Finance

Finance is a term for matters regarding the management, creation, and study of money and
investments.[1] Specifically, it deals with the questions of how and why an individual, company or
government acquires the money needed – called capital in the company context – and how they
spend or invest that money.[2] Finance is then often split into the following major categories:
corporate finance, personal finance and public finance.[1]

At the same time, and correspondingly, finance is about the overall "system" [1] – i.e., the financial
markets that allow the flow of money, via investments and other financial instruments, between and
within these areas; this "flow" is facilitated by the financial services sector. A major focus within
finance is thus investment management – called money management for individuals, and asset
management for institutions – and finance then includes the associated activities of securities
trading and stock broking, investment banking, financial engineering, and risk management.

Given its wide scope, finance is studied in several academic disciplines, and, correspondingly, there
are several related professional qualifications that can lead to the field.

Contents

1 History of Finance

2 The financial system

3 Areas of finance

3.1 Personal finance

3.2 Corporate finance

3.3 Public finance

4 Financial theory

4.1 Financial economics

4.2 Financial mathematics

4.3 Experimental finance

4.4 Behavioral finance

5 See also

6 References

7 External links

History of Finance

Though its principles are much older, the origin of Finance can been traced to the start of civilization.
We see continuous reformation and innovation in Finance throughout history.
The earliest historical evidence is from the year 3000 BC. We see that Banking originated in
Babylonian empire where in Temples and palaces were used as safe places for the storage of
valuables. Initially, the valuable that can be deposited was only grain, but later cattle and precious
materials are also included. Almost during the same time period, in the Sumerian city Uruk in
Mesopotamia trade was supported by lending. The usage of interest as well was found to be used. In
Sumerian “interest” was mas, which also meant calf. In Greece and Egypt the words used for interest
(tokos and ms respectively) also meant “to give birth”. In these cultures interest indicates an
increase in something. They seem to consider it from lenders point of view.[3]

During the Reign of Hammurabi (1792-1750 BC) in Babylon (the capital city of Babylonia). The
famous Code of Hammurabi includes laws governing banking operations. The Babylonians, were
accustomed to charge interest at the rate of 20 per cent per annum.

In the Biblical world point of view within the Jewish Civilisation (1500 BC), Jews were not allowed to
take interest from other Jews, but they were allowed to take interest from the gentiles, as we see in
the scriptures writings such as:

"If you lend money to any of my people with you who is poor, you shall not be him as a creditor, and
you shall not exact interest from him. (Exodus:20)

You shall not lend upon interest to your brother, interest on money, interest on victuals [foodstuff]
interest on anything that is lent for interest. 20To a foreigner you may lend upon interest, but to
your brother you shall not lend upon interest…” (Deu:23).

The reason for the non-prohibition of the receipt by a Jew of interest from a Gentile, and vice versa,
is held by modern rabbis to lay in the fact that the Gentiles had at that time no law forbidding them
to practice usury; and that as they took interest from Jews, the Torah considered it equitable that
Jews should take interest from Gentiles. In Hebrew, interest is neshek.

In contrast to other ancient civilizations “interest is considered from borrowers point of view.

By 1200 BC Cowrie shell is used as “money” in China.

Abd by 640 BC, the Lydians started to use coin money. Lydia was the first place where permanent
retail shops opened. (Herodotus mentions the use of crude coins in Lydia in an earlier date, i.e. 687
BC.)

600 BC: Pythius became identified as the first banker that had records. He was operating both in
Western Anatolia and in Greece.

The arrival of coin usage as a means of representing money was represented in the years between
(600-570 BC) (1) Chinese started to use coins made of base metal. The cities under the Greek empire
such as Aegina (595 B.C.), Athens (575 B.C.) and Corinth (570 B.C.) started to mint their own coins.

Leading thinkers and statesmen, such as Marcus Pocius Cato Censorius [Cato the Elder] (234 BC-149
BC) and Marcus Pocius Cato Uicensis [Cato the Younger] (95 BC-46 BC) as well as Marcus Tallius
Cicero (106 BC-43 BC), Lucius Annaeus Seneca (4 BC-AD 65) and Masterius Plutarch (46 AD-120 AD)
were against usury. In Republican Rome (340 BC) interest was outlawed altogether (Lex Genucia
reforms). Under the banner of Julius Caesar, a ceiling on interest rates of 12% was set, and later
under Justinian, it was lowered even further to between 4% and 8%.
The core of finance in history was more focused on the banking system, the field of finance was
narrow. It took almost 2500 years to develop a system of interest, mint coins, bring in theories of
interest and inflation.[4] [1][2]

The financial system

Main articles: Financial services, financial market, and Circular flow of income

The financial system consists of the flows of capital that take place between individuals (personal
finance), governments (public finance), and businesses (corporate finance). Although they are
closely related, the disciplines of economics and finance are distinct. The "economy" is a social
institution that organizes a society's production, distribution, and consumption of goods and
services, all of which must be financed.

In general, an entity whose income exceeds its expenditure can lend or invest the excess, intending
to earn a fair return. Correspondingly, an entity where income is less than expenditure can raise
capital usually in one of two ways: (i) by borrowing, in the form of a loan (private individuals), or by
selling bonds (may be government bonds or corporate bonds); (ii) by a corporate selling equity, also
called stock or shares (may take various forms: preferred stock or common stock). The owners of
both bonds and stock may be institutional investors – financial institutions such as investment banks
and pension fund – or private individuals, called private investors or retail investors.

The lending is often indirect, through a financial intermediary such as a bank, or via the purchase of
notes or bonds (corporate bonds, government bonds, or mutual bonds) in the bond market. The
lender receives interest, the borrower pays a higher interest than the lender receives, and the
financial intermediary earns the difference for arranging the loan.[5][6][7] A bank aggregates the
activities of many borrowers and lenders. A bank accepts deposits from lenders, on which it pays
interest. The bank then lends these deposits to borrowers. Banks allow borrowers and lenders, of
different sizes, to coordinate their activity.

Investing typically entails the purchase of stock, either individual securities, or via a mutual fund for
example. Stocks are usually sold by corporations to investors so as to raise required capital in the
form of "equity financing", as distinct from the debt financing described above. The financial
intermediaries here are the investment banks, which find the initial investors and facilitate the listing
of the securities (equity and debt); and the securities exchanges, which allow their trade thereafter,
as well as the various service providers which manage the performance or risk of these investments.

Areas of finance

Personal finance

Main article: Personal finance

Personal finance[8] is defined as "the mindful planning of monetary spending and saving, while also
considering the possibility of future risk". Personal finance 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.[9] Personal finance may also involve paying for a
loan, or debt obligations. The main areas of personal finance are considered to be income, spending,
saving, investing, and protection.[10] The following steps, as outlined by the Financial Planning
Standards Board,[11] suggest that an individual will understand a potentially secure personal finance
plan after:
 Purchasing insurance to ensure protection against unforeseen personal events

Understanding the effects of tax policies (tax subsidies or penalties) management of personal
finances

Understanding the effects of credit on individual financial standing

Developing of a savings plan or financing for large purchases (auto, education, home)

Planning a secure financial future in an environment of economic instability

Pursuing a checking and/or a savings account

Preparing for retirement/ long term expenses[12]

Corporate finance

Main article: Corporate finance

Corporate finance deals with the sources of funding and the capital structure of corporations, the
actions that managers take to increase the value of the firm to the shareholders, and the tools and
analysis used to allocate financial resources. Short term financial management is often termed
"working capital management", and relates to cash-, inventory- and debtors management. In the
longer term, corporate finance generally involves balancing risk and profitability, while attempting to
maximize an entity's assets, net incoming cash flow and the value of its stock, and generically entails
three primary areas of capital resource allocation: (i) "capital budgeting", selecting which projects to
invest in; (ii) dividend policy, the use of "excess" capital; and (iii) "sources of capital", i.e. which
funding is to be used. The latter creates the link with investment banking and securities trading, in
that the capital raised will (generically) comprise debt, i.e. corporate bonds, and equity, often listed
shares.

Although "corporate finance" is in principle different from managerial finance which studies the
financial management of all firms, rather than corporations alone, the main concepts in the study of
corporate finance are applicable to the financial problems of all kinds of firms. Further, although
financial management overlaps with the financial function of the accounting profession, financial
accounting is the reporting of historical financial information, whereas as discussed, financial
management is concerned with increasing the firm's Shareholder value and increasing their rate of
return on the investment. Financial risk management, in this context, is about protecting the firm's
economic value using financial instruments to manage exposure to risk, particularly credit risk and
market risk, often arising from the firm's funding structures.

Public finance

Main article: Public finance

Public finance describes finance as related to sovereign states and sub-national entities
(states/provinces, counties, municipalities, etc.) and related public entities (e.g. school districts) or
agencies. It usually encompasses a long-term strategic perspective regarding investment decisions
that affect public entities.[13] These long-term strategic periods usually encompass five or more
years.[14] Public finance is primarily 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

Central banks, such as the Federal Reserve System banks in the United States and Bank of England in
the United Kingdom, are strong players in public finance, acting as lenders of last resort as well as
strong influences on monetary and credit conditions in the economy.[15]

Financial theory

Finance theory is studied and developed within the disciplines of management, (financial)
economics, accountancy and applied mathematics. Abstractly, finance is concerned with the
investment and deployment of assets and liabilities over "space and time": i.e. it is about performing
valuation and asset allocation today, based on risk and uncertainty of future outcomes,
incorporating the time value of money (determining the present value of these future values,
"discounting", requires a risk-appropriate discount rate).[2] Since the debate to whether finance is
an art or a science is still open,[16] there have been recent efforts to organize a list of unsolved
problems in finance.

Financial economics

Main article: Financial economics

Financial economics is the branch of economics studying the interrelation of financial variables, such
as prices, interest rates and shares, as opposed to goods and services. Financial economics
concentrates on influences of real economic variables on financial ones, in contrast to pure finance.
It centres on pricing and managing risk management in the financial markets, and thus produces
many of the and financial models commonly employed.

It is a field that essentially explores how rational investors would apply risk and return to the
problem of investment. The twin assumptions of rationality and market efficiency lead to modern
portfolio theory (the CAPM), and to the Black–Scholes theory for option valuation; it further studies
phenomena and models where these assumptions do not hold, or are extended.

"Financial economics", also considers investment under "certainty" (Fisher separation theorem,
"theory of investment value", Modigliani–Miller theorem) and hence also contributes to corporate
finance theory. Financial econometrics is the branch of financial economics that uses econometric
techniques to parameterize the relationships suggested.

Financial mathematics

Main article: Financial mathematics

Financial mathematics is a field of applied mathematics, concerned with financial markets. The
subject has a close relationship with the discipline of financial economics, which is concerned with
much of the underlying theory that is involved in financial mathematics. Generally, mathematical
finance will derive, and extend, the mathematical or numerical models suggested by financial
economics.

The field is largely focused on the modelling of derivatives, although other important subfields
include insurance mathematics and quantitative portfolio problems. See Outline of
finance#Mathematical tools and Outline of finance#Derivatives pricing.
In terms of practice, mathematical finance also overlaps heavily with the field of computational
finance (also known as financial engineering). Arguably, these are largely synonymous, although the
latter focuses on application, while the former focuses on modeling and derivation (see: Quantitative
analyst). There is also a significant overlap with financial risk management.

Experimental finance

Main article: Experimental finance

Experimental finance aims to establish different market settings and environments to observe
experimentally and provide a lens through which science can analyze agents' behavior and the
resulting characteristics of trading flows, information diffusion, and aggregation, price setting
mechanisms, and returns processes. Researchers in experimental finance can study to what extent
existing financial economics theory makes valid predictions and therefore prove them, and attempt
to discover new principles on which such theory can be extended and be applied to future financial
decisions. Research may proceed by conducting trading simulations or by establishing and studying
the behavior, and the way that these people act or react, of people in artificial competitive market-
like settings.

Behavioral finance

Main article: Behavioral economics

Behavioral finance studies how the psychology of investors or managers affects financial decisions
and markets when making a decision that can impact either negatively or positively on one of their
areas. Behavioral finance has grown over the last few decades to become central and very important
to finance.[17]

Behavioral finance includes such topics as:

Empirical studies that demonstrate significant deviations from classical theories.

Models of how psychology affects and impacts trading and prices

Forecasting based on these methods.

Studies of experimental asset markets and the use of models to forecast experiments.

A strand of behavioral finance has been dubbed quantitative behavioral finance, which uses
mathematical and statistical methodology to understand behavioral biases in conjunction with
valuation.