by Tewarit Maneechay
Finance studies and addresses the ways in which individuals, businesses, and organizations raise, allocate, and use monetary resources over time, taking into account the risks entailed in their projects. The term finance may thus incorporate any of the following:
The study of money and other assets;
The management and control of those assets;
Profiling and managing project risks;
The science of managing money;
As a verb, "to finance" is to provide funds for business or for an individual's large purchases (car, home, etc.).
The activity of finance is the application of a set of techniques that individuals and organizations (entities) use to manage their financial affairs, particularly the differences between income and expenditure and the risks of their investments.
An entity whose income exceeds its expenditure can lend or invest the excess income. On the other hand, an entity whose income is less than its expenditure can raise capital by borrowing or selling equity claims, decreasing its expenses, or increasing its income. The lender can find a borrower, a financial intermediary, such as a bank or buy notes or bonds in the bond market. The lender receives interest, the borrower pays a higher interest than the lender receives, and the financial intermediary pockets the difference.
A bank aggregates the activities of many borrowers and lenders. A bank accepts deposits from lenders, on which it pays the interest. The bank then lends these deposits to borrowers. Banks allow borrowers and lenders, of different sizes, to coordinate their activity. Banks are thus compensators of money flows in space.
A specific example of corporate finance is the sale of stock by a company to institutional investors like investment banks, who in turn generally sell it to the public. The stock gives whoever owns it part ownership in that company. If you buy one share of XYZ Inc, and they have 100 shares outstanding (held by investors), you are 1/100 owner of that company. Of course, in return for the stock, the company receives cash, which it uses to expand its business in a process called "equity financing". Equity financing mixed with the sale of bonds (or any other debt financing) is called the company's capital structure.
Finance is used by individuals (personal finance), by governments (public finance), by businesses (corporate finance), etc., as well as by a wide variety of organizations including schools and non-profit organizations. In general, the goals of each of the above activities are achieved through the use of appropriate financial instruments, with consideration to their institutional setting.
Finance is one of the most important aspects of business management. Without proper financial planning a new enterprise is unlikely to be successful. Managing money (a liquid asset) is essential to ensure a secure future, both for the individual and an organization.
Personal finance
Questions in personal finance revolve around
How much money will be needed by an individual (or by a family) at various points in the future?
Where will this money come from (e.g. savings or borrowing)?
How can people protect themselves against unforeseen events in their lives, and risk in financial markets?
How can family assets be best transferred across generations (bequests and inheritance)?
How do taxes (tax subsidies or penalties) affect personal financial decisions?
Personal financial decisions may involve paying for education, financing durable goods such as real estate and cars, buying insurance, e.g. health and property insurance, investing and saving for retirement.
Personal financial decisions may also involve paying for a loan.
Business finance
In the case of a company, managerial finance or corporate finance is the task of providing the funds for the corporations' activities. For small business, this is referred to as SME finance. It generally involves balancing risk and profitability. Long term funds would be provided by ownership equity and long-term credit, often in the form of bonds. These decisions lead to the company's capital structure. Short term funding or working capital is mostly provided by banks extending a line of credit.
On the bond market, borrowers package their debt in the form of bonds. The borrower receives the money it borrows by selling the bond, which includes a promise to repay the value of the bond with interest. The purchaser of a bond can resell the bond, so the actual recipient of interest payments can change over time. Bonds allow lenders to recoup the value of their loan by simply selling the bond.
Another business decision concerning finance is investment, or fund management. An investment is an acquisition of an asset in the hopes that it will maintain or increase its value. In investment management - in choosing a portfolio - one has to decide what, how much and when to invest. In doing so, one needs to
Identify relevant objectives and constraints: institution or individual - goals - time horizon - risk aversion - tax considerations
Identify the appropriate strategy: active vs passive - hedging strategy
Measure the portfolio performance
Financial management is duplicate with the financial function of the Accounting profession. However, Financial Accounting is more concerned with the reporting of historical financial information, while the financial decision is directed toward the future of the firm.
Shared Services
There is currently a move towards converging and consolidating Finance provisions into shared services within an organization. Rather than an organization having a number of separate Finance departments performing the same tasks from different locations a more centralized version can be created.
Finance of states
Country, state, county, city or municipality finance is called public finance. It is concerned with
Identification of required expenditure of a public sector entity
Source(s) of that entity's revenue
The budgeting process
Debt issuance (municipal bonds) for public works projects
Financial economics
From Wikipedia, the free encyclopedia
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Financial economics is the branch of economics concerned with resource allocation over time. It is further distinguished from other branches of economics by its "concentration on monetary activities", in which "money of one type or another is likely to appear on both sides of a trade" .
The questions addressed by the discipline are typically framed in terms of "time, uncertainty, options and information" .
Time: money now is traded for money in the future.
Uncertainty (or risk): The amount of money to be transferred in the future is uncertain.
options: one party to the transaction can make a decision at a later time that will affect subsequent transfers of money.
Information: knowledge of the future can reduce, or possibly eliminate, the uncertainty associated with future monetary value (FMV).
Subject matter
Given its scope, as above, financial economics tends to deal with the workings of financial markets, such as the stock market, and the financing of companies, and includes the following subject areas: Budgeting, saving, investing, borrowing, lending, insuring, hedging, diversifying, and asset management. Because the future is never known with certainty, a central concern of financial economics is the impact of uncertainty on resource allocation.
Financial economics thus attempts to answer questions such as:
How are the prices of financial assets determined (stocks, bonds, currencies, and commodities)?
What are the effects of a company choosing different methods of financing its operations, such as issuing shares or borrowing?
What portfolio of assets should an investor hold in order to best meet his/her objectives?
Assumptions
Financial economics is based on several assumptions - chief amongst these, that financial decision makers are rational (see Homo economicus; Efficient market hypothesis). However, recently, researchers in Experimental economics and Experimental finance have challenged this assumption empirically. Further, these assumptions are challenged - theoretically - by Behavioral finance, a discipline primarily concerned with the rationality, or lack thereof, of economic agents.
Other common assumptions include market prices following a random walk, or asset returns being normally distributed. Empirical evidence suggests that these assumptions may not hold, and in practice, traders and analysts, and particularly risk managers, frequently modify the "standard models".
Mathematical finance
Mathematical finance is the branch of applied mathematics concerned with the financial markets.
The subject has a close relationship with the discipline of financial economics, which is concerned with much of the underlying theory. Generally, mathematical finance will derive, and extend, the mathematical or numerical models suggested by financial economics. Thus, for example, while a financial economist might study the structural reasons why a company may have a certain share price, a financial mathematician may take the share price as a given, and attempt to use stochastic calculus to obtain the fair value of derivatives of the stock.
In terms of practice, mathematical finance also overlaps heavily with the fields of financial engineering and computational finance. Arguably, all three are largely synonymous, although the latter two focus on application, while the former focuses on modelling and derivation; see Quantitative analyst.
Many universities around the world now offer degree and research programs in mathematical finance.
Experimental finance
The goals of experimental finance are to establish different market settings and environments to observe experimentally and analyze agents' behavior and the resulting characteristics of trading flows, information diffusion and aggregation, price setting mechanism and returns processes. This can happen for instance by conducting trading simulations or establishing and studying the behaviour of people in artificial competitive market-like settings.
Researchers in experimental finance can study to what extent existing financial economics theory makes valid predictions and attempt to discover new principles on which theory can be extended.
Finance:Portfolio Theory
Harry Markowitz
"Portfolio Selection", Journal of Finance, 7 (1),1952, 77-91.
Description: Development of the utility framework which shows an optimum can be reached using a portfolio of investments. In effect the first real proof that you should not put all your eggs in one basket.
Importance: Precursor to most modern portfolio theory work in finance.
Capital asset pricing model
William Forsyth Sharpe
"Capital asset prices: A theory of market equilibrium under conditions of risk", Journal of Finance, 19 (3), 1964, 425-442
Description: Development of the Capital asset pricing model used to determine appropriate prices for assets.
Importance: Topic creator, Influence
The pricing of options and corporate liabilities
Fischer Black and Myron Scholes
"The Pricing of Options and Corporate Liabilities" Journal of Political Economy 81, 1973, 637–654.
Description: It developed the Black-Scholes model for determining the price of options, in particular stock options. The use of the Black-Scholes formula has become pervasive in financial markets, and has been extended by numerous refinements.
Importance: Breakthrough, Influence
Financial plan
In general usage, a financial plan can be a budget, a plan for spending and saving future income. This plan allocates future income to various types of expenses, such as rent or utilities, and also reserves some income for short-term and long-term savings. A financial plan can also be an investment plan, which allocates savings to various assets or projects expected to produce future income, such as a new business or product line, shares in an existing business, or real estate.
In business, a financial plan can refer to the three primary financial statements (balance sheet, income statement, and cash flow statement) created within a business plan. Financial forecast or financial plan can also refer to an annual projection of income and expenses for a company, division or department. A financial plan can also be an estimation of cash needs and a decision on how to raise the cash, such as through borrowing or issuing additional shares in a company.
While a financial plan refers to estimating future income, expenses and assets, a financing plan or finance plan usually refers to the means by which cash will be acquired to cover future expenses, for instance through earning, borrowing or using saved cash.
Right-financing
The Concept of Right-Financing
The concept of right-financing was coined by English Political Economist Dr. Peter Middlebrook to highlight the importance of adopting the appropriate policy, institutional and financial support mechanisms to maximize sustainable returns on both public and private investments over time. The term goes beyond the public sector restructuring concept of right-sizing in that it looks to assess the policy mandate and size of an institutional entity, its functions and their discharge, as well as the staffing structure and establishment with regard meeting investment and development objectives. Whilst originally applied to the security sector, its application as a conceptual framework brings governance, public and private investment finance principles to work towards an optimal financing framework for a given investment.
Whilst originally used to refer to the fiscal vulnerabilities faced by fragile and post conflict states in establishing sustainable national security systems, the concept of right-financing is premised on the importance of adopting sound public finance management and public and private investment principles in support of overall economic effectiveness, efficiency and fiscal sustainability. Right-financing is therefore essentially about determining an acceptable supply of financing for government and private sector entities as they look to deliver higher-quality and more equitable services over time. Establishing the right policy, institutional, financing, debt and loan, revenue, fiscal, monetary and security decisions early on in the investment phase is therefore essential to establishing an effective economic growth policy, institutional and risk management framework.
Use in Private and Public Investment Financing
The right-financing can be extended to guide public and private corporations in raising funds in capital markets (both equity and debt) and in strengthening strategic investment advice with regard to mergers, acquisitions and other types of financial transactions. To this end, the concept of right-financing “ supports the determination of sustainable economic policies, strategies, financial institutions and market delivery capacities that balance governance and accountability, service quality and fiscal sustainability concerns with regard to both public and private investments”. The right-financing approach takes into consideration the political economy of change and its implication for the investment climate; the processes of production, the acts of buying and selling, and their relationships to law, markets, customs and government.
For more on right-financing follow the external links to the OECD and World Bank.
The Concerning web link
Investment
Investment or investing is a term with several closely-related meanings in business management, finance and economics, related to saving or deferring consumption. An asset is usually purchased, or equivalently a deposit is made in a bank, in hopes of getting a future return or interest from it. Literally, the word means the "action of putting something in to somewhere else" (perhaps originally related to a person's garment or 'vestment').Click for read more...
Settlement (finance)
Settlement (of securities) is the process whereby securities or interests in securities are delivered, usually against payment, to fulfill contractual obligations, such as those arising under securities trades.
This involves the delivery of securities to perform contractual delivery obligations. It usually also involves the corresponding payment of a purchase price. Usually settlement is preceded by trading, which involves entering into contracts of sale and purchase.
Although settlement is generally becoming quicker, in most markets a number of business days still elapse between trading and settlement (the settlement date). The settlement date for marketable stocks is usually three business days after the trade was executed and for listed options and government securities it is usually one day. A number of risks arise for the parties during the settlement interval, which are managed by the process of clearing, which follows trading and precedes settlement. Clearing involves modifying those contractual obligations so as to facilitate settlement, often by netting and novation.Click for read more...
Behavioral finance
Behavioral finance and behavioral economics are closely related fields which apply scientific research on human and social cognitive and emotional biases to better understand economic decisions and how they affect market prices, returns and the allocation of resources. The fields are primarily concerned with the rationality, or lack thereof, of economic agents. Behavioral models typically integrate insights from psychology with neo-classical economic theory.
Behavioral analyses are mostly concerned with the effects of market decisions, but also those of public choice, another source of economic decisions with some similar biases.Click for read more...
studyfinance.com
studyfinance.com is the web site for students of introductory finance at The University of Arizona. It is designed to serve as a starting point to learn about what finance majors do, how to get started in a finance career, and the finance curriculum at The U of A.Click for read more...
Wharton Finance Knowledge Project
Wharton Finance Knowledge Project - aimed to offer free access to finance knowledge for students, teachers, and self-learners.Click for read more...
Financial Glossary
The financial glossary is provided for informational purposes only, and is not intended for trading purposes. The editor shall not be liable for any errors or delays in the content, or for any actions taken in reliance thereon. Click for read more...
TheStreet.com Glossary
TheStreet.com Glossary for stock market related financial definitions Click for read more...
Behavioral Finance Research Initiative
OUR MISSION
The International Center for Finance at the Yale School of Management provides active support for research in financial economics by its fellows and disseminates their work to the world's academic and professional communities. The Center�s fellowship is comprised of leading scholars in and outside of the Yale School of Management who work on key empirical and theoretical problems in financial economics. The Center provides a physical locus for their activities consistent with the belief that financial research is by its nature a collaborative venture. To that end, the Center offers data, technology, and staff support for empirical research and underwrites academic conferences that bring together distinguished researchers to cooperatively develop ideas. In addition, the Center provides summer research support and funding for visiting fellows and travel support for doctoral student fellows. The ICF�s working paper series is available both on-line and in print.
CENTER ACTIVITIES
Center fellows produce leading-edge research in key areas of finance, including asset pricing, corporate finance, investment management, market microstructure, behavioral finance, fixed income and derivatives, international financial markets, law and finance, and the history of financial markets. Our special programs include finance conferences at which the world�s leading scholars present their current research. Past conferences have focused on the evolution of the capital markets, developments in market microstructure, behavioral finance, and advances in derivatives and fixed income research. Our distinguished visitor series has featured policymakers such as Sir Leon Brittan and Secretary of the Treasury Lawrence Summers, as well as such noted investors as George Soros. The Center�s summer visiting fellow program provides offices and computer facilities for off-term visitors. A year-round weekly seminar series on new research in financial economics is open to the Yale community and provides a forum for interdisciplinary discussion.
CENTER ASSETS
The International Center for Finance is housed in an historic mansion on Hillhouse Avenue adjacent to the Yale School of Management, the Yale Economics Department, and the Yale Center for International and Area Studies. It maintains a first-class laboratory for empirical research, including state-of-the-art computer facilities and databases and a working paper archive and finance journal library. In addition to the directors, the staff includes a program administrator, a database manager and computer system administrator, a webmaster, and two programmers. The Center provides spacious offices for fifteen research fellows and temporary offices for summer fellows and adjunct professors. Yale University is firmly committed to providing both substantial annual funding for research and assistance in raising future endowment funds to secure the Center�s continued growth.
Click for read more...
Definition of Behavioral finance, and content of this website section
Definition: Behavioral Finance (BF) is the application of individual and collective psychology to finance
and by extension to economics, under the name Behavioral Economics (BE) (*).
(*) Click here for a short description of economics and finance.
BF is based on the study of
* (Behavioral finance micro) how investors make choices and, as part of this decision process, investor behavioral biases / errors,
* (Behavioral finance macro) their effects on financial markets, such as anomalies & inefficiencies on asset prices and returns.
* Other aspects of - not fully rational - financial behaviors and money attitudes (in savings, borrowing, insuring, tax management, gambling...)
BF tries to detect and understand those biases / anomalies, and if possible to use them in investment strategies.
To find more complete definitions of BF, please look at the links in chapter 2. below. Click for read more...
Reference
Wikipedia. 2007. Investment(online). from www.wikipedia.org when 11/07/2007
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