SOURCES OF WEALTH

FINANCE
Finance is known as the life-blood of the
company.
Finance is the application of economic
principles to decision-making that involves the
allocation of money under conditions of
uncertainty.
Finance provides the framework for making
decisions as to how those funds should be
obtained and then invested. It is the financial
system that provides the platform by which funds
are transferred from those entities that have funds
to invest to those entities that need funds to
invest.
FINANCIAL SYSTEM

Financial system allows households,

companies and the government who have
available funds to invest these funds in more
potentially productive vehicles that can result in
faster growth in the economy. The financial
system encourages fund savings from its
stakeholders and transform these savings
efficiently into investment vehicles that help the
economy grow faster.
 Financial system is a set of arrangements
or conventions embracing the lending and
borrowing of funds by non-financial economic
units and the intermediation of this function by
financial intermediaries in order to facilitate the
transfer of funds, to create additional money
when required, and to create markets in debt
and equity instruments (and their derivatives)
so that the price and allocation of funds are
determined efficiently. – Faure, AP.
 Financial system is composed of network of
inter-related systems of financial markets,
intermediaries and services. The financial system
of a country carries out the essential economic
function that transfers funds from parties that have
available funds to parties that need funds.
 Matching the difference in spending (excess
funds from one party to the fund gap of another
party) is the main reason for the existence of a
financial system.
The financial system permits an efficient
method to move funds between entities who have
funds and entities who need funds. Financial
systems serve as a regular, time-efficient and cost-
effective link between fund providers and fund
demanders.
Within the financial system, funds are
efficiently transferred from one party to another
through innovative schemes on savings and
investments that investors are willing to partake in.
Funds can flow from lender-savers to the
borrower-spenders in two routes: via direct
financing or indirect financing:

Direct Financing. In this route, the borrower-

spenders borrow and deal directly with lenders
through selling financial instruments (or
securities).

Financial instruments represent claims on the

future income or assets of the borrower.
Borrowers recognize financial instruments as
liabilities while lenders recognize these as
asset. Buying stocks directly from a company is
also considered as direct financing.
Indirect Financing. In this route, the
borrowing activity between both parties still
happens though indirectly through the
intervention of a financial intermediary.

Financial Intermediaries are special types

of financial entities that act as a third party to
facilitate the borrowing activity between
lenders and borrowers. Ex: banks, insurance
companies
ELEMENTS OF THE FINANCIAL SYSTEM
1. Demanders and Suppliers (Who are the players?)

Demanders of Fund are individuals or corporation

that who be needing financial support for them to
start their business, fund for their working capital, or
planned expansion.

Because of this intent, they are the party in the

system that is known to be the borrower because
they will be asking for funds with a promise to return
them in the future in the form of interest or dividends.
Suppliers of Fund are individuals or corporation
who are in other side of the system that are willing to
provide and/or has excess wealth and are looking for
opportunity to keep it growing. These are people or
investors that are willing to extend financial support
with interest. These players are also considered as
the lenders in the system.
2. Financial Intermediaries (How will the exchange
occur?)

Financial intermediaries are special types of

financial entities that act as a third party to facilitate
the borrowing activity between lenders and
borrowers.

Often, potential borrowers do not have an idea

which parties or entities are willing to lend out money
to them and vice-versa. This gap in awareness
makes it difficult for financial transaction to occur.
 This is where financial intermediaries come
into the picture. They gather funds from lenders and
redistribute it to borrowers through an investment
vehicle like loans.

Potential lenders and borrowers then just need

to visit a financial intermediary to participate in the
financial transaction. The lenders and borrowers do
not even know who the ultimate individual or firm is
who provided or demanded for the funds. They only
need to have access to the financial intermediary to
enjoy the benefits of the financial transaction.
3. Financial Instruments (What will be used?)

Financial instruments are medium of exchange

of contractual obligation of a party, where such
contract can be traded.

Is any contract that gives rise to a financial

asset of one entity and a financial liability or equity
instrument of another entity.

International Financial Reporting Standards

defined financial instruments as a contract where a
party recognizes it as an asset while the party treats
it as a liability.
4. Financial Markets (Where will it be traded?)

Financial Markets is the venue where

suppliers and buyers of financial instruments meet.
There are two types of financial markets depending
on the instrument that were being traded.

For cash financial instruments, these are

exchanged in the money market. For derivative
financial instrument, it will be traded in the capital
markets.
5. Regulatory Environment (How it is controlled?)

Risk is inherent in every business operation.

Moreover, for financial systems since it involves
different business and financial risks, government
should intervene in the system.
Regulatory environment is the governance
body to ensure that the transactions that occur
within the financial systems complies with the laws
and regulations imposed to the actors as well as the
elements that plays within the system. Financial
systems are normally regulated by Central banks.