific work performed. 224. EXCERCISABLE OPTIONS: Options matured and yet to be converted in stock. 225. STOCK PRICE PERFORMANCE Performance of a stock in a stock exchange in a considerable time. The high and low price quotation of that is compared to study the movement of the stock of a company. 226. ELECTION AND RE ELECTION OF A DIRECTOR The shareholders once a year in Annual Meeting shall elect the Directors of the Company for a certain period of time at the end of which they have to retire. The Directors who retire are eligible to be reappointed as directors and their proposal is put to vote for reelection. 227. ALTERNATE DIRECTOR A person is appointed in the place of a Director who stays away from the place where Board Meetings are usually held. 228. ADDITIONAL DIRECTOR A person appointed by the Board of Directors. 229. SECRETARY AND LEGAL COUNSEL An officer of a business concern who may keep records of directors' and stockholders' meetings and of stock ownership and transfer and help supervise the company's interests. He acts as a liaison officer between the Board of Directors and the share holders. Looks after as the meetings of the Board of Directors and committeesAn attorney. 230. MANAGEMENT BOARD The management board is in charge of the management of the company according to its own business judgment and represents the company in its business dealings and in litigation. 231. SUPERVISORY BOARD

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Supervisory Board functions like that of Board of Directors. In the Dual Board system that exist in Germany, France and other European countries, these Boards assume the supreme position of the management of the Company. 232. BOARD OF STATUTORY AUDITORS There Boards are common in Japan and Italy. These are the auditors elected by the members of the Company in Annual Meeting to oversee the audit aspects, supervision of decisions of the Company and assist in appointment of the Independent Auditors. 233. CHAIRMAN EMIRETUS Emeritus is an honorific title given to a retired Chairman or other professional The term is used when persons of importance in a given profession retires. 234. LEAD DIRECTOR When in a company, same person holds both Chairmanship of the Board and Chief Executive officer Position, in order to monitor the acts of such person one of the board members will be appointed as Lead Director. In order to be appointed as Lead Director, the person should be an Independent Director. 235. PRESIDENT AND CHAIRMAN The chief officer of an organization (as a corporation or institution) usually entrusted with the direction and administration of its policies and Decision making and he is called as president However in countries like Germany a President is like a chairman of Board of Directors He is one of the BOD The presiding officer of a meeting, committee, or board He could be Executive Chairman or Non Executive Chairman An Executive Chairman is an employee of the Company but not the Non Executive Chairman 236. PROXY CARD Proxy card is a form (card) to appoint a proxy on behalf of a stock holder to attend a annual or special meeting. 237. SUBSIDIARY AND WHOLLY OWNED SUBSIDIARY A company whose voting stock is more than 50% controlled by another company, usually referred to as the parent company. A subsidiary whose parent company owns 100% of its common stock. 238. AFFILIATES
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A corporation may be referred to as an affiliate of another when it is related to it but not strictly controlled by it, as with a subsidiary relationship, or when it is desired to avoid the appearance of control. This is sometimes seen with multinational companies that need to avoid restrictive laws (or negative public opinion) on foreign ownership. 239. TREASURER Many organizations, particularly not-for-profit organizations such as charities unions and churches, appoint treasurers, are responsible for generating income for the group, whether this be through pricing of a product, organizing sponsorship, or arranging fundraising events. The treasurer would also be part of the group which would oversee how the money is spent, either directly dictating expenditure or authorizing it as required. 240. CERTIFICATE OF INCORPORATION AND CERTIFICATE OF MERGER

A certificate issued by a state's secretary of state that shows acceptance of a corporation's articles of incorporation. Certificate confirming the merger of two entities by the concerned regulating authority. 241. PRINCIPAL EXECUTIVE OFFICER AND CHIEF EXECUTIVE OFFICER

The highest-ranking executive in an organization. Employed by and accountable to its board of directors. He has the ultimate executive responsibility or authority within an organization responsible for carrying out the policies of the board of directors on a day-to-day basis Although it is possible to have more than one CEO in a company, generally the job is not shared. All other management other than BOD reports to the CEO. 242. CHIEF FIANANCIAL OFFICER AND CHIEF OPERATING ACCOUNTING OFFICER This is the senior manager who is responsible for overseeing the financial activities of an entire company. This includes signing checks, monitoring cash flow, and financial planning. By comparison of CEO with CFO as strategic business partner and statutory duties under SEC and Sarbanes-Oxley Act, both are equal ranking top executive and separate posts.
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Chief operating officer (or COO) is a corporate officer responsible for management of day-to-day activities of the corporation. The COO is one of the highest ranking members of an organization, monitoring the daily operations of the company and reporting to the chief executive officer directly. The COO in some companies is also the president, but they are usually an executive or senior vice president 243. ATTORNEY-IN-FACT attorneys-in-fact An attorney who may or may not be a lawyer who is given written authority to act on another's behalf esp. by a power of attorney compare 244. POWER OF ATTORNEY A legal instrument authorizing one to act as another's attorney or agent. 245. RELATED PARTY TRANSACTIONS A business deal or arrangement between two parties who are joined by a special relationship prior to the deal. For example, a business transaction between a major shareholder and the corporation, such as a contract for the shareholder's company to perform renovations to the corporation's offices, would be deemed a related-party transaction. 246. VENTURE CAPITAL Money made available for investment in innovative enterprises or research, especially in high technology, in which both the risk of loss and the potential for profit may be considerable. Also called risk capital. 247. PORTFOLIO MANAGEMENT The art and science of making decisions about investment mix and policy, matching investments to objectives, asset allocation for individuals and institutions, and balancing risk vs. performance. thereby increasing the interconnectedness of different markets

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MEMORABLE MOMENT

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I had memorable movement at the age of 13 years when I was in 8 th standard. I bagged first in Cartoon TV Drawing Competition. This has unearned my hidden talent, I am good in Drawing pictures and figures and paintings also. On behalf of Sindu Public School which is my school. I participated in the Drawing Competition. I had Lot of confidence that I shall reach the finals. I did it finally. I got appreciation from my school Principal & Teachers and family members. My friends too appreciated my talent. With the same Inspiration now I am drawing figures and pictures in all competitions during my college days also. MY FAVORITE HOLIDAY SPOT My favorite Holiday spot is my native village. i.e., Ampalam located 30Km away from Srikakulam District. During my School days I used to go to my native village alone with my friends for enjoying holidays. In Village we used to go to PrasannaSeethaRamaSwamyTemple which is in the outskirts of my village. Beside temple there is a Lake which is very big in size. I used to swim in the Lake along with my friends. I used to enjoy the green paddy fields. Which comes on the way to the temple. There are small streams along the side of a paddy fields and fresh water flouring in the streams. There is a mango groove near the Village. I along with my friends used to have vana bhojanam under the shade of the mango groove. There is a swing on the tree branches we all used to take a nap under the shade of the tree. The VamsadaraRiver flowing near in my Village. This River meets in Bay of BengalSea. This is located two kilometer at my village. The light house established near by sea. It is the signal of way to the ships. BEST FRIEND
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Friend is the dearest one in the world. With whom we can express & exchange views, feelings and ideas. A best friend always comes for our rescue in bad days. Friend is the person who understands our feelings. In the crisis period a friend gives morale support and makes us feel at home. A best friend always gives the worthiness which touches our heart. A friend is so lovable because he is so special to us. A friend gives hope he is honest. He is a place when there is no where to go. He is precious & sincere & true. The best friendship is causes more important than relationship. The best friend helps for of all good wishes. Happiness comes only when we meet a best friend, a best friend is a corner stone of our success in our life.

1) 2) 3) 4)

Dream Job
What was the most difficult time in your life? How did you overcome these difficulties? If you could make one scientific discovery in your lifetime, what would it be? Explain why you would or would not recommend a movie you saw recently.

Is giving the Right to Vote to an eighteen year old a mistake? Discuss. India is a biggest democratic country in the world. In a democratic country the peoples representatives are elected through elections to parliament and assembly. The above two elections will be held once in five years. In Indian democracies voting right of a citizen starts at the age of 18 years. He or She should enroll their names in the voters list. Giving right to vote to an eighteen year old is not a mistake because youth is considered as strength of India. Young generation people are considered to have age between 18-40 years. The franchise of exercising the vote has become right of every citizen. An eighteen year old citizen is considered to be matured as he completes his college education. An 18-year old citizen has new and innovative
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thoughts and ideas. He/She will be in a position to decide what is right and what is wrong. Todays youth is considered as tomorrow is matured citizens. Generally youth has young blood and they lack maturity in thinking. But youth are considered to be vote bank to many prospective leaders. Youth leaders emerges as victors and they can become future trend setters. Hence an 18 year old voters play pivotal role in the elections. Advertising: Information or manipulation? An Advertising plays major role in reaching the hearts and minds of people. An advertising is defined as providing product information to the customer or user. Information about the product is provided to a customer in a brief manner though advertisement. Information is reached to a common man very easily

through advertisement . advertisement is a publicity medium through which price , product features, benefits of the product are explained to a common man. Advertisement can be made through various media viz.., 1) Television, Radio, Cinemas & Movies (electronic media) 2) Hoardings, Cutouts , sign boards (Print Media)and finally through newspapers, magazines, journals etc (Print Media) Advertisement is not a manipulation thing. Customers will not accept if a company manipulates the things. The company will sink if it manipulates through advertisement. Consumer awareness is a strong aspect in todays world. A customer is satisfied only if any company gives correct information. With the recent advertisements in websites through internet. People are in a position to compare every thing. Hence advertisement is information to customers in brief manner. Effectiveness of financial reforms and globalization

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The financial reforms have conceptlised during the able leader ship of Sri P.V.Narashimha Rao Prime Minister of India during the year 1991. New industry policy, New economic policy, globalization, privatization has made India to progress towards success. The foreign investors have com forward to setup business units in India. The Indian economy started improving from 1991 on wards. Most of the projects were thrown open to the private players. The technological revolution has made India progress towards successes. Privatization was down in many government corporations and public sectors under taken. Dr. Manmohan sing the then finance minister has given more packages to the foreign companys to excrage foreign investors. There was a revolution in the auto mobile sector like Maruthi-Suzike, Hero-Honda, Kawaski-Bajaj,TVSSuzuki, Escorts-Yamaha. The per capita incomes of Indian people have improved due to the above police. RECENT MOVIE (Nuvvastanante ne vaddantana) Nuvvustanante ne vaddantana is a heart touching movie for every body, directed by prabudeva. The movie is simple straight and regarding true love. The story revolves around a boy and girl who have lived in the role. The story starts when the hero comes for a marriage to India from England. He likes the simplicity of the girl. For the sake of his home he stays back is India and goes to the girls place and request girls brother to agree for marriage. Girls brother puts condition to do agriculture and produce durable the actual yield. During the course of time he faces lot of problems and finally achieves the success for the true love. The story moves around both sentiment comedy and family drama. There is no violence in the movie. The Picturisation is done in the rural India village with excellent scenic beauty. The story shows the determinant and hard work for achieving love. VISION 2020 Vision 2020 is a concept of government of AP formulated by the then CM of AP Sri.N.Chandra Babu Naidu. Vision 2020 encrages growth in percapita income
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of an individual. Employment Opportunities to the unemployed youth. Better economic condition to the common man. Providing food shelters & cloth to Below Poverty line (BPL) families providing healthy living conditions to the poor. The concept highlights in providing health & medical facilities to the rural people. Propagating education to rural poor and making India literate country. Encouraging rural people for thrift groups. Banking sector provides loans to the educated unemployed youth. To improve communication facilities in rural areas. Providing good roads by connecting all villages to towns taking IT to revolution in the rural arias women empowerment plays a major role in vision 2020. Women development and child welfare comes in the above concepts. India has a vision of becoming number one in agriculture as 70% of Indian population lives in rural areas and thus depends on agricultures usage of modern equipment & machinery in agriculture power way for rapid development. Batter civic activities and good health is the criteria in the urban areas. Vision 2020 helps India to become worlds top economy as India has abundant natural resources and geographical conditions. Let us all give helping hand in making India No.1 through the concept of vision 2020. IMPACT OF MEDIA ON NEW GENERATION Media is the most powerful source in the success of the new generation. Electronic media has brought revolution in the recent past. Todays generation due to globalization are moving towards new culture. As India is the second biggest country in population in the world. Media plays biggest role especially news papers radio and television globalization ha made drastic downfall of TV sets an average Indian family can afford to buy a T.V Communication has created revolution in the new generation. Cell phones and other telephones has lot of impact on the youth. Fashion and style due to western countries culture has attracted todays youth. Newspapers are making maximum coverage in the rural areas. Youth are able to get all information through news papers. Rapid political changes and development has made new generation to change their life styles. Television has become a part of life in the rural areas also. Rural youth too are changing their attitude. As 70% of Indias population is in rural areas and due to the penetration of media in to the lives of rural population, there is an impact of media on new generation.
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Todays youth are tomorrows intellectuals and this is possible only through good aspects taken from the media like television. In the television various channels are broad casting programmes like movies, fashion show, crime relate programmes, entertainment programmes. The youth should take good aspects and not violence culture. The government should ban obscene and violence programmes. Censorship should be more strict internet in creating sensation youth are attracted towards internet chatting, surfing and browsing. Obscene web sites are attracting youth. Especially pornographic sites are making youth to get diverted. Indian government should make arrangements to stop pomographic sites and obscenity so that youth can browse only good & healthy web sites. This helps new generation to become helpful and play a major part in building Indian economy and taking India to become a giant in the world. TERRORISM Terrorism is a global problem. All countries in the world are taking special measures to combat terrorism. Terrorism has spread all over the world and is a threat to the global peace. Terrorism is a major obstacle in the development of a country. Terrorism is defined as brutal massacre in the society. The target of terrorists may be militaries, one particular community etc, In India terrorism is a major problem in areas. Like Jammu & Kashmir, Punjab, Gujarat, Andhra Pradesh, Uttar Pradesh, Arunachal Pradesh, Maharashtra etc.., In the recent past terrorism is seen across the Border States. Amarnath Piligrims were attacked by the terrorists to create panic. In Mumbai during the year 1991 terrorists planted RDX Bombs in 6 to 7 places and created havoc. Government of India has created a separate TADA Court TADA is a terrorism control authority. In Hyderabad during August 2007 the terrorists planted bombs in two places. Nearly 46 people died. The terrorists have used RDX bombs.
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Government of India has allocated special budget to combat terrorism. Special Forces have been deployed to counter terrorism. The September 2001 attack on cyber towers of New York in USA by the terrorists. In England recently there were terrorists attacks. In New Delhi terrorists have attacked Parliament Bhavan by a suicide bomb team. All the countries are taking all measures to combat terrorism. People were informed through electronic media print media to be cautions of any suspecting material like bombs, Tiffin box bombs etc.., No country will develop with the terrorism problem. People should be educated by anti-terrorism measures for the development of mankind and global peace. IMPACT OF MOBILE PHONE ON YOUR LIFE (MOBILE REVELATION) Mobile phones have created revolution in todays world. Mobile technology has bridged the gap between people. World has become global village through communication. Communication is a powerful medium. With the advent of mobile phone technology through wireless technology the world has become a very small place. Mobile has two technologies GSM and CDMA. Many MNC companies like NOKIA, SONY ERRICSON, LG, MOTOROLA, SAMSUNG etc.., have invented many models. The mobile phone service providers like AIRTEL, HUTCH, IDEA, RELIANCE, TATA, BSNL, VODAPHONE etc.., have nearly created revolution. Mobile phone hand set Manufactures are offering in-built cameras FMs, MP3 Options for people. Latest technology like Bluetooth is introduced compact and slim handsets have been manufactured. Mobile phone service providers are providing CUG (Close Used Group) services, life time incoming facilities; they are also introducing call casts at very low prices. STD and ISD calls at lower prices. A total mobile phone technology is based on digital technology. World has become digital help lines are created, call free numbers are provided. Fixed land lines are slowly reduced by the service provided. After globalization i.e., in the year 1991, India
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has become number one country in the world to have largest mobile phone connections in the recent past. SMS facilities, MMS facilities, E-Mail Facilities were provided by the service providers. GPRS (Global Position Research System) services are provided by the service providers.

FAMOUS PERSONALITY
(Roll Model)

One Cricketer who is a versatile cricket Player in the world. He is an all rounder and little genius. He started his career at the age of 16 years. Still going strong by creating records. He is none other then little master sachin Ramesh Tendulkar. The first batsman to score 10,000 runs in one-day cricket. The name itself strikes terror in the hearts of bowlers all around the world. In batting, he has reached a stage that others can only dream of. He has destroyed practically every bowling attack is the world. He has tremendous power in his fore arms and can hit the ball out of almost every ground in the world. He plays each of his shots amargingly. Highest centuries are in his credit. Sachin is compared with Sir. Don Broder who is a legend of world cricket. TRAFFIC PROBLEMS India is the second biggest country in the world in population. 70% of India population stays in rural areas. Most of the rural populations are moving to cities for employment. Due to migration the cities are becoming over populated causing traffic jams and other traffic related problems. Traffic problems are caused due to following problems: 1) Un planned Roads (narrow Roads) 2) Construction of worshiping places on the middle of the roads 3) Usage of two wheelers, four wheelers
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Non-working of traffic signals In sufficient traffic police force Non availability of road dividers People not following the traffic rules People not using the zebra crossing Due to the above problems people are facing traffic problems leading to traffic jams. Local government should take measures to control the traffic problems. Like 1) 2) 3) 4) 5) Planning for one way traffic Construction of road dividers Providing Zebra Crossing Recruiting more traffic police in the citys Introducing separate tracks for four wheelers and three wheelers and two wheelers 6) Construction of foot over bridge of for the pedestrians 7) Providing more signals in the junctions 8) Introducing awareness programs to the people by way of advertisements in TV & FM Radios, News Papers. Q) Write an email to your project manager for the extension of project period? Dear Sir, This has reference to our project work. As you are aware we are closing the project & the time period of the project is 2 months. Presently the project is in the midway. I am to inform you that, I need fifteen days leave as I got urgent personal work at my native place which is unavoidable. My presence is needed there. May I request you to kindly consider extending the project period for fifteen more days. With best regards Siva Rama Krishna.N

4) 5) 6) 7) 8)

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Q) You have been invited to attend a meeting which requires your conformed participation you are unable to attend it. Write a formal E-mail to your manager explaining region for your absence? Dear Sir, This has reference to the meeting for which I was invited to attend and I was conformed participant. I started for the meeting in the morning and on the way office. I met with an accident. An auto has hit my bike form back side has I was taking U-Turn. I fell down from the bike and had fracture in my left leg. There was a swelling in the ankle region with a fracture in the ankle bone. I was rushed to the hospital for the treatment. The Doctor was advised to me to take rest for one month has I could not able to walk properly. I regret for the absence for the meeting. Which might have caused inconvience. With Regards. XXXXXXXXX Q) What According to you was the most significant event that occurred in India and why was it significant? We sure to support your position which specific point and examples you may use example from your reading, observation or knowledge of subject as history literature science? Terrorism Attacks: Indian sub content is facing the problem of terrorist attacks by killing innocent people. The recent bomb blast in three places of Hyderabad city. Has made people to worry about there existence and peaceful life. The unknown terrorist have planted RDX Bombs in three different places namely LumbiniPark, Gokul Chat and Makka Masjid innocent people died in the attacks. The terrorist have planted bombs in public places to disturb the normal life. People from all walks of life, all religion have condemned the attack. The government should take all measure to control the terrorist activities in the country. The government should provide security measures to people in temples, mosques and churchs by deploying police forces. Government should make wide publicity in electronic media and print media for awareness of minimum security measures.

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Example:TTD (Tirumala Tirupathi Devastanams) has introduced metal detectors and finger print devices to keep track of People. Worshiping god. Anti bomb squads should be deployed during festivals calibrations for the VVIP visits. CC cameras should be installed in all public places like cinema thereaters, business establishments etc, Government should impart training of bomb detections. To the civilians and other government employers for precautionary measure. Every citizen should be aware of not giving hours on rent to the unknown people and do not entertain the strangers.

Common topics: Happiest movement in your life Habit that ruin health Moral values in the competition world

Corporate Finance
Arguably, the role of a corporation's management is to increase the value of the firm to its shareholders while observing applicable laws and responsibilities. Corporate finance deals with the strategic financial issues associated with achieving this goal, such as how the corporation should raise and manage its capital, what investments the firm should make, what portion of profits should be returned to shareholders in the form of dividends, and whether it makes sense to merge with or acquire another firm. Balance Sheet Approach to Valuation If the role of management is to increase the shareholder value, then managers can make better decisions if they can predict the impact of those decisions on the firm's value. By observing the difference in the firm's equity value at different points in time, one can better evaluate the effectiveness of financial decisions. A rudimentary way of 190

Finance Material valuing the equity of a company is simply to take its balance sheet and subtract liabilities from assets to arrive at the equity value. However, this book value has little resemblance to the real value of the company. First, the assets are recorded at historical costs, which may be much greater than or much less their present market values. Second, assets such as patents, trademarks, loyal customers, and talented managers do not appear on the balance sheet but may have a significant impact on the firm's ability to generate future profits. So while the balance sheet method is simple, it is not accurate; there are better ways of accomplishing the task of valuation. Cash vs. Profits Another way to value the firm is to consider the future flow of cash. Since cash today is worth more than the same amount of cash tomorrow, a valuation model based on cash flow can discount the value of cash received in future years, thus providing a more accurate picture of the true impact of financial decisions. Decisions about finances affect operations and vice versa; a company's finances and operations are interrelated. The firm's working capital flows in a cycle, beginning with cash that may be converted into equipment and raw materials. Additional cash is used to convert the raw materials into inventory, which then is converted into accounts receivable and eventually back to cash, completing the cycle. The goal is to have more cash at the end of the cycle than at the beginning. The change in cash is different from accounting profits. A company can report consistent profits but still become insolvent. For example, if the firm extends customers increasingly longer periods of time to settle their accounts, even though the reported earnings do not change, the cash flow will decrease. As another example, take the case of a firm that produces more product than it sells, a situation that results in the accumulation of inventory. In such a situation, the inventory will appear as an asset on the balance sheet, but does not result in profit or loss. Even though the inventory was not sold, cash nonetheless was consumed in producing it. Note also the distinction between cash and equity. Shareholders' equity is the sum of common stock at par value, additional paid-in capital, and retained earnings. Some people have been known to picture retained earnings as money sitting in a shoe box or bank account. But shareholders' equity is on the opposite side of the balance sheet from cash. In fact, retained earnings represent shareholders' claims on the assets of the firm, and do not represent cash that can be used if the cash balance gets too low. In this regard, one can say that retained earnings represent cash that already has been spent. Shareholder equity changes due to three things:

net income or losses payment of dividends share issuance or repurchase.

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Finance Material Changes in cash are reported by the cash flow statement, which organizes the sources and uses of cash into three categories: operating activities, investing activities, and financing activities. Cash Cycle The duration of the cash cycle is the time between the date the inventory (or raw materials) is paid for and the date the cash is collected from the sale of the inventory. A company's cash cycle is important because it affects the need for financing. The cash cycle is calculated as: days in inventory + days in receivables - days in payables Financing requirements will increase if either of the following occurs:

Sales increase while the cash cycle remains fixed in duration. Increased sales increase the value of assets in the cycle. Sales remain flat but the cash cycle increases in duration.

While financially it makes sense to reduce the length of the cash cycle, such a reduction should not be done without considering the impact on operations. For example, one must consider the impact on customer and supplier relations as well as the impact on order fill rates. Revenue, Expenses, and Inventory A firm's income is calculated by subtracting its expenses from its revenue. However, not all costs are considered expenses; accounting standards and tax laws prohibit the expensing of costs incurred in the production of inventory. Rather, these costs must be allocated to inventory accounts and appear as assets on the balance sheet. Once the finished goods are drawn from inventory and sold, these costs are reported on the income statement as the cost of goods sold (COGS). If one wishes to know how much product the firm actually produced, the cost of goods produced in an accounting period is determined by adding the change in inventory to the COGS. Assets Assets can be classified as current assets and long-term assets. It is useful to know the number of days of certain assets and liabilities that a firm has on hand. These numbers are easily calculated from the financial statements as follows: Accounts Receivable (A/R) Number of days of A/R = ( accounts receivable / annual credit sales ) ( 365 ). This also is known as the collection period.

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Finance Material Inventory Number of days of inventory = ( inventory / annual COGS ) ( 365 ). This also is known as the inventory period. On the liabilities side: Payables Number of days of accounts payable = ( accounts payable / COGS ) ( 365 ), assuming that all accounts payable are for the production of goods. This also is known as the payables period.

Financial Ratios A firm's performance can be evaluated using various financial ratios. Ratios are used to measure leverage, margins, turnover rates, return on assets, return on equity, and liquidity. Additional insight can be gained by comparing ratios among firms in the industry.

Bank Loans Bank loans can be classified according to their durations. There are short-term loans (one year or less), long-term loans (also known as term loans), and revolving loans that allow one to borrow up to a specified credit level at any time over the duration of the loan. Some revolving loans automatically renew at maturity; these loans are said to be "evergreen."

Sources and Uses of Cash It can be worthwhile to know where a firm's cash is originating and how it is being used. There are two sources of cash: reducing assets or increasing liabilities or equity. Similarly, a company uses cash either by increasing assets or decreasing liabilities or equity.

Sustainable Growth A company's sustainable growth rate is calculated by multiplying the ROE by the earnings retention rate.

Firm Value, Equity Value, and Debt Value 193

Finance Material The value of the firm is the value of its assets, or rather, the present value of the unlevered free cash flow resulting from the use of those assets. In the case of an allequity financed firm, the equity value is equal to the firm value. When the firm has issued debt, the debt holders have a priority claim on their interest and principal, and the equity holders have a residual claim on what remains after the debt obligations are met. The sum of the value of the debt and the value of the equity then is equal to the value of the firm, ignoring the tax benefits from the interest paid on the debt. Considering taxes, the effective value of the firm will be higher since a levered firm has a tax benefit from the interest paid on the debt. If there is outstanding preferred stock, the firm value is the sum of the equity value, debt value, and preferred stock value, plus the value of the interest tax shield. The debt holders and stock holders each have a claim on the cash flows of the firm. In a given time period, the debt holders have a claim equal to the interest payments during that period plus any principal payments that are due. The stock holders then have a claim equal to the unlevered free cash flow in that period plus the cash generated by the interest tax shield, minus the claims of the debt holders.

Capital Structure The proportion of a firm's capital structure supplied by debt and by equity is reported as either the debt to equity ratio (D/E) or as the debt to value ratio (D/V), the latter of which is equal to the debt divided by the sum of the debt and the equity. One can quickly convert between the D/E ratio and the D/V ratio by using the following relationships: D/V=(D/E)/(1+D/E) D/E=(D/V)/(1-D/V)

Risk Premiums

Business risk is the risk associated with a firm's operations. It is the undiversifiable volatility in the operating earnings (EBIT). Business risk is affected by the firm's investment decisions. A measure for the business risk is the asset beta, also known the unlevered beta. In terms of the discount rate, the return on assets of a firm can be expressed as a function of the risk-free rate and the business risk premium (BRP): rA = rF + BRP

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Finance Material

Financial risk is associated with the firm's capital structure. Financial risk magnifies the business risk of a firm. Financial risk is affected by the firm's financing decision.

Total corporate risk is the sum of the business and financial risks and is measured by the equity beta, also known as the levered beta. The business risk premium (BRP) and financial risk premium (FRP) are reflected in the levered (equity) beta, and the return on levered equity can be written as: rE = rF + BRP + FRP

Debt beta is a measure of the risk of a firm's defaulting on its debt. The return on debt can be written as: rD = rF + default risk premium

Cost of Capital The cost of capital is the rate of return that must be realized in order to satisfy investors. The cost of debt capital is the return demanded by investors in the firm's debt; this return largely is related to the interest the firm pays on its debt. In the past some managers believed that equity capital had no cost if no dividends were paid; however, equity investors incur an opportunity cost in owning the equity of the firm and they therefore demand a rate of return comparable to what they could earn by investing in securities of comparable risk. The return required by debt holders is found by applying the CAPM:

rD = rF + betadebt ( rM - rF )

The required rate of return on assets (that is, on unlevered equity) can be found using the CAPM:

rA = rF + betaunlevered ( rM - rF )

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Finance Material

Using the CAPM, a firm's required return on equity is calculated as:

rE = rF + betalevered ( rM - rF )

Under the Modigliani-Miller assumptions of constant cash flows and constant debt level, the required return on equity is:

rE = rA + (1-)(rA - rD)(D / E)

where is the corporate tax rate.

The overall cost of capital is a weighted-average of the cost of its equity capital and the after-tax cost of its debt capital. The weighted average cost of capital (WACC) then is given by:

WACC = rE (E / VL) + rD (1-)(D / VL)

Assuming perpetuities for the cash flows, the weighted average cost of capital can be calculated as: WACC = rA [ 1 - (D / VL)]

Neglecting taxes, the WACC would be equal to the expected return on assets because the WACC is the return on a portfolio of all the firm's equity and all of its debt, and such a portfolio essentially has claim to all of the firm's assets.

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Finance Material For arbitrary cash flows, and under the assumption that the debt to value ratio is held constant, the following relationship derived by James A. Miles and John R. Ezzell is applicable:

WACC = rA - rD (D / VL)(1+rA) / (1+rD)

Under the same assumptions, the cost of equity capital can be calculated from r A and rD using the following relationship from Miles and Ezzell:

rE = rA + [ 1 - rD / (1+rD)] [ rA - rD ] D/E

For low values of rD, [ 1 - rD / (1+rD)] is approximately equal to one, and the expression can be simplified if high precision is not required. If one cannot assume a constant debt to value ratio, then the APV method should be used.

Estimating Beta In order to use the CAPM to calculate the return on assets or the return on equity, one needs to estimate the asset (unlevered) beta or the equity (levered) beta of the firm. The beta that often is reported for a stock is the levered beta for the firm. When estimating a beta for a particular line of business, it is better to use the beta of an existing firm in that exact line of business (a pure play) rather than an average beta of several firms in similar lines of business that are not exactly the same. Expressing the levered beta, unlevered beta, and debt beta in terms of the covariance of their corresponding returns with that of the market, one can derive an expression relating the three betas. This relationship between the betas is:

betalevered = betaunlevered [ 1 + (1 - ) D/E ] - betadebt(1- ) D/E betaunlevered = [ betalevered + betadebt(1- ) D/E ] / [ 1 + (1 - ) D/E ]

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The debt beta can be estimated using CAPM given the risk-free rate, bond yield, and market risk premium.

Unlevered Free Cash Flows To value the operations of the firm using a discounted cash flow model, the unlevered free cash flow is used. The unlevered free cash flow represents the cash generated by the firm's operations and is the cash that is free to be paid to stock and bond holders after all other operating cash outlays have been performed.

Terminal Value The value of the firm at the end of the last year for which unique cash flows are projected is known as the terminal value. The terminal value is important because it can represent 50% or more of the total value of the firm.

Three Discounted Cash Flow Methods for Valuing Levered Assets APV (Adjusted Present Value) Method The APV approach first performs the valuation under an unlevered all-equity assumption, then adjusts this value for the effect of the interest tax shield. Using this approach, VL = VU + PVITS where VL = value if levered VU = value if financed 100% with equity PVITS = present value of interest tax shield The unlevered value is found by discounting the unlevered free cash flow at the required return on assets. The present value of the interest tax shield is found by discounting the interest tax shield savings at the required return on debt, rD. The APV method is useful for valuing firms with a changing capital structure since the return on assets is independent of capital structure. For example, in a leveraged buyout, the debt to equity ratio gradually declines, so the required return on equity and the weighted average cost of capital change as the lenders are repaid. However, when calculating the terminal value it may be appropriate to assume a stable capital structure, so in calculating the terminal value in a leveraged buyout situation the WACC method may be a better approach.

Flows to Equity Method 198

Finance Material The flows to equity method sums the NPV of the cash flows to equity and to debt. Then, VL = E + D WACC Method The WACC method discounts the unlevered free cash flow at the weighted average cost of capital to arrive at the levered value of the firm.

Cash Flows to Debt and Equity When calculating the amount of cash flowing to debt and equity holders, it is not appropriate to use the unlevered free cash flows because these cash flows do not reflect the tax savings from the interest paid. Starting with the UFCF, add back the taxes saved to obtain the total amount of cash available to suppliers of capital.

Hurdle Price At times a firm may wish to know at what price it would have to sell its product for a particular investment to have a positive net present value. A procedure for determining this price is as follows:

Express the operating cash flow in terms of price. There may be multiple phases such as a short start-up period, a long operating period, and a final year in which the terminal value is calculated.

Write out the expression for the NPV using the appropriate discount rate. For the longer operating period, one can calculate an annuity factor to multiply by the operating cash flow expression. Solve the expression for the cash flow that would result in an NPV of zero.

Since the operating cash flow was written in terms of price, the price now can be found.

Debt Valuation While debt may be issued at a particular face value and coupon rate, the debt value changes as market interest rates change. The debt can be valued by determining the 199

Finance Material present value of the cash flows, discounting the coupon payments at the market rate of interest for debt of the same duration and rating. The final period's cash flow will include the final coupon payment and the face value of the bond.

Investment Decision If the unlevered NPV of a project is negative, aside from potential strategic benefits, the project is destroying value, even if the levered NPV is positive. The firm always could benefit from the tax shield of debt by borrowing money and putting it to other uses such as stock buybacks.

Optimal Capital Structure The total value of a firm is the sum of the value of its equity and the value of its debt. The optimal capital structure is the amount of debt and equity that maximizes the value of the firm.

Share Buyback If a firm has extra cash on hand it may choose to buy back some of its outstanding shares. One interesting aspect of such transactions is that they can be based on information that the firm has that the market does not have. Therefore, a share buyback could serve as a signal that the share price has potential to rise at above average rates.

Mergers and Acquisitions Companies may combine for direct financial reasons or for non-financial ones such as expanding a product line. The target firm usually is acquired at a premium to its market value, with the hope that synergies from the merger will exceed the price premium. Mergers and acquisitions do not always achieve their goals, as promised syngeries may fail to materialize.

Appendix
Compounding and Discounting Compound annual growth rate (CAGR): ( FV/C )1/T - 1 Continuous compounding: FVt = C er t

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Finance Material Perpetuity: PV = C / r Growing perpetuity: PV = C / ( r - g ) T-year annuity (T equally spaced payments): PV = ( C / r ) [ 1 - 1/(1+r)T ] T-year growing annuity: PV = [C / (r - g)] { 1 - [(1+g) / (1+r)]T }

HP 19BII Calculator Tip IRR Calculation:

Press the yellow button then "EXIT" to reset the calculator. Press button under "FIN" Pess button under "CFLO" Press yellow button then INPUT to clear list Press button under "YES" Enter the initial cash inflow (negative number for outflow). Press "INPUT". For "FLOW(1)", enter the cash flow value for the end of year 1, then press "INPUT". Enter the number of periods for that value, then press "INPUT". For "FLOW(2)", enter the next cash flow value, then press "INPUT". The number of times will default to the previous number. Press "INPUT" to keep, or enter a new value. When the cash flow entries are complete, press the button under "CALC". Press the button under "IRR%" to calculate the IRR of the cash flow.

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Security Analysis
Security analysis is about valuing the assets, debt, warrants, and equity of companies from the perspective of outside investors using publicly available information. The security analyst must have a thorough understanding of financial statements, which are an important source of this information. As such, the ability to value equity securities requires cross-disciplinary knowledge in both finance and financial accounting. While there is much overlap between the analytical tools used in security analysis and those used in corporate finance, security analysis tends to take the perspective of potential investors, whereas corporate finance tends to take an inside perspective such as that of a corporate financial manager.

Equity Value and Enterprise Value The equity value of a firm is simply its market capitalization; that is, the market price per share multiplied by the number of outstanding shares. The enterprise value, also referred to as the firm value, is the equity value plus the net liabilities. The enterprise value is the value of the productive assets of the firm, not just its equity value, based on the accounting identity: Assets = Net Liabilities + Equity Note that net values of the assets and liabilities are used. Any cash and cashequivalents would be used to offset the liabilities and therefore are not included in the enterprise value. 202

Finance Material As an analogy, imagine purchasing a house with a market value of $100,000, for which the owner has $50,000 in equity and a $50,000 assumable mortgage. To purchase the house, the new owner would pay $50,000 in cash and assume the $50,000 mortgage, for a total capital structure of $100,000. If $20,000 of that market value were due to $20,000 in cash locked in a safe in the basement, and the owner pledged to leave the money in the house, the cash could be used to pay down the $50,000 mortgage and the net assets would become $80,000 and the net liabilities would become $30,000. The "enterprise value" of the house therefore would be $80,000.

Valuation Methods Two types of approaches to valuation are discounted cash flow methods and financial ratio methods. Two discounted cash flow approaches to valuation are: 1. value the cash flow to equity, and 2. value the cash flow to the enterprise. The "cash flow to equity" approach to valuation directly discounts the firm's cash flow to the equity owners. This cash flow takes the form of dividends or share buybacks. While intuitively straightforward, this technique suffers from numerous drawbacks. First, it is not very useful in identifying areas of value creation. Second, changes in the dividend payout ratio result in a change in the calculated value of the company even though the operating performance might not change. This effect must be compensated by adjusting the discount rate to be consistent with the new payout ratio. Despite its drawbacks, the equity approach often is more appropriate when valuing financial institutions because it treats the firm's liabilities as a part of operations. Since banks have significant liabilities that are owed to the retail depositors, they indeed have significant liabilities that are part of operations. The "cash flow to the enterprise" approach values the equity of the firm as the value of the operations less the value of the debt. The value of the operations is the present value of the future free cash flows expected to be generated. The free cash flow is calculated by taking the operating earnings (earnings excluding interest expenses), subtracting items that required cash but that did not reduce reported earnings, and adding non-cash items that did reduce reported earnings but that did not result in cash expenditures. Interest and dividend payments are not subtracted since we are calculating the free cash flow available to all capital providers, both equity and debt, before financing. The result is the cash generated by operations. The free cash flow basically is the cash that would be available to shareholders if the firm had no debt - the cash produced by the business regardless of the way it is financed. The expected future cash flow then is discounted by the weighted average cost of capital to determine the enterprise value. The value of the equity then is the enterprise value less the value of the debt. 203

Finance Material When valuing cash flows, pro forma projections are made a certain number of years into the future, then a terminal value is calculated for years thereafter and discounted back to the present.

Free Cash Flow Calculation The free cash flow (FCF) is calculated by starting with the profits after taxes, then adding back depreciation that reduced earnings even though it was not a cash outflow, then adding back after-tax interest (since we are interested in the cash flow from operations), and adding back any non-cash decrease in net working capital (NWC). For example, if accounts receivable decreased, this decrease had a positive effect on cash flow. If the accounting earnings are negative and the free cash flow is positive, the carryforward tax benefit is in effect realized in the current year and must be added to the FCF calculation.

Leverage In 1958, economists and now Nobel laureates Franco Modigliani and Merton H. Miller proposed that the capital structure of a firm did not affect its value, assuming no taxes, no bankruptcy costs, no transaction costs, that the firm's investment decisions are independent of capital structure, and that managers, shareholders, and bondholders have the same information. The mix of debt and equity simply reallocates the cash flow between stockholders and bondholders, but the total amount of the cash flow is independent of the capital structure. According to Modigliani and Miller's first proposition, the value of the firm if levered equals the value if unlevered:

VL = V U However, the assumptions behind Proposition I do not all hold. One of the more unrealistic assumptions is that of no taxes. Since the firm benefits from the tax deduction associated with interest paid on the debt, the value of the levered firm becomes:

VL = VU + tcD where tc = marginal corporate tax rate.

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Finance Material When considering the effect of taxes on firm value, it is worthwhile to consider taxes from a potential investors point of view. For equity investors, the firm first must pay taxes at the corporate tax rate, tc, then the investor must pay taxes at the individual equity holder tax rate, te. Then for debt holders, After-tax income = ( debt income )( 1 td ) For equity holders, After-tax income = ( equity income )( 1 tc )( 1 te ) The relative advantage (if any) of equity to debt can be expressed as: Relative Advantage (RA) = ( 1 tc )( 1 te ) / ( 1 td ) RA > 1 signifies a relative advantage for equity financing. RA < 1 signifies a relative advantage for debt financing.

One can define T as the net advantage of debt : T = 1 RA

For T positive, there is a net advantage from using debt; for T negative there is a net disadvantage. Empirical evidence suggests that T is small; in equilibrium T = 0. This is known as Miller's equilibrium and implies that the capital structure does not affect enterprise value (though it can affect equity value, even if T=0).

Calculating the Cost of Capital Note that the return on assets, ra, sometimes is referred to as ru, the unlevered return. Gordon Dividend Model:

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Finance Material P0 = Div1 / ( re g ) where P0 = current stock price, Div1 = dividend paid out one year from now, re = return of equity g = dividend growth rate Then: re = ( Div1 / P0 ) + g

Capital Asset Pricing Model: The security market line is used to calculate the expected return on equity:

re = rf + e ( rm rf ) where rf = risk-free rate, rm = market return e = equity beta However, this model ignores the effect of corporate income taxes. Considering corporate income taxes: re = rf ( 1 tc ) + e [ rm rf ( 1 tc ) ] where tc = corporate tax rate.

Once the expected return on equity and on debt are known, the weighted average cost of capital can be calculated using Modigliani and Miller's second proposition:

WACC = re E / ( E + D ) + rd D / ( E + D )

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Finance Material Taking into account the tax shield:

WACC = re E / ( E + D ) + rd ( 1 tc ) D / ( E + D )

For T = 0 (no tax advantage for debt), the WACC is equivalent to the return on assets, ra. rd is calculated using the CAPM: rd = rf + d [ rm rf ( 1 tc ) ] For a levered firm in an environment in which there are both corporate and personal income taxes and in which there is no tax advantage to debt (T=0), WACC is equal to r a, and the above WACC equation can be rearranged to solve for re:

re = ra + (D/E)[ ra rd(1 tc) ]

From this equation it is evident that if a firm with a constant future free cash flow increases its debt-to-equity ratio, for example by issuing debt and repurchasing some of its shares, its cost of equity will increase. ra also can be calculated directly by first obtaining a value for the asset beta, a, and then applying the CAPM. The asset beta is: a = e ( E / V ) + d ( D / V )( 1 tc ) Then return on assets is calculated as:

ra = rf ( 1 tc ) + a [ rm rf ( 1 tc ) ]

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Finance Material In summary, for the case in which there is personal taxation and in which Miller's Equilibrium holds ( T = 0 ), the following equations describe the expected returns on equity, debt, and assets:

re = rf ( 1 tc ) + e [ rm rf ( 1 tc ) ]

ra = rf ( 1 tc ) + a [ rm rf ( 1 tc ) ]

rd = rf + d [ rm rf ( 1 tc ) ]

The cost of capital also can be calculated using historical averages. The arithmetic mean generally is used for this calculation, though some argue that the geometric mean should be used. Finally, the cost of equity can be determined from financial ratios. For example, the cost of unleveraged equity is:

re,U = [ re, L + rf,debt ( 1 tc ) D/E ] / ( 1 + D/E )

re,L = b(1+g) / (P/E) + g where b = dividend payout ratio

g = ( 1 b ) (ROE) where (1 b) = plowback ratio.

The payout ratio can be calculated using dividend and earnings ratios: b = ( Dividend / Price ) ( Price / Earnings) 208

Finance Material

Share Buy-Back

Take a firm that is 100% equity financed in an environment in which T is not equal to zero; i.e., there is a net tax advantage to debt. If the firm decides to issue debt and buyback shares, the levered value of the firm then is:

VL = VU + T (debt) The number of shares that could be repurchased then is: n = (debt) / ( price per share after relevering) where the price per share after relevering is: VL / (original number of outstanding shares) The buyback will lower the firm's WACC.

Project Valuation The NPV of a capital investment made by a firm, assuming that the investment results in an annual free cash flow P received at the end of each year beginning with the first year, and assuming that the asset is financed using current debt/equity ratios, is equal to: NPV = P0 + P / WACC

Warrant Valuation Warrants are call options issued by the firm and that would require new shares to be issued if exercised. Any outstanding warrants must be considered when valuing the equity of the firm. The Black-Scholes option pricing formula can be used to value the firm's warrants.

Valuation Calculation Once the free cash flow and WACC are known, the valuation calculation can be made. If the free cash flow is equally distributed across the year, an adjustment is necessary to 209

Finance Material shift the year-end cash flows to mid-year. This adjustment is performed by shifting the cash flow by one-half of a year by multiplying the valuation by ( 1 + WACC )1/2. The enterprise value includes the value of any outstanding warrants. The value of the warrants must be subtracted from the enterprise value to calculate the equity value. This result is divided by the current number of outstanding shares to yield the per share equity value.

PEG Ratio As a rule of thumb, the P/E ratio of a stock should be equal to the earnings growth rate. Mathematically, this can be shown as follows: P = D / re + PVGO where P = price D = annual dividend re = return on equity PVGO = present value of growth opportunities. For high growth firms, PVGO usually dominates D / re. PVGO is equal to the earnings divided by the earnings growth rate.

Treatment of Goodwill Prior to 2002, amortization of goodwill was an expense on the income statement, but unlike depreciation of fixed assets, amortization of goodwill is not tax deductible. In 2002, FASB Statement No. 142 discontinued the depreciation of goodwill and specified that it be kept on the books as a non-depreciating asset and written off only when its value is determined to have declined.

Glossary APV: Adjusted Present Value

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Finance Material CAPM: Capital Asset Pricing Model EBIT: Earnings Before Interest and Taxes EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization Enterprise Value: Market value of a firm's equity plus the net market value of its debt.

Enterprise value = market cap + LTD - net cash & investments

FCF: Free Cash Flow LTD: Long-Term Debt MRP: Market risk premium, defined as rm rf , unless it specifically is referred to as taxadjusted market risk premium, in which case there would be a factor to adjust rf for taxes. NOPLAT: Net Operating Profits Less Adjusted Taxes OLS: Ordinary Least Squares (method of regression) PEG: The ratio of P/E to growth rate in earnings. RADR: Risk Adjusted Discount Rate RAYTM: Rating-Adjusted Yield-To-Maturity ROE: Return On Equity; equivalent to the expected return on retained earnings YTM: Yield To Maturity

Financial Ratios

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Finance Material A firm's performance can be evaluated using financial ratios. Referencing these ratios to those of other firms allows a comparison to be made. The following is a listing of some useful ratios. Leverage : Assets / Shareholder's Equity Gross Margin = Gross Profit / Sales. Gross margin measures the profitability considering only variable costs and is a measure of the percentage of revenue that goes to fixed costs and profit. Net Profit Margin = Net Income / Sales Total Asset Turnover = defined as Sales / Total Assets Return on Assets (ROA) = Net Income / Assets ROA is a measure of the return on money provided by both owners and creditors, and is a measure of how efficiently all resources are managed. Return on Equity (ROE) = defined as Net Income / Equity where the equity value is the shareholder's equity at the end of the period in which the income was earned. ROE is a measure of the return on money provided by the firm's owners. ROE can be calculated indirectly as: ROE = ( Net Income / Total Assets ) ( Total Assets / Equity ) ROE also can be calculated using DuPont analysis : ROE = (Net Income / Sales)(Sales / Total Assets)(Total Assets / Equity)

This states that ROE is determined by multiplication of three levers: ROE = (net profit margin) (total asset turnover) (leverage) These levers are readily viewed on the company's financial statements. While ROE's may be similar among firms, the levers may differ significantly.

Liquidity The term working capital is used to describe the current items of the balance sheet. Working capital includes current assets such as cash, accounts receivable, and inventory, and current liabilities such as accounts payable and other short term liabilities. Net working capital is defined as non-cash current operating assets minus non-debt current operating liabilities. Cash, short-term debt, and current portion of long212

Finance Material term debt are excluded from the net working capital calculation because they are related to financing and not to operations. Two commonly used liquidity ratios are the current ratio and the quick ratio. Current Ratio : defined as Current Assets / Current Liabilities. The current ratio is a measure of the firm's ability to pay off current liabilities as they become due. Quick Ratio : defined as Quick Assets / Current Liabilities. The quick ratio also is known as the acid test. Quick assets are defined as cash, accounts receivable, and notes receivable - essentially current assets minus inventory.

Free Cash Flow

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Finance Material When valuing the operations of a firm using a discounted cash flow model, the operating cash flow is needed. This operating cash flow also is called the unlevered free cash flow (UFCF). The term "free cash flow" is used because this cash is free to be paid back to the suppliers of capital.

Calculating Free Cash Flow For a particular year, the unlevered free cash flow is calculated as follows: 1. Start with the annual sales and subtract cash costs and depreciation to calculate the earnings before interest and taxes (EBIT). The EBIT also is referred to as the operating income and represents the pre-tax earnings without regard to how the business is financed. 2. Calculate the earnings before interest and after tax (EBIAT) by multiplying the EBIT by one minus the tax rate. Note that the EBIAT represents the after-tax earnings of the firm as if it were financed entirely with equity capital. 3. To arrive at the UFCF, add the depreciation expense back to the EBIAT, and subtract capital expenditures (CAPEX) that were not charged against earnings and subtract any investments in net working capital (NWC). The free cash flow calculation in equation form: Operating Income (EBIT) = Revenues Cash Costs Depreciation Expense EBIAT = EBIT Taxes, where Taxes = (tax rate)(EBIT)

UFCF = EBIAT + Depreciation Expense CAPEX Increase in NWC

Capital expenditures are calculated by solving for CAPEX in the following equation: BV of Assets at Year End = BV of assets at Beginning of Year + CAPEX Depreciation An additional cash adjustment may be necessary for an increase in deferred taxes that would have a positive impact on cash flow.

Terminal Value
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Finance Material In a discounted cash flow valuation, the cash flow is projected for each year into the future for a certain number of years, after which unique annual cash flows cannot be forecasted with reasonable accuracy. At that point, rather than attempting to forecast the varying cash flow for each individual year, one uses a single value representing the discounted value of all subsequent cash flows. This single value is referred to as the terminal value. The terminal value can represent a large portion of the valuation. The terminal value of a piece of manufacturing equipment at the end of its useful life is its salvage value, typically less than 10% of the present value. In contrast, the terminal value associated with a business often is more than 50% of the total present value. For this reason, the terminal value calculation often is critical in performing a valuation. The terminal value can be calculated either based on the value if liquidated or based on the value of the firm as an ongoing concern.

Terminal Value if Liquidated If the firm is to be liquidated, the liquidation value can be based on book value, salvage value, or break-up value, but liquidation value usually understates the terminal value of a healthy business. One must make assumptions about the salvage value of the assets and net working capital. The net working capital may have a certain recovery rate since it might not be readily liquidated at balance sheet values. In the pro forma projections, one often may assume that net working capital will grow at the same rate as cash flow. The terminal value if the firm is liquidated then is the sum of the discounted value of the cash flow, the recovered net working capital, and the salvage value of the long-term assets, including any tax benefits.

Terminal Value of the Ongoing Firm For an ongoing firm, the terminal value may be determined by either using discounted cash flow (DCF) estimates or by using multiples from comparable firms. For the DCF method, if the unlevered free cash flow is growing at a rate of g per year for a set number of years, the terminal value can be calculated by modeling the cash flow as a T-year growing perpetuity. At the end of T years, one can assume a different growth rate (possibly zero) or liquidation. If multiples from comparable firms are used, the price/earnings ratio, market/book values, or cash flow multiples are commonly used. The unlevered terminal value is calculated using the return on assets (rA) as the discount rate. The levered terminal value is calculated using the weighted average cost of capital (WACC) as the discount rate.

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Finance Material Terminal Value of the Debt The terminal value of debt or preferred stock is simply the projected book value of the debt or preferred stock in the year that the terminal value is being calculated.

Terminal Value of the Common Stock The terminal value of the common stock is the total levered terminal value less the terminal value of the debt, less the terminal value of the preferred stock (adding in the amount from any warrants that are exercised at their exercise price), plus the cash gained from the exercise of any common and preferred warrants.

Debt Valuation

In the enterprise model of valuation, the firm's equity value is calculated by subtracting the value of the firm's debt from the enterprise value. Debt valuation then becomes an important component of a valuation of the firm's equity. A company's debt is valued by calculating the payoffs that debt holders can expect to receive, taking into account the risk of default. The default risk is addressed by considering the probability of default and the amount that could be recovered in that event. For modeling purposes, one may assume that the cash flow from the recovered amount is realized at the end of the year of default. Debt valuation may take one of the following two approaches: 1. Discount the expected cash flow at the expected bond return; or 2. Discount the scheduled bond payments at the rating-adjusted yield-to-maturity. 216

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Debt Valuation - Method 1 Discount the expected cash flow at the expected bond return Under this method, the value of the bond is the sum of the expected annual cash flows discounted at the expected bond return: Value = the sum for each year t of E(cash flow)t / ( 1 + rdebt )t where E(cash flow)t = expected cash flow in year t. For a one year bond: Value = E(cash flow) / [1 + E(rd)] The expected bond return is the risk-adjusted discount rate, rdebt. The expected cash flow is the cash flow considering the probability of default: E(cash flow) = ( 1 + C ) F + ( 1 - ) F where C F = = = = probability of no default recovery rate in case of default, (percentage of face value) annual coupon rate of the bond face value of the bond

rdebt can be calculated using the CAPM: rdebt = rf + debtS&P500 where S&P500 = risk premium for the market portfolio debt = covariance between rdebt and the market return; rf = yield to maturity on a risk-free bond having the same maturity. If debt is not known, it can be found using ordinary least squares regression. If = 1 (no default risk), then rdebt = yield to maturity. The difference in rdebt and YTM reflects the default risk.

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Debt Valuation - Method 2 Discount the scheduled bond payments at the rating-adjusted yield-to-maturity For this method, estimate the rating-adjusted yield-to-maturity (RAYTM) by averaging the market yield-to-maturities (YTM) of bonds in the same group. The promised cash flows then are discounted at this rate that already has factored in the default risk.

Markov Chain Representation A firm's debt rating can change over time, and the value of future cash flows should take into account the possibility of one or more rating changes. In this regard, bond valuation can be modeled as a Markov Chain problem in which a transition matrix is constructed for the probabilities of the firm's debt moving from one rating to another. For example, if there are five possible ratings: A, B, C, D, E, and F; and xy represents the probability of moving from state x to state y, then the transition matrix would look like the following:

AA AB AC AD AE BA BB BC BD BE CA CB CC CD CE DA DB DC DD DE EA EB EC ED EE

For multiple periods, the transition matrices for each period must be multiplied in order to calculate the multi-period probabilities. This multiplication easily can be performed by spreadsheet software.

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Black-Scholes Option Pricing Formula

In their 1973 paper, The Pricing of Options and Corporate Liabilities, Fischer Black and Myron Scholes published an option valuation formula that today is known as the BlackScholes model. It has become the standard method of pricing options. The Black-Scholes formula calculates the price of a call option to be: C = S N(d1) - X e-rT N(d2) where C = price of the call option S = price of the underlying stock X = option exercise price r = risk-free interest rate T = current time until expiration N() = area under the normal curve d1 = [ ln(S/X) + (r + 2/2) T ] / T1/2 219

Finance Material d2 = d1 - T1/2

Put-call parity requires that: P = C - S + Xe-rT

Then the price of a put option is: P = Xe-rT N(-d2) - S N(-d1)

Assumptions The Black-Scholes model assumes that the option can be exercised only at expiration. It requires that both the risk-free rate and the volatility of the underlying stock price remain constant over the period of analysis. The model also assumes that the underlying stock does not pay dividends; adjustments can be made to correct for such distributions. For example, the present value of estimated dividends can be deducted from the stock price in the model.

Warrant Pricing Warrants are call options issued by a corporation. They tend to have longer durations than do exchange-traded call options. Warrants can be valued by the Black-Scholes model, but some modifications must be made to the parameters. When warrants are exercised, the company typically issues new shares at the exercise price to fill the order. The resulting increase in shares outstanding dilutes the share value. If there were n shares outstanding, and m warrants are exercised, represents the percentage of the value of the firm that is represented by the warrants, where = m/(m+n) When using the Black-Scholes model to value the warrants, it is worthwhile to use total amounts instead of per share amounts in order to better account for the dilution. The current share price S becomes the enterprise value (less debt) to be acquired by the warrant holders. The exercise price is the total warrant exercise amount, adjusted for the fact that in paying cash to the firm to exercise the warrants, the warrant holders in effect are paying a portion of the cash, , to themselves. 220

Finance Material The inputs to the Black-Scholes model for both option pricing and warrant pricing are outlined in the following table. Black-Scholes Parameters for Pricing Options and Warrants Input Parameter S X T r Option Pricing current share price exercise price per share Warrant Pricing V, where V is enterprise value minus debt. total warrant exercise amount multiplied by (1 - ). interest rate standard deviation for returns on enterprise value, including warrants

current time to expiration average T for warrants interest rate standard deviation of stock return

Mergers and Acquisitions

A corporate merger is the combination of the assets and liabilities of two firms to form a single business entity. In everyday language, the term acquisition tends to be used when a larger firm absorbs a smaller firm, and merger tends to be used when the combination is portrayed to be between equals. In a merger of firms that are approximate equals, there often is an exchange of stock in which one firm issues new shares to the shareholders of the other firm at a certain ratio. For the sake of this discussion, the firm whose shares continue to exist (possibly under a different company name) will be referred to as the acquiring firm and the firm whose shares are being replaced by the acquiring firm will be referred to as the target firm. Excluding any synergies resulting from the merger, the total post-merger value of the two firms is equal to the pre-merger value. However, the post-merger value of each individual firm likely will be different from the pre-merger value because the exchange ratio of the shares probably will not exactly reflect the firms' values with respect to one another. The exchange ratio is skewed because the target firm's shareholders are paid a premium for their shares. Synergy takes the form of revenue enhancement and cost savings. When two companies in the same industry merge, such as two banks, combined revenue tends to decline to the extent that the businesses overlap in the same market and some customers become alienated. For the merger to benefit shareholders, there should be cost saving opportunities to offset the revenue decline; the synergies resulting from the merger must be more than the initial lost value.

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Finance Material To calculate the minimum value of synergies required so that the acquiring firm's shareholders do not lose value, an equation can be written to set the post-merger share price equal to the pre-merger share price of the acquiring firm as follows: (pre-merger value of both firms + synergies) = pre-merger stock price post-merger number of shares

The above equation then can be solved for the value of the minimum required synergies. The success of a merger is measured by whether the value of the acquiring firm is enhanced by it. The practical aspects of mergers often prevent the forecasted benefits from being fully realized and the expected synergy may fall short of expectations.

Investment Management
Investment management is about attaining investment objectives under specified constraints; for example, achieving the best possible return for a given level of risk. To meet these objectives, the investor may buy equity in an asset such a stock, a fund, or real estate, or buy debt issued by governments and corporations. By effectively managing such investments the investment manager can achieve a higher return for a specified acceptable level of risk. There are many tools for reaching this goal.

Expected Return and Portfolio Variance The two basic metrics for an investment portfolio are the return and the variance. In the case of an individual dividend-paying stock, the return is given by: Ri = [(P1 + D1) / P0] - 1, where D1 is the dividend paid at time t = 1.

The future return of a stock or a portfolio is not known with certainty; there are different probabilites for different return scenarios, one of which actually will unfold.

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Finance Material Given n possible return scenarios, each with its own probability pi, the expected return is: E(R) = i=1,n pi Ri The variance of such a stock or portfolio is given by: 2 = i=1,n pi [Ri - E(R)]2 Portfolios A portfolio has certain advantages over a single security. The return of one security may tend to move in the same direction as the return of another security, but in the opposite direction of the return of a third security. Because of these tendencies, when securities are grouped into a portfolio, for a given expected return the variance of that return can be reduced. The joint tendencies between the returns can be measured by covariances. The covariance in two securities' returns is given by: Cov(R1, R2) = 12 = 12 12 The correlation coefficient between security i and the market is given by: im = im / i m For two securities, 2p = i=1,n j=1,n xixj ij 2p = x21 21 + x22 22 + 2 x1 x2 12 = x21 21 + x22 22 + 2 x1 x2 12 12 where x2 = 1 - x1 Note that if T-bills that earn the risk-free rate are included, for RF = 0. Given two securities, many different portfolios can be constructed by varying the weighting of each security in the portfolio. To find the minimum variance portfolio, set d1 / dx1 = 0 => x1 = (22 - 12 12) / (21 + 22 - 2 12 12)

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Finance Material For an equally weighted portfolio with all standard deviations equal and all covariances equal to zero: Var(Rp) = (1/N2) i=1,n Var(Ri) = (1/N) Var(Ri) = (1/N) 2i and p = (1/N1/2) i Risk Adjusted Return Different investors have different aversions to risk. When managing a portfolio for a particular investor, the goal is to maximize the portfolio return for the level of risk that the investor is willing to take. The following model can be used: Maximize Z = E(Rp) - A Var(Rp) where A = investor's aversion to risk as measured by the variance of the portfolio return. To maximize the function assuming the investor's assets are only in the market portfolio and the riskfree asset, first let wm = the fraction of assets in the market portfolio. Then E(Rp) = rF + wm (Rm - rF) and Var(Rp) = w2m 2m. Then Z = rF + wm [E(Rm)- rF] - 0.5 A w2m 2m and dZ/dwm = E(Rm) - rF - A wm 2m = 0 Solving for A, A = [E(Rm) - rF] / ( wm 2m)

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Beta The risk of an individual security in a well diversified portfolio can be measured by its beta. Such risk is nondiversifiable. Beta of an individual security with respect to the market is: im = im / 2m = Cov(Ri, RSP500) / Var(RSP500) Beta of a risk-free asset with respect to the market = 0. Betas determined using historical data are subject to estimation error. Merrill Lynch and some other firms adjust this value back towards the mean beta of the market (=1) or industry using adjusted = w historical + (1-w) "true" The lower the confidence in historical, the lower should be the value chosen for w. Beta of a portfolio: pm = xi im , where xi is the weight. One is willing to accept a lower return on a security or a portfolio having a negative beta since it can reduce the portfolio risk as part of a larger portfolio. Efficient portfolios lie on the capital market line (CML). This CML is not a part of the CAPM. For this line to be used, there must be perfect correlation between the portfolio in question and the market portfolio. This implies that the line is only for those portfolios that are a combination of the tangential portfolio (usually the market portfolio) and the risk-free rate. CML: E(Rp) = RF + [ E(Rm) - RF ] p / m If borrowing is not permitted, the rational risk-averse investor will choose a portfolio along the capital market line up to the efficient frontier, and then follow the efficient frontier for levels of higher risk and return. The variance and expected return of the market portfolio can be obtained by combining any two portfolios that lie on the efficient frontier and solving for the weights in the following expression: E(Rm) = w1 E(R1) + (1-w1) E(R2)

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Finance Material The covariance between any two portfolios on the efficient frontier can be found by finding the weights needed to emulate the market portfolio and then solving for 12 in the following equation: 2p = w21 21 + w22 22 + 2 w1 w2 12

CAPM The Sharpe-Lintner version of the capital asset pricing model implies that as a result of all investors holding the market portfolio, there is a linear relation between the expected return on a security and its . The following is the security market line - any security's expected return will lie on this line. This line applies to all securities, not just efficient portfolios. E(Ri) = RF + [ E(Rm) - RF ] im Sharpe-Lintner E(Ri) = Rz + [ E(Rm) - Rz ] im Black Expected return of a portfolio using CAPM: E(Rp) = RF + [ E(Rm) - RF ] pm If the assumption of equal borrowing and lending rates is relaxed, investors no longer are required to hold the market portfolio; instead, they can hold a range of portfolios along the efficient frontier between the point of tangency of the lending line and the point of tangency of the borrowing line. CAPM requires the measure of two unknown quantities - market risk premium and beta. However, attempts to estimate expected returns by using historical stock return data have resulted in std errors about double those of CAPM, because for CAPM the better precision in the estimate of the market risk premium more than offsets the additional estimation error in beta. There have been many difficulties in testing CAPM. Roll argued that the CAPM must always hold for ex post data if the proxy chosen for the market is efficient. He also argued that it is impossible to measure the true market, so the CAPM cannot be tested. However, in 1982 Stambaugh found that adding other risky assets such as corporate bonds, real estate, and consumer durables to the market portfolio did not materially affect the tests.

Single Factor Model (Market Model)

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Finance Material Rit = ai + iRmt + eitt = 1, ..., T where eit is the distance from the regression line at time t. The mean value of e it = 0 and the covariance between Rm and ei = 0. This is a regression model that characterizes the risk of a security over time by measuring its beta over a time interval. iis different from the im used in the CAPM in that im is more of a present-day beta rather than one taken over time. In the traditional approach of testing the CAPM, in the first step one uses this model to measure the beta of all securities (or portfolios). In the second step one estimates the CAPM itself by regressing the security returns on the estimated betas. When testing CAPM in this manner, one must question the validity of tests using ex post data to test the ex ante CAPM. Also, there is measurement error in individual security betas. Using portfolios instead in the first-pass regression helps. Variance using the single-factor model: Var(Ri) = 2i Var(Rm) + Var(ei) where Ri, Rm, and ei are random variables. The variance of the mean return ai is zero by definition, so this term falls out. In a well-diversified portfolio, Var(ei) = 0. In this equation, 2i Var(Rm) is the variance explained by the market. The percent of variance explained by the market then is given by 2i Var(Rm) / 2i = R2 Note that (1-R2) is the idiosyncratic variance. These expressions apply to portfolios as well by replacing i with p. For two portfolios or securities in which their ei's are uncorrelated, the covariance between them is given by: ij = i j 2m . This is derived by finding the covariance between: Rit = ai + iRmt + eit and Rjt = ai + jRmt + ejt

Cross Section of Common Stock Returns Fama and French used a multi-factor model using additional risk factors related to size, price/book, etc. They concluded that three "risk" factors were sufficient.

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Finance Material Gabriel Hawawini and Donald Keim's paper reports that stock returns depended size, E/P, CF/P, P/B, and prior returns. However, these factors were not due to risk. The premia related to size and P/B are mainly due to the January effect. It is unlikely that the risk is higher in January. The size & P/B premia are uncorrelated across international markets. This is inconsistent with the notion of well-integrated international markets, in which similar risks should result in similar returns.

Market-Neutral Strategies Market-neutral strategies balance the market risk by going long on some securities and short on others. Some people propose using the T-bill rate as a benchmark against which to compare the market return of a such a strategy. One can argue that even though the market-neutral strategy is risky, since it has zero beta it does not contribute to the risk of the market portfolio and therefore should not command a premium over the risk-free rate. On the other hand, if the expected returns on the long side are higher than those on the short, the benchmark return should exceed the risk-free rate.

Trading Costs An important factor in the performance of high-turnover portfolios is the amount of the trading costs, including explicit costs such as commissions, fees, and taxes, the market maker spread, the impact of trading on market price, and the opportunity cost incurred during the delay between the time the decision is made and the time the trade is executed. Trading costs can be reduced through passive fund management and electronic trading.

Long-Term Investing The conventional wisdom is that over the long run, stock will generate returns superior to those of bonds. But while the variance of the geometric means of the returns declines as the time horizon increases, the variance of the terminal wealth increases. If a put option were purchased to insure a certain terminal wealth, the cost of that option would increase as the time horizon increases. To the extent that option prices are a measure of risk, the risk of stock investments then increases as the time horizon lengthens. The optimal asset allocation is a function of the present wealth, target future wealth, risk tolerance, and time horizon. Long-term returns are difficult to analyze statistically because as the historical time horizon increases, the number of possible independent samples of returns decreases. In 1991, Butler and Domian illustrated a procedure that attempts to overcome this difficulty by first listing the monthly returns for the S&P 500 and the long-term bonds over a long historical time horizon. By randomly selecting data, 228

Finance Material returns over various long-term holding periods can be emulated by multiplying the appropriate number of random samples. An almost limitless number of samples for each holding period can be generated using this method. Performing such an analysis with data taken from the 792 months from 1926-1991 indicates that over a 10-year time period, there is an 11% chance that stocks will underperform bonds; over a 20-year time period this probability reduces to 5%.

Defined-Benefit Pension Plans In a defined-benefit plan, the plan sponsor (usually an employer) guarantees a level of future benefits to the plan participants, taking responsibility for any shortfall in the investment performance of the plan. FASB 87 requires that any unfunded liability in the present value of the benefits appear on the balance sheet of the employer. One alternative for the plan sponsor is to place the present value of the plan liability into government bonds of the same duration as the liability, in which case there is no chance of shortfall and the liability is fully immunized. Furthermore, because pension plans are not taxed, the incentive to hold equity in order to take advantage of lower taxes on capital gains is diminished. For a given level of risk, tax implications increase the return most for investments such as bonds, which have a large spread between pre-tax and after-tax return. An alternative to bonds is for the pension fund to place its money into riskier assets such as common stocks. Under this latter alternative, there exists both the chance of a shortfall and the chance of a surplus. However, FASB 87 does not permit a surplus to be reported as an asset on the sponsor's balance sheet, and the surplus often gets allocated to the plan participants. Nonetheless, for many reasons it is common for firms to hold equity in their pension funds. The Pension Benefit Guarantee Corporation (a federal agency) guarantees the benefits, and the sponsor's premiums are independent of the risk level of the pension fund's investments. For employers in financial distress, the pension guarantee from PBGC effectively is a put option. Given that put options increase in value as risk increases, there is an incentive for some firms to invest the pension fund in risky assets. In defined-benefit plans there exists the opportunity for tax arbitrage. The plan sponsor can issue debt in order to buy equity in the pension plan. The pension plan then can invest the funds in bonds. Because of the tax status of the pension fund, the taxes on the pension plan's bond interest will be deferred, and the sponsor will enjoy the interest tax shield from its debt issuance. The sponsor then realizes an arbitrage profit equal to the interest rate multiplied by the corporate tax rate, with no increase in the firm's overall risk.

Arbitrage Pricing Theory In 1976, Steve Ross presented the arbitrage pricing theory (APT) as an alternative to the CAPM that requires fewer assumptions. The APT is an equilibrium theory, which differs from a factor model in that it specifies relationships between expected returns 229

Finance Material across securities and attributes that influence those securities. A factor model allows the first term in the model, the expected return, to differ across securities and therefore can represent either and efficient or an inefficient market. Ross assumed that returns have the first term in common, and the other terms depend on several different systematic factors, as opposed to the single market risk premium factor of the CAPM. The model takes the form: Rpt = E(Rp) + p1I1t + p2I2t + ... + pKIKt + ept where Ii= value of the ith factor, pi = sensitivity of the return to the ith factor, k = number of factors, and ept equals the idiosyncratic variation in the return. Assuming an efficient market in equilibrium, the first term to the right of the equal sign is the same for all securities and is approximately equal to the risk-free rate. Examples of factors that could be included in the model are monthly industrial production, changes in expected inflation, unexpected inflation, unexpected changes in the risk premium, and unexpected shifts in the term structure of interest rates. Such variables likely affect most or all stocks.

Market-Neutral Strategies Revisited Given that "alpha" is the return above the market return, by constructing a portfolio long on positive alpha stocks and short on negative alpha stocks, one can cancel the effect of the market. This market-neutral strategy sometimes is referred to as a "double alpha, no beta" strategy. Because such a strategy is uncorrelated with the market, the volatility depends on non-market factors. If the market-neutral portfolio is well-diversified across many types of industries, the volatility can be low. If the portfolio is concentrated in a smaller number of stocks and industries, the volatility can be high. Furthermore, if the portfolio is not balanced among stocks of different size or value/growth measures, there could be higher volatility as a result of these non-market risk factors.

Mutual Funds Mutual funds charge fees to their investors. Transaction fees called loads sometimes are charged for fund purchases or redemptions. Such fees are deducted directly from the investor's account and represent a charge for the broker's service of providing information and fund selection advice. Operating expenses are fees that are deducted from the fund earnings before distribution to investors, and typically average slightly more than 1% per year. Two components of operating expenses are management fees and 12b-1 fees. The 12b-1 fees represent a reimbursement for the fund's marketing expenses.

Style Analysis

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Finance Material Mutual funds can be characterized according to investment style, such as value or growth. However, the actual fund composition may not correspond closely to its stated investment style, and reports of portfolio holdings may not be very representative since they are only snapshots taken at one point in time. This limitation makes the public's view of the holdings subject to distortions such as "window-dressing," in which the portfolio manager buys stocks that have performed well so that investors will see those stocks in the portfolio holdings (cost basis is not reported) and perceive the manager to be capable of selecting the top performers. Style analysis is a method of characterizing the true style of a fund based on its behavior, not on its stated objectives and holdings. Style analysis is performed by first selecting a set of indices that correspond to particular styles, such as small-cap value, small-cap growth, large-cap value, large-cap growth, and cash. Using a weighted combination of these indices, one can construct a passive benchmark portfolio that tracks the return of the portfolio being analyzed as closely as possible. Assume that there are five indices available with which to compose the benchmark. The following steps are used to analyze the style: 1. Define the benchmark return for period t to be: RBenchmark,t = w1R1,t + w2R2,t + w3R3,t + w4R4,t + w5R5,t 2. Define the tracking error to be: et = RFund,t - RBenchmark,t 3. Solve for the weights by minimizing the standard deviation of the mean tracking error over the entire time period being analyzed under the constraint that the weights sum to one and are each greater than or equal to zero (unless net short positions are permitted in the fund). The standard deviation of the tracking error is given by: (e) = [ ( 1 / T-1 ) t=1,T (et - emean)2 ]1/2

Evaluating Fund Performance When the popular press publishes mutual fund performance rankings, it usually does not consider the risk that the portfolio manager took to achieve that return. Such rankings do not necessarily reflect the skill of the manager. To adjust for risk, one should consider the ratio of excess returns to risk, or consider risk-adjusted differential returns. For the risk, one can use standard deviations or betas.

The "Sharpe Measure": [ E(Rp) - E(RF) ] / p 231

Finance Material The "Treynor Measure": [ E(Rp) - E(RF) ] / p Std dev. differential measure: [ E(Rp) - E(RF) ] - [ E(RB) - E(RF) ] p / B "Jensen Measure": [ E(Rp) - E(RF) ] - [ E(RB) - E(RF) ] p

The Jensen measure is perhaps the most widely used measure of fund performance. In the above measures, Rpis the return of the portfolio under test, RB is the return of a passive benchmark portfolio, RF is the risk-free rate, and E(R) represents the mean historical returns. In determining which measure to use, one should consider the purpose of the measurement. For portfolios that represent a large portion of its investors' assets, a method that uses standard deviation should be used; the Sharpe Measure and the other Std. deviation differential measure are more appropriate. For ranking fund performance, the ratio of excess return to risk should be measured; the Sharpe Measure or the Treynor Measure are more appropriate.

Market Efficiency There is some evidence of some autocorrelation in stock prices. Small amounts of both positive autocorrelation, in which stock returns tend to move in the direction of the previous period, and negative autocorrelation, in which returns tend to move in a direction opposite to that of the previous period, have been observed. In situations of positive autocorrelation, momentum investing strategies should be employed, and in situations of negative autocorrelation, contrarian strategies should be used. However, for shorter term trading, any advantage from these techniques is neutralized by trading costs, and for longer terms there is not yet enough data to confirm or deny any net advantage.

Timing the Market Some investors have attempted to time the market to increase their returns, increasing their stake in equities when they predict an up market and decreasing it when they predict a down market. QuickMBA's market timing page covers this topic in more detail.

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Bonds Coupon bearing notes and bonds typically make fixed interest payments two times per year. Zero coupon bonds are sold at a discount and pay off their face values at maturity. Zero coupon treasury securities are issued by commercial institutions who separate the interest and principal payments. These zero coupon bonds are known as CAT's, TIGR's, and STRIP's. Bond prices often are quoted in the format x:y, where x is the integer dollar amount and y is the fractional amount in 32nd's of a dollar. The spot rate is the rate that would correspond to a single cash flow at maturity for a bond purchased today, as is the case with a zero coupon bond. A notation used for spot rates is rn, where n is the number of periods (e.g. years) into the future when a loan made today is to mature. The forward rate is the rate at which a future loan is made today. A notation used for forward rates is fm,n, where m is the number of periods from the present when the loan is to commence, and n is the number of periods into the future when the loan is to end. Forward rates can be expressed in terms of spot rates: 1 + fm,n = ( 1 + rn ) / ( 1 + rm ) The ask price of a U.S. Treasury bill is calculated from the "asked" rate (not asked yield) as follows: Ask Price = 10,000 [ 1 - asked rate ( N / 360 ) ] where N = the number of days until maturity. The implied rate (spot rate) is ( 10,000 / Ask Price - 1 ). This implied rate does not represent an annualized basis. The annualized rate is found by raising the implied rate to the 365/N power: Annualized Rate = ( Implied Rate )365 / N The bond equivalent yield is the yield to maturity y that satisfies the following equation: P = n=1,N Cn / ( 1 + y/2 )n where P = price, Cn = cash flow at the end of each period, N = number of periods. For a zero coupon bond there is only one cash flow at maturity. The value of a coupon bond can be modeled as a portfolio of zero-coupon bonds having face values and maturity dates that correspond to the coupon payments and dates.

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Finance Material Summing the prices of the zero-coupon bonds then would give the value of the coupon bond, and any difference would represent an arbitrage opportunity. Forward rates can be calculated using the prices and returns of bills, notes, or bonds provided they cover the proper time periods. For example, given the six month spot rate r0.5, one can calculate the one year spot rate r1.0 by using the data for a one year note the following equation: Price = coupon1 / (1+r0.5) + (coupon2 + face value) / (1+r1.0) Once the spot rates are known, the forward rate can be calculated as already illustrated. The spot rate is not quoted on an annualized basis. To annualize it: Annualized Yield = (Spot Rate)x/y where x is the number of periods in one year, and y is the number of periods included in the spot rate. The duration of a bond often is thought of in terms of time until maturity. However, in addition to the payoff of the face value at maturity, there are the coupon payment cash flows that influence effective duration. Two bond with equal yield-to-maturities and maturity dates will have different effective durations if their coupon rates are different. Frederick Macaulay suggested the following method of determining duration: Effective Duration = t=1,T t { [ Ct / ( 1+y/2 )t ] / [t=1,T Ct / ( 1+y/2 )t] } where T = life of the bond in semiannual periods, Ct = cash flow at end of tth semiannual period, y = yield to maturity, expressed as a bond-equivalent yield. A zero-coupon bond has no coupon payments and therefore its effective duration always is equal to the time until maturity and does not change as yield-to-maturity changes. Duration essentially measures the sensitivity of a bond's price to movements in interest rates. By this definition, duration is defined as D(P/P)/[(1+r)/(1+r)] If one plots the price of a non-callable bond as a function of its yield, the plot will be concave up (convex down) rather than linear. This curvature is called convexity, and in this case, positive convexity. Convexity is due to the fact that effective duration increases as interest rates decrease.

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Finance Material Because of the effectively shorter duration, the coupon bond yield curve will be below that of the zero coupon bond when forward rates are rising with time, and above it when they are dropping. Zero coupon rates often are more useful for capital budgeting purposes. Research has found that diversified portfolios of junk bonds have lower variance than those of high-grade bonds. There are several contributing factors to this initially surprising result. First, while individual junk bonds are risky, much of this risk can be diversified in a portfolio. Second, because of the higher coupon rate, junk bonds effectively have a shorter duration than do higher grade bonds and therefore a lower sensitivity to interest rate movements. Third, junk bonds are more likely to be called than are higher-grade bonds, since there is a strong incentive to refinance at lower rates if the issuer's credit improves. This characteristic reduces the effective duration resulting in less volatility.

Stock Indexes

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Finance Material Stock indexes are useful for benchmarking portfolios, for generalizing the experience of all investors, and for determining the market return used in the Capital Asset Pricing Model (CAPM). A hypothetical portfolio encompassing all possible securities would be too broad to measure, so proxies such as stock indexes have been developed to serve as indicators of the overall market's performance. In addition, specialized indexes have been developed to measure the performance of more specific parts of the market, such as small companies. It is important to realize that a stock price index by itself does not represent an average return to shareholders. By definition, a stock price index considers only the prices of the underlying stocks and not the dividends paid. Dividends can account for a large percentage of the total investment return.

Weighting One characteristic that varies among stock indexes is how the stocks comprising the index are weighted in the average. Even if no explicit weighting is applied when calculating an average, there may be an implicit one. While a one dollar price change in one stock in a simple stock price index will have the same effect as a one dollar change in any other stock, a given percentage increase of a higher price stock influences the index more than a corresponding percentage increase of a lower price stock. For example, a 1% change in a $100 stock will change the index more than a 1% change in a $10 stock. For this reason, indexes that are based on the simple summation of stock prices are referred to as price-weighted. In a price-weighted index, a change in the stock price of the largest company in the index would influence the average no more than an equal change in the stock price of the smallest company in the index. However, the larger company's performance will have a greater impact on the economy. To consider the size of a company, a market capitalization weighted index (or value-weighted index) can be used, in which a company's impact on the index is proportional to the size of the company. In valueweighting, in effect the market capitalization of the stocks influence the index, not the prices. For this reason, there is no need to adjust for stock splits. Some indexes do not weight for market capitalization, but do adjust for price differences to remove the implicit price weighting. This unweighted method tracks the performance of an index in which equal dollar amounts are invested in the underlying stocks. Some consider an unweighted index to be a good indicator of the market's performance from the perspective of the investor who places an equal amount of money in each stock in his or her portfolio, regardless of its market capitalization. However, if every investor placed an equal amount of money in each investment, relatively few investors would own small-cap stocks, so an unweighted index would not reflect the portfolio performance of the average investor when all investors are considered. 236

Finance Material There are hundreds of indexes that are designed to measure the broad market or specific parts of it. Here are some of the more commonly-used indexes, listed in alphabetical order.

Dow Jones Industrial Average The Dow Jones Industrial Average is a price-weighted index of industrial stocks and is the most widely quoted stock index. In the early 1880's, there was no broad market measure - investors focused on the prices of individual stocks. On July 3rd, 1884 Dow Jones & Co. first published an index of 11 companies in the Customer's Afternoon Letter, which later became the Wall Street Journal. At that time, there were 9 railroad stocks and 2 industrial stocks in the index. In 1884, the railroads were the largest and most stable companies. The stocks of industrial companies were considered speculative investments. In 1896, Charles Dow introduced an index for industrial stocks and the original Dow average became a railroad stock index. More companies were added to the industrial index until 1928, when the number was increased to 30. The Dow Jones Industrial Average uses a divisor to adjust for events that result in no change in a company's value but that would otherwise influence the index. One such event is a stock split; another is the replacement of one company in the index by another. While this adustment does not result in a change in the index value when a stock splits, because the index is price-weighted the newly split stock will have a lower price and therefore less influence on the index.

Dow Jones Transportation Average The Dow Jones Transportation Average is a price-weighted index. It originated from the index of 9 railroad stocks and 2 industrial stocks that Dow Jones & Co. introduced in 1884. In 1896 when the original index became the Dow Jones Railroad Average the industrial stocks were removed from it. Later, the Railroad Average was renamed to the Transportation Average. In addition to railroads, today the average includes other transportation stocks such as airlines and trucking companies.

Dow Jones Utility Average The Dow Jones Utility Average is a price-weighted index of 15 utility stocks, especially electric utilities and gas utilities. It was created in 1929 with 18 stocks, was increased to 20 stocks six months later, then reduced to 15 stocks in 1938.

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Nasdaq Composite Index The Nasdaq Composite Index is a market capitalization weighted index of more than 5000 stocks. Comprising all Nasdaq-listed common stocks, it is the most commonly used index for tracking the Nasdaq.

Russell 2000 The Russell 2000 is a market capitalization weighted index. It was created in 1984 by the Frank Russell Company. The Russell universe of stocks covers 3000 companies, and the Russell 2000 represents the smallest two-thirds of those companies. As such, it is a small-cap index.

S&P 100 The S&P 100 is a market capitalization weighted index of large-cap companies. This index also is known by its ticker symbol, OEX. It comprises 100 large blue-chip companies across a wide range of industries.

S&P 500 The S&P 500 is a market cap weighted index of large-cap companies from a variety of industries. It includes industrial, utility, transportation, and financial stocks. The S&P 500 is widely used as a benchmark by institutional investors.

Value Line Composite Index The Value Line Composite Index is a broad, unweighted index of approximately 1700 companies covered in the Value Line Investment Survey.

Wilshire 5000 The Wilshire 5000 is a market capitalization weighted index. It was created by Wilshire Associates in 1974. It is the broadest index, including virtually every actively traded U.S. stock.

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Recommended Reading
Isaacman, Max, How To Be An Index Investor Covers the following topics: Overview and Trading of Exchange Index Shares Individual and Professional Strategies for Using Exchange Shares Behavioral Finance The Electronic Index Investor and Trader The Select Sector SPDRs DIA SPY and MDY QQQ WEBS

Trading Costs
The cost associated with trading securities can have a non-negligible impact on portfolio return. Trading costs include the following:

Explicit costs - commissions, fees, and taxes. Market maker spread - difference between the bid and ask prices that the specialist sets for a stock; the specialist keeps the difference as compensation for providing immediacy. For less liquid stocks, the specialist has greater exposure to adverse price movements and likely will make the spread larger. 239

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Market impact - results when high volume trades influence the market price. Market impact can be broken into two components - a temporary one and a permanent one. The temporary component is due to the need for liquidity to fill the order. The permanent impact is due to the change in the market's perception of the security as a result of the block trade. Opportunity cost - the effective cost of price movements that occur before the trade executes.

NYSE specialists sometimes may appear to have a monopoly on trading their respective securities, creating a larger than necessary spread between bid and ask. However, there is more competition than is initially obvious. First, there is competition for the specialist positions, providing the specialist incentive to price fairly. Furthermore, there are other specialists on the floor who may be willing to trade within the spread if it is too wide. The total trading cost of a buy transaction is calculated by taking the percentage increase of the average purchase price as compared to the price when the buy decision was made, and adding the commissions, fees, and taxes as a percentage of the price when the buy decision was made. Active portfolio managers attempt to outperform passive benchmarks, but trading costs reduce any realized advantages. Typical trading commissions run 0.20% of the transaction amount, and the typical cost due to bid-ask spread and market impact is 0.55%. The total cost of a trade then is 0.75% of the trade amount. If a fund has a portfolio turnover rate of 80%, and for every sell transaction the stock is replaced via a buy transaction, a total of 160% of the portfolio value will be transacted each year. For trading costs of 0.75% per transaction, the annual trading costs amount to (1.6)(0.75%) = 1.20% of the portfolio value. If one adds a 0.3% management fee to this amount, the total becomes 1.50%.

Reducing Trading Costs: Passively Traded Funds Passive portfolios have lower transaction costs and overall trading costs. The transaction cost is typically 0.25% of the transaction value, since a passive portfolio does not have to trade as quickly and can be more patient with each transaction. A typical turnover rate for a passive portfolio is about 4% per year, and assuming replacement 8% of the portfolio value will be transacted each year for annual trading costs of only (0.08)(0.25%) = 0.02% of the portfolio value. Passive portfolios have lower management fees, for example, 0.10%, so the total of trading costs and management fees is only 0.12%, compared to 1.50% for a typical actively managed fund. Passively managed funds that track an index often have returns less than that of the index because of trading costs, especially for small-cap indices in which the securities are less liquid. These trading costs can be reduced if the weights of the securities in the fund are allowed to deviate somewhat from the index, since both trading volume and the 240

Finance Material need for immediacy are reduced. The correlation with the index still can remain quite high under the relaxed weights. In 1982 Dimensional Fund Advisors (DFA) introduced a passive small-cap "9-10" fund composed of the lower two deciles of NYSE market capitalization. The fund sacrificed tracking accuracy by allowing the weights to deviate in order to minimize trading costs. The result was higher performance than other small-cap funds. The 9-10 fund even outperformed the stocks in the lower two market capitalization deciles of the NYSE, partly due to the following strategies: 1. The 8th decile is treated as a hold range, not a sell range, 2. The DFA waits a minimum of one year before buying IPO's, 3. The fund does not buy stocks selling for less than $2 or having less than $10 million in market capitalization, 4. The fund does not buy NASDAQ stocks having fewer than four market makers, 5. The fund does not buy bankrupt stocks, and 6. The fund is passive, not rigidly indexed. Note that using the 8th decile as a hold range effectively increases the average market cap of the portfolio and increases returns in periods in which large caps outperform small caps, such as in the 1980's.

Reducing Trading Costs: Electronic Trading Electronic crossing networks have lower trading costs than do exchanges because of lower commissions, no bid-ask spread, and elimination of market impact. By matching the natural buyers and sellers of a security at some predetermined price, for example, the NYSE closing price, electronic crossing networks eliminate the need for a market maker to provide liquidity. However, crossing networks require buyers and sellers to participate in order for there to be liquidity. Furthermore, there are the disadvantages of potentially limited liquidity and no inherent price discovery mechanism. Electronic communications networks are computerized bulletin boards for matching trades. Because the traders can remain anonymous, price impact is diminished. Another electronic trading mechanism is the single-price call auction in which buyers and sellers simply place limit orders. The market clearing price is set at the intersection of the supply and demand curves.

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Market Timing
Some investment managers and individual investors attempt to improve their performance by timing the market and adjusting their portfolio according to predictions about the market or specific sectors. Examples of market timing include switching among sectors, switching among different countries' securities, switching between stocks and bonds, or switching between stocks and risk-free treasury bills. The effect of correctly timing the market would be to increase the portfolio beta in up markets and decrease it in down markets. For the purpose of this discussion, an up market is one in which the market return exceeds the risk-free rate, and a down market is one in which the market return is less than the risk-free rate. Proponents of market timing may argue that the market timer does not have to be correct 100% of the time in order to benefit from timing. Some even may argue that for market timing to be worthwhile, the timer simply must be right more often than wrong. Opponents to market timing may argue that the financial markets are fairly efficient, and therefore there is little to be gained from attempting to time them. Furthermore, there are transaction costs and tax implications associated with buying and selling stocks, 242

Finance Material both of which create an inherent disadvantage for the market timer. Finally, opponents of market timing may argue that no market timer can be correct 100% of the time, and the lost opportunity caused by missing a bull market or the significant losses of getting caught in a bear market require much more than 50% of a market timer's predictions to be correct in order to benefit from the strategy. One can test this argument by creating a model to determine how accurate the market timer's predictive ability must be in order to benefit from the strategy. William Sharpe provided such a framework for evaluating the potential of market timing in his 1975 publication "Likely Gains from Market Timing". The potential gains from market timing can be modeled by considering an investor who switches between 100% equity and 100% cash equivalents invested at the risk-free rate. The goal is to determine what the probability of correctly predicting up or down markets must be in order to make timing worthwhile. Define: up = probability of an up market down = probability of a down market pcorrect = probability of correctly predicting an up or down market where an up market is defined as the situation in which stock returns exceed the riskfree rate in the period under consideration. Historically, up = 67% and down = 33% One then can draw a tree that leads to four outcomes: 1. 2. 3. 4. Up market, predicted up. [ probability = uppcorrect ] Up market, predicted down. [ probability = up(1 pcorrect) ] Down market, predicted up. [ probability = down(1 pcorrect) ] Down market, predicted down. [ probability = downpcorrect ]

Using historical market data from 1934 to 1972 and analyzing returns assuming various levels of predictive ability, the result is that in order to perform better than simply remaining fully invested in stocks, one must be able to predict the market with at least 83% accuracy, a predictive ability that would be extremely difficult for even the best market timer to sustain. However, this comparison has not considered risk - staying fully invested at all times results in more portfolio variance. The market timer is not invested in stocks 100% of the time, and therefore experiences less variability in portfolio return. To make a fair comparison, one must adjust for the differences in risk. If one compares the market timer's return to that of a portfolio of stocks and cash weighted to have the same standard deviation as the market timer's portfolio, the result is that the market timer must be correct 74% of the time in order to perform better than the passive portfolio of 243

Finance Material the same risk. So even after adjusting for risk, a significant predictive ability still is required. One can evaluate the success or failure of a portfolio manager's market timing strategy by performing the following regression: Rpt RFt = a + b(Rmt RFt) + c(Rmt RFt)2 + ept

where Rp is the portfolio return, RF is the risk-free rate, Rm is the market return. If the value of c is greater than zero, than some ability to time the market has been demonstrated. An alternative method is to perform the following regression: Rpt RFt = a + b(Rmt RFt) + c[(Rmt RFt)Dt] + upt

In this regression, Dt = 1 if Rmt> RFt, 0 otherwise. If the value of c is greater than zero, than some ability to time the market has been demonstrated. Using this equation, b is the beta in down markets, b+c is the beta in up markets, and c is the difference in the up market and down market betas.

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