Sophisticated analytical methods (viz. wide-angle X-ray scattering, Fourier transform infrared spectroscopy, and scanning electron microscopy have been applied to investigate the mechanism of toughening of epoxy cresol novolac resin due to the addition of carboxy-terminated polybutadiene (CTPB) liquid functional rubber. The average molecular interchain spacing < R > in Angstroms of neat epoxy and epoxy-rubber blends were calculated from the strong maximum in the diffraction scan using established equations. The half-width < HW > of the maximum was used to qualitatively describe the distribution of < R >. An increase in < R > value signifies formation of a separate packing order, as well as an increase in the free volume which, however, varies with the extent of compatibilization between epoxy cresol novolac and CTPB. Fourier transform infrared studies convincingly establish the crosslinking between the oxirane group of epoxy and the carboxyl group of CTPB as reflected in the characteristic peak shifts in the blends, compared with individual polymers. The merger of several peaks of individual polymers, as well as the appearance of minor peaks elsewhere, were also evident. Scanning electron microscopy studies have also been undertaken to study the phase morphology development, as well as changes in the fracture surface topography with varied CTPB content.