M. Sc and M.

Phil diaries

1. Financial economics
 Book: intermediate financial management by Brigham and Gaffe;
Financial theory and coporate finance by westen and Copeland
Advance capital budgeting
 Financial institution instrument and markets by Christopher Viney

Risk: uncertainty or probability that actual return will be different from expected return.

 Difference between value stock and growth stock

 Read about mudarba (two parties, one provides money and other services. Capital provider act
as sleeping partner. Profit is determined according to capital-sharing ration. While, musharaka
(both parties provide capital and services – profit is distributed according to capital sharing
ratio)
 Wakala – principle agent relationship: have to pay either take service or not. While JUALA:
performance based e.g. if you receive any service you’ll pay for that
 Endowment fund: work like perpetuity. It means that you’ll not use amount but will get rate of
return on that amount for infinite period.
 Learn about Sukuk, Libor and Kibor

Value stock large companies low risk low return

Growth stock related to smaller companies. Risk return is high

How to determine that if a security is risk free or not?

 Via holding period and maturity period

Let assume the security you have has holding period of 1 year and maturity period of 5 year. After 1
year you will get money but bond isn’t still mature. While there is no more holding period. So what
is risk here? Interest rate risk! Because after 1 year interest rate can decrease and it will lead to
interest rate risk.

Now let’s assume holding period is 1 year and maturity period is 6 month. If means after 6 months
you’ll reinvest so there exist reinvestment risk. Again it would be risk free asset

If both holding period and maturity period are equal it implies that its risk free asset. But still
there exist some issue. Inflation so it’s clear that no treasury can ever is completely risk free.

 Research about retained earning

 What is meant by stock split ? When share price got high, buyer and sellers for that got
clearance. Its phenomenon that adjust the trading of share whose price got high by splitting it
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into small shares leading to trading again. While stock merger is when prices go too low then
there is need of merger price. So by merge, its negative impact is decreased.

Common size analysis and Variance analysis:

1. Operational variance 2) planning variance

What is budget? It is statement of expected revenues, expenses and cash flows for specific period
explained in monetary terms.

 All public sectors budgeting in Pakistan is incremental budgeting. While zero based budgeting
has nothing to do past. Annual justification of resources. One other type of budgeting is activity
based budgeting: every activity creates cost so allocation will do on the basis of activity.

There are how many kinds of securities?

1. Bonds
2. Preferred stocks (guaranteed dividend; redeemable; no voting rights generally)
3. Common stock (dividend is not fixed and there is no regular dividend)

 Type of bonds
1. Federal/ Govt/ Treasury bond: issued by govt, safest of all
2. Corporate bond: issued by corporation, chances of default
3. State/municipal bond: less chances on default
4. Foreign bond

 Euro bonds
The bonds issued other than home country

 Characteristics of bonds
o Par value
o Coupon rate
o Time to maturity

What is yield to maturity? Rate at which current price will be equal to returns.

What is Yield to call? Generally speaking, bonds are callable over several years and are normally called
at slight premium. But question is why bonds are called back? Due to change in interest rate, For
example if interest rate is 10% at time of issue of bond but decreases after some time. Company will call
back and will pay call back return. It’ll issues at new rate i.e. 8%.

Normal and non-normal projects: normal projects are followed by inflows after outflows, while in case
of non normal projects in period 1 there is cost and then inflow in period 1 and then again there is
inflow in period 2 and 3 without any outflow or vice versa.

 For project selection: Payback method ignores cash inflows received afterward. In case of
independent projects if NPV of both projects is positive then accept both. If NPV=0 it means that
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cost has been recovered and 2ndly RRR has been paid to investor. Similarly if IRR > cost of
capital NPV is positive. NPV is better measure than IRR.

CASE: Investing in one stock

It must be kept in view the level of recession or depression in mind. The first break through of
portfolio is given by Marocuitz (Noble prize winner) through mean variance. Never invest in one stock,
invest in more than one stock and choose those whose correlation is minimum. COV (A, B) should be
negative or minimum. Stocks that are negatively correlated have less risk. So to minimize the risk
while making portfolio, always choose those stocks that are negatively correlated and have minimum
weight.

Derivatives: is a financial product designed to manage risk exposure. It has a price. Derivative implies
that its price is derived from an underlying physical market product, a commodity such as gold or
financial security such as shares or certain debt instruments.

Option: is a contract which gives the owner the right but not obligation to buy or sell an underlying
asset at specified strike price or before a specified

What is banking? Business activity of accepting and safeguarding money owned by other individuals and
entities and then lending out this money in order to earn a profit.

Bank Code: a voluntary code of practice adopted by banks and building societies in their dealing with
their customers.

Bank draft: a check drawn by one bank against funds deposited into its account at other bank,
authorizing the second bank to make payments to individuals named in the draft. Banking industry can
be divided into following sector:

1. Retail banking
2. Commercial
3. Cooperative
4. Investment
5.
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Open Economy Macroeconomics

1. What is basic difference between small and large open economy?

2. Explain the advantages of indirect ER?

3. What is an arbitrage? What are its results?

4. Is there direct relationship between capital account and GNP> yes or no.
Why?
No, because GNP is MV of goods and services produced by domestic FOP during current period. So
earning received from labor and capital working abroad is recorded in current account and not in capital
account. In capital account, we record sale and purchase of assets in foreign markets, so there is no
direct relationship between capital account and GNP.

5. What is relative purchasing power parity and what it implies?

The rate of appreciation of nominal ER equals the foreign inflation rate minus domestic inflation rate.
Relative purchasing power parity usually works well for high inflation countries because in those
countries change in relative inflation rates are usually much larger than changes in real ER.

6. What is currency swap?

A swap involves the exchange of principal and interest in one currency for the same in another currency.
Suppose US company needs to acquire Swiss francs and Swiss company need to acquire US $. Then both
can arrange currency swap on i-rate (fixed), agreed upon a common date for exchange.

7. Explain the main idea of purchasing power parity?

The idea that similar foreign and domestic goods or basket of goods should have the same price in terms
of same currency is call PPP. It is represented as

E (nominal) = P (Foreign) / P (Domestic)

8. What is difference between real and effective real ER?

An ER adjusted to reflect the different inflation rates in the countries of two currencies is called RER.
ERER is weighted average of value of a country’s currency relative to a basket of other major currencies
adjusted for difference in inflation.

9. There is no major difference between spot rate and forward rate as both
are decided in the current time period. True or false? Explain.
False, Spot rate is present value of a currency. This rate is constantly changing due to trading on
currency exchange. While forward rate is a specific ER at which two parties agree to trade currencies.
Parties in question enter into a forward contract that specifies on ER and a future date of exchange.
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10. Speculator and arbitrageur tend to earn profit by purchasing

currency when it is cheap and selling it when it becomes expensive.
True or false, Explain
False. Arbitrage earn profit by immediate purchase and sale of currency while speculator by future
expectation.

11. A country is facing persistent trade deficit and monetary

authorities decide to devalue the currency to get rid of this situation.
Despite of improved trade balance situation, country faces a further
worsening of trade balances. What could be possible reason?
There is perfect J-curve example in which country faces continuous deficit and devalues its currency to
fix it, but there are two effects. One is SR and second is LR, situation will be improved in LR. Its imports
are price inelastic and so exports are because of already existing contracts.

12. How fixed ER and flexible ER regime affect the BOP of a country?
no automatic BOP adjustment is related to fixed ER. The BOP problem would have to be solved by
reduction or expansion in level of AD. This action would give birth to other problems like
unemployement, deflation and economic slowdown. Whereas flexible ER provide automatic BOP
adjustments where deficit is eliminated by depreciation and surplus by appreciation of currency.

13. How could ER differential result in higher capital inflow?

14. What does a ‘forward market’ means? What are its main
functions?
Market dealing in commodities, currencices and securities for future delivery at prices agreed upon
today is called forward market.

15. What is the basic difference between Solow growth model and
Endogeous growth model?
Technology is main difference.
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Macro Economics

Books:
 William Scarth, Bernanke; David Romer; McCallum
 You must be aware of static, rational and adaptive expectation, Solow and Ramsey model;
balanced and unbalanced growth theories; endogenous and exogenous growth theories;
 Growth centers and poles
 According to monetarist, inflation is always and everywhere a monetary phenomenon.
 Different theories of business cycle: actual output fluctuates around LR average growth path.
o Classical model, Keynesian model, monetarist model, new classical and new Keynesian
model

Growth facts
1. Enormous differences in real per capita GDP across different countries
2. There are significant differences in growth rates across different countries
3. Growth rates aren’t constant over time
4. Countries relative position in distribution of world’s DGP is not immutable. Countries can move
from being rich to being poor and vice versa.

Solow and Ramsay model

In Solow model, study state capital stock may not be equal to golden rate. Its assumption in Solow
model that saving rate is exogenous. Ramsay model is same as Solow model, the only difference is that
saving is not exogenous rather agents take decision on saving that maximize their life time utility.

 Solow growth model assumptions are

o Countries produced and consume only one commodity
o There is no international trade
o Technology is exogenous
o Saving rate is exogenous i.e. people save a constant fraction of
their income
o Each person in the economy supply one unit of labor
o Technology grows at constant rate. And population growth is
exogenous.
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Econometrics
 Autocorrelation: correlation of given series with itself. One assumption of CLRM is that there is
no autocorrelation.
 Anova, F-testing, hypothesis testing; Hetroskedasticity and homeskedastcity
 Multicollinearity: it occurs when no of parameters to be estimated are greater than no of
observation. Or number of explanatory variables is greater than number of observations.
 R square; coefficient of determination;
 There are two methods of hypothesis testing. One is confidence interval approach and other is
pre-test approach.
 Cross sectional data (set of values or observation that one or more variables take at one point
of time only) and time series data (set of values or observations that variable X takes at different
time intervals) and panel data (combination of time series and cross sectional data)

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Micro economics
 Comparative static analysis
It depends on two effects. First, effect of change in income of consumer and 2 nd effect of change in
price of consumer.

Marshallian demand curve include SE and IE while Hicksian include SE only

 Cobb Douglas PF
Q = f (K, L) = A Kα Lβ

It can exhibit any degree of return to scale depending on value of α and β.

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Monetary Economics (Mishkin)

 Field of economics that deals with theories, ideas, concepts and issues related to money

History
Why monetary economics as a separate field? Money as a commodity has many important features
which are not in other commodities. Monetary policy has overwhelmingly important effects on
variable related to individuals e.g. wages, prices, employment level and output level etc.

Before WW-1, currency was fully backed by gold reserves. After war, inflation rate increased there
was need of printing new money and gold was not enough. Thus fixed ER or more importantly gold
standard collapsed. In 1930s there was great depression. Then Brettonwood system came and for
protection of IMS was IMF and IBRD were established. According to this system, all currencies would
set parity in response to dollar and dollar would set parity with respect to gold. Thus somehow fixed
ER system was saved from collapse and now most of currencies were pegged with dollar.

But why dollar? Because US has one-half of worlds manufacturing capacity, two-third of gold
reserves.

This system collapsed during 1970s oil crisis and then monetarist system was introduced. Fixed ER
system fully collapsed and thus managed floating ER or dirty floating was introduced as patch up try
but oil price shock led to full collapse of BWS.

Monetarism
Fiscal policy isn’t effective. They led to restatement of QTM. Paul Volcker administration, president
of Fed, had done “monetarist experiment’, but it wasn’t practiced in any country.

Theories of Md (Mishkin Ch: 21)

 QTM by classical (money as medium of exchange) and Cambridge economists (people save for
transactive purpose too, money as store of value) Md = f(Y)
 Liquidity preference theory by J. M Keynes (transactive motive, speculative and precautionary
motive) Md = f (Y, i)
 Inventory theoretic approach by Baumol and Tobin Md= f (L, i ,b)

Tobin theory was that there is no normal rate of interest to which general i-rate has to divert.
Though money pays no interest but it is riskless too. Bonds pay nominal return but these are risky as
well. They could result in capital gain or loss. Tobin say’s that there is no Plunger (only bonds/ only
money) rather individual hold some portion of wealth in form of money and remaining in form of
bonds as doing so would minimize the risk.

Main difference between Keynesian theory and Tobin theory is that Tobin says that interest rate is
different for all goods like on durable, equity, stocks and assets. While Keynes just categorizes all
these in just one category and assumes that there is just one type of interest on all these
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 Portfolio diversification theory:

 Restatement of QTM by Milton Friedman

Friedman didn’t introduced broader term of bond, rather shown that expected return on different
assts as determinants of demand for money. This theory explains that money and goods are
substitutes. Assets demand is positive for wealth, expected returns, and liquidity but negative for
risk.

What is High powered money? The liabilities of central bank those are usable as money.

External Finance Premium (EFP):

The difference between funds raised internally and funds raised externally.

Read inside the Black box by Bernanke and Geltor

Types of ER
 Direct ER: price of foreign currency in terms of domestic currency. Rs 155/$. Opposite for
indirect ER
 Nominal and real ER. RER is unit free. In real life, we don’t use RER. If RER = 1, it means
purchasing power parity holds and both countries have same competitive position. If RER < 1,
foreing country has favourable competitive position.
 Fixed ER: central bank announces an ER and then is always willing to buy and sell foreign
currency at that rate. This is possible only, if the central bank has huge foreign exchange
reserves.
 Flexible ER policy: in this policy regime, ER is determined by market forces that is demand and
supply of foreign exchange and central bank doesn’t intervene in market.
 Managed float: in this policy regime central bank has some unannounced ER limits. ER is free to
float within that limit and whenever ER crosses the limit from either side, cental bank intervene
in the market to put ER back.


Effects of increase in Ms
 Liquidity effect ( i-rate fall): Ms > Md. People will induce to buy more bonds, so price of bonds
will increase and interest rate will fall.
 Income effect: expansionary influence on economy leading to increase in income  Md  i-
rate
 Price level effect
 Expected inflation effect

The monetary transmission mechanism

o Interest rate; ER; price of financial assets and banking channel

OMO: Repo (Repurchase agreement)

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A ST loan by commercial bank from central bank. While in reverse repo central bank take loan
from commercial bank.
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Public Economics
 production, distribution, allocation and exchange efficiency.
 The evaluation of public programs are based on balancing the efficiency and equity as there
exist trade-off between these.
 Welfare should be made on the basis of consequences of different policies in terms of gains and
losses of policies
 Crowding out is phenomemon in which explansionary fiscal policy causes i-rate to rise and
investment to decrease, therefore, increase in government spending crowd out investment
spending.

5.
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International Economics
Books:
 Salvatore, international economics, 9th Edition
 International economics – theory and policy, Paul R. Krugman and Maurice Obstfeld

Case study:
 The difference between international and national trade: describe in detail different marketing
channels, firms, currencies, documents, suppliers etc for a US and foreign product such as
Corvette and a Mazda Miata
 Labor productivity and comparative advantage: pick any two countries and compare their trade
and productivity by industry
 Competition and international trade
 The evolution of MNCs
 Alternative trade theories: Product cycle, technological gap, EOS, Linder hypothesis
 Non tariff measures
 Tariff protection: Arguments for protection (many industries have been involved in controversy
for decades over tariff rates. Pick one that is interesting and review the arguments over time),
Effective rates of protection
 Regional integration: recent example which could be analyzed.
 Immiserizing growth

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Mathematical Economics
Books:
 Fundamental methods of mathematical economics by Alpha C. Chiang
 Essential mathematics for economics and business by Bradely, Teresa and Paton Paul
 The structure of Economics: A Mathematical analysis