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Finance is a term for the management, creation, and study of
money In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in the left corner">174x174px Money is any item or verifiable record that is generally a ...

money
and
investment Investment is the dedication of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In , the purpose of investing is to generate a from the inve ...

investment
s. Pamela Drake and
Frank Fabozzi Frank J. Fabozzi is an United States, American economist, educator, writer, and investor, currently Professor of Finance at EDHEC Business School and a Member of Edhec Risk Institute. He was previously a Professor in the Practice of Finance and Bec ...
(2009)
What Is Finance?
/ref> Specifically, it deals with the questions of how an individual,
company A company, abbreviated as co., is a Legal personality, legal entity representing an association of people, whether Natural person, natural, Legal person, legal or a mixture of both, with a specific objective. Company members share a common pu ...

company
or
government A government is the system or group of people governing an organized community, generally a state State may refer to: Arts, entertainment, and media Literature * ''State Magazine'', a monthly magazine published by the U.S. Department ...

government
acquires moneycalled
capital Capital most commonly refers to: * Capital letter Letter case (or just case) is the distinction between the letters that are in larger uppercase or capitals (or more formally ''majuscule'') and smaller lowercase (or more formally ''minusc ...
in the context of a business and how they spend or invest that money."Finance"
Farlex Financial Dictionary. 2012
Finance is then often divided into the following broad categories:
personal finance Personal finance is the financial management Financial management may be defined as the area or function in an organization which is concerned with profitability, expenses, cash and credit, so that the "organization may have the means to car ...

personal finance
,
corporate finance Corporate finance is the area of finance that deals with sources of funding, the capital structure of corporations, the actions that managers take to increase the Value investing, value of the firm to the shareholders, and the tools and analysis ...
, and
public finance Public finance is the study of the role of the in the . It is the branch of that assesses the and of the public authorities and the adjustment of one or the other to achieve desirable effects and avoid undesirable ones. The purview of pu ...
. At the same time, and correspondingly, ''finance'' is about the i.e., the
financial market A financial market is a market Market may refer to: *Market (economics) *Market economy *Marketplace, a physical marketplace or public market Geography *Märket, an island shared by Finland and Sweden Art, entertainment, and media Films *Ma ...
s that allow the
flow of money The money flow index (MFI) is an Oscillator (technical analysis), oscillator that ranges from 0 to 100. It is used to show the ''money flow'' (an approximation of the dollar value of a day's trading) over several days. The steps to calculate the mo ...
, via investments and other
financial instruments Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money available which could ...
, between and within these areas; this "flow" is facilitated by the
financial services Financial services are the economic services provided by the finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of mone ...
sector. Finance therefore refers to the study of the
securities A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...
markets, including
derivatives Derivative may refer to: In mathematics and economics *Brzozowski derivative in the theory of formal languages *Derivative in calculus, a quantity indicating how a function changes when the values of its inputs change. *Formal derivative, an opera ...
, and the
institutions Institutions, according to Samuel P. Huntington, are "stable, valued, recurring patterns of behavior". Institutions can refer to social mechanism, mechanisms which govern the behavior of a set of individuals within a given community, and are ide ...
that serve as intermediaries to those markets, thus enabling the flow of money through the economy. A major focus within finance is thus
investment management Investment management is the professional asset management Asset management refers to a systematic approach to the governance and realization of value from the things that a group or entity is responsible for, over their whole life cycles. It ...
called
money management Money management is the process of expense tracking, investing, budgeting, banking and evaluating taxes of one's money which is also called investment management Investment management is the professional asset management of various securities ...
for individuals, and
asset management Asset management refers to a systematic approach to the governance and realization of value from the things that a group or entity is responsible for, over their whole life cycles. It may apply both to tangible asset In financial accountancy, f ...
for institutionsand finance then includes the associated activities of
securities trading A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any fo ...
and stock broking,
investment bank Investment is the dedication of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In finance Finance is the study of financial institution ...
ing,
financial engineering Financial engineering is a multidisciplinary field involving financial theory, methods of engineering Engineering is the use of scientific method, scientific principles to design and build machines, structures, and other items, including b ...

financial engineering
, and
risk management Risk management is the identification, evaluation, and prioritization of risk In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty Uncertainty refers to Epistemology, epistemic situations involving ...

risk management
. Fundamental to these areas is the valuation of assets such as stocks, bonds, loans, but also, by extension, entire companies.
Asset allocation Asset allocation is the implementation of an investment strategyIn finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of ...

Asset allocation
, the mix of investments in the portfolio, is also fundamental here. Although they are closely related, the disciplines of
economics Economics () is a social science Social science is the branch A branch ( or , ) or tree branch (sometimes referred to in botany Botany, also called , plant biology or phytology, is the science of plant life and a bran ...

economics
and finance are distinct. The
economy An economy (; ) is an area of the production Production may be: Economics and business * Production (economics) * Production, the act of manufacturing goods * Production, in the outline of industrial organization, the act of making products ( ...

economy
is a social institution that organizes a society's production, distribution, and consumption of goods and services, all of which must be financed. Similarly, although these areas overlap the financial function of the
accounting profession Accounting or Accountancy is the measurement ' Measurement is the number, numerical quantification (science), quantification of the variable and attribute (research), attributes of an object or event, which can be used to compare with other obj ...
,
financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as businesses and corporat ...
is the reporting of historical financial information, whereas finance is forward looking. Given its wide scope, finance is studied in several academic disciplines, and, correspondingly, there are several and professional certifications that can lead to the field.


The financial system

As above, the financial system consists of the flows of capital that take place between individuals (
personal finance Personal finance is the financial management Financial management may be defined as the area or function in an organization which is concerned with profitability, expenses, cash and credit, so that the "organization may have the means to car ...

personal finance
), governments (
public finance Public finance is the study of the role of the in the . It is the branch of that assesses the and of the public authorities and the adjustment of one or the other to achieve desirable effects and avoid undesirable ones. The purview of pu ...
), and businesses (
corporate finance Corporate finance is the area of finance that deals with sources of funding, the capital structure of corporations, the actions that managers take to increase the Value investing, value of the firm to the shareholders, and the tools and analysis ...
). "Finance" thus studies the process of channeling money from savers and investors to entities that need it. Savers and investors have money available which could earn interest or dividends if put to productive use. Individuals, companies and governments must obtain money from some external source, such as loans or credit, when they lack sufficient funds to operate. In general, an entity whose income exceeds its
expenditureExpenditure is an outflow of money Image:National-Debt-Gillray.jpeg, In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in the left corner, 174 ...
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 government or corporate bonds; (ii) by a corporation selling
equity Equity may refer to: Finance, accounting and ownership *Equity (finance), ownership of assets that have liabilities attached to them ** Stock, equity based on original contributions of cash or other value to a business ** Home equity, the differe ...
, also called stock or shares (which may take various forms:
preferred stock Preferred stock (also called preferred shares, preference shares, or simply preferreds) is a component of share capital__NOTOC__ A corporation A corporation is an organization—usually a group of people or a company—authorized by the stat ...
or
common stock Common stock is a form of corporate equity Equity may refer to: Finance, accounting and ownership *Equity (finance), ownership of assets that have liabilities attached to them ** Stock, equity based on original contributions of cash or other va ...
). The owners of both bonds and stock may be ''
institutional investor An institutional investor is an entity which pools money to purchase , , and other investment assets or originate loans. Institutional investors include s, s, s, , , s, s, , s, s, , , and s. Operating companies which invest excess capital in the ...
s'' financial institutions such as investment banks and
pension funds A pension fund, also known as a superannuation fund in some countries, is any plan, fund, or scheme which provides retirement income. Pension funds typically have large amounts of money to invest and are the major investors in listed and private ...
– or private individuals, called ''
private investors An angel investor (also known as a business angel, informal investor, angel funder, private investor, or seed investor) is an individual who provides capital for a business start-up, usually in exchange for convertible debt or ownership equity. ...
'' or ''retail investors''. The
lending In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations etc. The recipient (i.e., the borrower) incurs a debt and is usually liable to pay interest on that debt ...

lending
is often indirect, through a
financial intermediary A financial intermediary is an institution or individual that serves as a middleman among diverse parties in order to facilitate financial transactions. Common types include commercial banks, investment banks, stockbrokers, pooled investment funds, ...
such as a
bank A bank is a financial institution Financial institutions, otherwise known as banking institutions, are corporation A corporation is an organization—usually a group of people or a company—authorized by the State (polity), stat ...

bank
, or via the purchase of notes or bonds ( corporate bonds,
government bond A government bond or sovereign bond is an debt obligation issued by a national government to support government spending. It generally includes a commitment to pay periodic interest, called ''coupon payments,'' and to repay the face value on t ...
s, or mutual bonds) in the
bond market The bond market (also debt market or credit market) is a financial market A financial market is a market Market may refer to: *Market (economics) *Market economy *Marketplace, a physical marketplace or public market Geography *Märket, an i ...
. The lender receives interest, the
borrower A debtor or debitor is a legal entity (legal person) that owes a debt Debt is an obligation that requires one party, the debtor A debtor or debitor is a legal entity (legal person) that owes a debt Debt is an obligation that re ...
pays a higher interest than the lender receives, and the financial intermediary earns the difference for arranging the loan. 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 In finance, stock (also capital stock) consists of all of the shares In financial markets A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities i ...
, either individual securities, or via a
mutual fund A mutual fund is a professionally managed investment fund An investment fund is a way of investment, investing money alongside other investors in order to benefit from the inherent advantages of working as part of a group such as reducing the ri ...
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 bank Investment is the dedication of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In finance Finance is the study of financial institution ...
s. The investment banks find the initial investors and facilitate the listing of the securities, typically shares and bonds. Additionally, they facilitate the securities exchanges, which allow their trade thereafter, as well as the various service providers which manage the performance or risk of these investments. These latter include
mutual funds A mutual fund is a professionally managed investment fund Image:Financial info.jpg, The values and performance of collective funds are listed in newspapers. An investment fund is a way of investment, investing money alongside other investors in or ...
,
pension funds A pension fund, also known as a superannuation fund in some countries, is any plan, fund, or scheme which provides retirement income. Pension funds typically have large amounts of money to invest and are the major investors in listed and private ...
, wealth managers, and stock brokers, typically servicing retail investors (private individuals). Inter-institutional trade and investment, and fund-management at this scale, is referred to as "wholesale finance". Institutions here extend the products offered, with related trading, to include bespoke options, swaps, and
structured productsA structured product, also known as a market-linked investment, is a pre-packaged structured finance Structured finance is a sector of finance, specifically financial law that manages Leverage (finance), leverage and Financial risk, risk. Strategies ...
, as well as ; this "
financial engineering Financial engineering is a multidisciplinary field involving financial theory, methods of engineering Engineering is the use of scientific method, scientific principles to design and build machines, structures, and other items, including b ...

financial engineering
" is inherently mathematical, and these institutions are then the major employers of "quants" (see below). In these institutions,
risk management Risk management is the identification, evaluation, and prioritization of risk In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty Uncertainty refers to Epistemology, epistemic situations involving ...
,
regulatory capital A capital requirement (also known as regulatory capital or capital adequacy) is the amount of capital a bank A bank is a financial institution that accepts Deposit account, deposits from the public and creates a demand deposit while simulta ...
, and
compliance Compliance can mean: Healthcare * Compliance (medicine) In medicine, patient compliance (also adherence, capacitance) describes the degree to which a patient correctly follows medical advice. Most commonly, it refers to medication or drug compli ...
play major roles.


Areas of finance

As above, finance comprises, broadly, the three areas of personal finance, corporate finance, and public finance. Although they are numerous, other areas, such as
investment Investment is the dedication of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In , the purpose of investing is to generate a from the inve ...

investment
s, risk management,
quantitative finance Mathematical finance, also known as quantitative finance and financial mathematics, is a field of applied mathematics Applied mathematics is the application of mathematics, mathematical methods by different fields such as physics, engineering, me ...
/ financial engineering - discussed in the next section - and development finance typically overlap these; likewise, specific arrangements such as
public–private partnership A public–private partnership (PPP, 3P, or P3) is an arrangement between two or more Public sector, public and private sectors of a long-term nature.Hodge, G. A and Greve, C. (2007), Public–Private Partnerships: An International Performance Re ...
s.


Personal finance

Personal finance 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 good In economics, a durable good or a hard good or consumer durable is a Good (economics), good that does not quickly wear out or, more specifically, one that yields utility over time rather than being completely Consumption (economics), consumed in ...
s such as
real estate Real estate is property consisting of land and the buildings on it, along with its natural resources such as crops, minerals or water; immovable property of this nature; an interest vested in this (also) an item of real property, (more genera ...

real estate
and cars, buying
insurance Insurance is a means of protection from financial loss. It is a form of risk management Risk management is the identification, evaluation, and prioritization of risk In simple terms, risk is the possibility of something bad happening. ...

insurance
, investing, and saving for
retirement Retirement is the withdrawal from one's position or occupation or from one's active working life. A person may also semi-retire by reducing work hours or workload. Many people choose to retire when they are old or incapable of doing their job d ...

retirement
. Personal finance may also involve paying for a loan or other debt obligations. The main areas of personal finance are considered to be income, spending, saving, investing, and protection. The following steps, as outlined by the Financial Planning Standards Board, 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, subsidies, or penalties on the management of personal finances; * Understanding the effects of credit on individual financial standing; * Developing 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 or other long term expenses.


Corporate finance

Corporate finance deals with the actions that managers take to increase the value of the firm to the shareholders, the sources of funding and the
capital structure Capital structure in corporate finance Corporate finance is the area of finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and manag ...

capital structure
of corporations, and the tools and analysis used to allocate financial resources. While corporate finance is in principle different from managerial finance, which studies the
financial management Financial management may be defined as the area or function in an organization which is concerned with profitability, expenses, cash and credit, so that the "organization may have the means to carry out its objective as satisfactorily as possibl ...
of all firms rather than corporations alone, the concepts are applicable to the financial problems of all firms, and this area is then often referred to as “business finance”. Typically "corporate finance" relates to the ''long term'' objective of maximizing the value of the entity's assets, its
stock In finance, stock (also capital stock) consists of all of the shares In financial markets A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities i ...

stock
, and its return to shareholders, while also balancing risk and profitability. This entails three primary areas: #
Capital budgeting Capital most commonly refers to: * Capital letter Letter case (or just case) is the distinction between the letters that are in larger uppercase or capitals (or more formally ''majuscule'') and smaller lowercase (or more formally ''minusc ...
: selecting which projects to invest in - here, accurately determining value is crucial, as judgements about asset values can be "make or break" #
Dividend policy Dividend policy is concerned with financial policies regarding paying cash dividend A dividend is a distribution of profits by a corporation A corporation is an organization—usually a group of people or a company—authorized by the sta ...
: the use of "excess" funds - are these to be reinvested in the business or returned to shareholders #
Capital structure Capital structure in corporate finance Corporate finance is the area of finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and manag ...

Capital structure
: deciding on the mix of funding to be used - here attempting to find the optimal capital mix re debt-commitments vs
cost of capital In economics Economics () is a social science Social science is the branch A branch ( or , ) or tree branch (sometimes referred to in botany Botany, also called , plant biology or phytology, is the science of plant l ...
The latter creates the link with
investment banking An investment bank is a financial services Financial services are the economic services provided by the finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is conce ...
and
securities trading A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any fo ...
, as above, in that the capital raised will generically comprise debt, i.e.
corporate bond A corporate bond is a bond Bond or bonds may refer to: Common meanings * Bond (finance) In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with ...
s, and
equity Equity may refer to: Finance, accounting and ownership *Equity (finance), ownership of assets that have liabilities attached to them ** Stock, equity based on original contributions of cash or other value to a business ** Home equity, the differe ...
, often listed shares. Re risk management in corporates, see
below Below may refer to: *Earth *Ground (disambiguation) *Soil *Floor *Bottom (disambiguation) *Less than *Temperatures below freezing *Hell or underworld People with the surname *Fred Below (1926–1988), American blues drummer *Fritz von Below (1853 ...
. Financial managers - i.e. as opposed to corporate financiers - focus more on the ''short term'' elements of profitability, cash flow, and "
working capital management Corporate finance is the area of finance that deals with sources of funding, the capital structure of corporations, the actions that managers take to increase the Value investing, value of the firm to the shareholders, and the tools and analysis u ...
" (
inventory Inventory (American English American English (AmE, AE, AmEng, USEng, en-US), sometimes called United States English or U.S. English, is the set of varieties of the English language native to the United States. Currently, American English ...
, credit and
debtor A debtor or debitor is a legal entity (legal person) that owes a debt Debt is an obligation that requires one party, the debtor A debtor or debitor is a legal entity (legal person) that owes a debt Debt is an obligation that ...
s), ensuring that the firm can safely and profitably carry out its financial ''and operational'' objectives; i.e. that it: (1) can service both maturing short-term debt repayments, and scheduled long-term debt payments , and (2) has sufficient cash flow for ongoing and upcoming . See and .


Public finance

Public finance describes finance as related to sovereign states, sub-national entities, and related public entities or agencies. It generally encompasses a long-term strategic perspective regarding investment decisions that affect public entities. These long-term strategic periods typically encompass five or more years. Public finance is primarily concerned with: * Identification of required expenditures of a public sector entity; * Source(s) of that entity's revenue; * The budgeting process; * Debt issuance, or
municipal bond A municipal bond, commonly known as a muni, is a bond Bond or bonds may refer to: Common meanings * Bond (finance) In finance Finance is the study of financial institutions, financial markets and how they operate within the financial sys ...
s, for public works projects. Central banks, such as the
Federal Reserve System The Federal Reserve System (also known as the Federal Reserve or simply the Fed) is the central bank A central bank, reserve bank, or monetary authority is an institution that manages the and of a or formal monetary union, and ove ...
banks in the
United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country Continental United States, primarily located in North America. It consists of 50 U.S. state, states, a Washington, D.C., ...

United States
and the
Bank of England The Bank of England is the central bank of the United Kingdom and the model on which most modern central banks have been based. Established in 1694 to act as the Kingdom of England, English Government's banker, and still one of the bankers for t ...

Bank of England
in the
United Kingdom The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain,Usage is mixed. The Guardian' and Telegraph' use Britain as a synonym for the United Kingdom. Some prefer to use Britain as shorth ...

United Kingdom
, are strong players in public finance. They act as lenders of last resort as well as strong influences on monetary and credit conditions in the economy.


Investment management

Investment management is the professional asset management of various securities - typically shares and bonds, but also other assets, such as real estate and commodities - in order to meet specified investment goals for the benefit of investors. As above, investors may be institutions, such as insurance companies, pension funds, corporations, charities, educational establishments, or private investors, either directly via investment contracts or, more commonly, via collective investment schemes like mutual funds,
exchange-traded funds An exchange-traded fund (ETF) is a type of investment fund and exchange-traded product, i.e. they are traded on stock exchanges. ETFs are similar in many ways to mutual funds A mutual fund is an open-end professionally managed investment fund ...
, or
REIT A real estate investment trust (REIT) is a company that owns, and in most cases operates, income-producing real estate Real estate is property consisting of land and the buildings on it, along with its natural resources such as crops, minera ...
s. At the heart of investment management is
asset allocation Asset allocation is the implementation of an investment strategyIn finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management o ...

asset allocation
- diversifying the exposure among these
asset classes In finance, an asset class is a group of financial instrument Financial instruments are monetary Contract, contracts between parties. They can be created, traded, modified and settled. They can be cash (currency), evidence of an ownership inter ...
, and among individual securities within each asset class - as appropriate to the client's
investment policy An investment policy is any government regulation or law that encourages or discourages foreign investment in the local economy, e.g. currency exchange limits. Explanation As globalization Globalization, or globalisation ( Commonwealth ...
, in turn, a function of risk profile, investment goals, and investment horizon (see
Investor profile An investor profile or style defines an individual's preferences in investment Investment is the dedication of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, ...
). Here: *
Portfolio optimizationPortfolio optimization is the process of selecting the best portfolio (asset In financial accountancy, financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) ...
is the process of selecting the best portfolio given the client's objectives and constraints. *
Fundamental analysis Fundamental analysis, in accounting and finance, is the analysis of a business's financial statements (usually to analyze the business's assets, Liability (financial accounting), liabilities, and earnings); health; and Competition, competitors an ...
is the approach typically applied in valuing and evaluating the individual securities. Overlaid, is the portfolio manager's investment style - broadly,
active Active may refer to: Music * Active (album), ''Active'' (album), a 1992 album by Casiopea * Active Records, a record label Ships * Active (ship), ''Active'' (ship), several commercial ships by that name * HMS Active, HMS ''Active'', the nam ...
vs
passive Passive may refer to: * Passive voice, a grammatical voice common in many languages, see also Pseudopassive (disambiguation), Pseudopassive * Passive language, a language from which an interpreter works * Passivity (behavior), the condition of sub ...
,
value Value or values may refer to: * Value (ethics) In ethics Ethics or moral philosophy is a branch of philosophy Philosophy (from , ) is the study of general and fundamental questions, such as those about Metaphysics, existence, reason, E ...
vs growth, and small cap vs.
large cap Market capitalization, commonly called market cap, is the market value of a publicly traded company's shares outstanding, outstanding shares. Market capitalization is equal to the share price multiplied by the number of shares outstanding. Sinc ...
- and
investment strategy In finance Finance is a term for the management, creation, and study of money In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in th ...
. In a well diversified portfolio, achieved
investment performanceInvestment performance is the Rate of return, return on an investment portfolio. The investment portfolio can contain a single asset or multiple assets. The investment performance is measured over a specific period of time and in a specific currenc ...
will, in general, largely be a function of the asset mix selected, while the individual securities are less impactful. The specific approach or philosophy will also be significant, depending on the extent to which it is complementary with the market cycle. A quantitative fund is managed using computer based techniques (increasingly,
machine learning Machine learning (ML) is the study of computer algorithms that can improve automatically through experience and by the use of data. It is seen as a part of artificial intelligence. Machine learning algorithms build a model based on sample data ...

machine learning
) instead of human judgement. The actual trading also, is typically automated via sophisticated algorithms.


Risk management

Risk management Risk management is the identification, evaluation, and prioritization of risk In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty Uncertainty refers to Epistemology, epistemic situations involving ...

Risk management
, in general, is the study of how to control risks and balance the possibility of gains; it is the process of measuring risk and then developing and implementing strategies to manage that risk.
Financial risk managementFinancial risk management is the practice of protecting economic value In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (eco ...
is the practice of protecting corporate value by using financial instruments to manage exposure to risk, here called "hedging"; the focus is particularly on credit and market risk, and in banks includes operational risk. *
Credit risk A credit risk is risk of default Default may refer to: Law * Default (law), the failure to do something required by law ** Default (finance) In finance Finance is the study of financial institutions, financial markets and how they ope ...
is risk of default on a debt that may arise from a borrower failing to make required payments; *
Market risk Market risk is the risk In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty Uncertainty refers to Epistemology, epistemic situations involving imperfect or unknown information. It applies to predic ...
relates to losses arising from movements in market variables such as prices and exchange rates; *
Operational risk Operational risk is "the risk of a change in value caused by the fact that actual losses, incurred for inadequate or failed internal processes, people and systems, or from external events (including legal risk), differ from the expected losses" ...
relates to failures in internal processes, people and systems, or to external events. Financial risk management is related to corporate finance in two ways. Firstly, firm exposure to market risk is a direct result of previous capital investments and funding decisions; while credit risk arises from the business' credit policy, and is often addressed through
credit insuranceCredit insurance refers to several kinds of insurance relating to financial Credit (finance), credit: *Trade credit insurance, purchased by businesses to insure payment of credit ''extended by'' the business *Payment protection insurance, purchased ...
. Secondly, both disciplines share the goal of enhancing, or at least preserving, the firm's
economic value In economics Economics () is a social science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services. Economics focuses on the beh ...
. See also "ALM" and
treasury management Treasury management (or treasury operations) includes management Management (or managing) is the administration of an organization, whether it is a business, a not-for-profit organization, or government body. Management includes the activit ...
. (
Enterprise risk managementEnterprise risk management (ERM) in business includes the methods and processes used by organizations to manage risks and seize opportunities related to the achievement of their objectives. ERM provides a framework for risk management, which typical ...
, the domain of
strategic management In the field of management Management (or managing) is the administration of an organization An organization, or organisation (Commonwealth English The use of the English language English is a West Germanic languages, We ...
, addresses risks to the firm's overall objectives.) For banks and other wholesale institutions, risk management hedging the various positions held by the institution - trading positions and long term exposures - and on calculating and monitoring the resultant regulatory- and
economic capital __NOTOC__ In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money ...
under
Basel IV The Basel IV standards are changes to global bank capital requirements that were agreed in 2017 and are due for implementation in January 2023. They amend the international banking standards known as the Basel Accords The Basel Accords refer to the ...
. The calculations here are mathematically sophisticated, and within the domain of
quantitative finance Mathematical finance, also known as quantitative finance and financial mathematics, is a field of applied mathematics Applied mathematics is the application of mathematics, mathematical methods by different fields such as physics, engineering, me ...
as
below Below may refer to: *Earth *Ground (disambiguation) *Soil *Floor *Bottom (disambiguation) *Less than *Temperatures below freezing *Hell or underworld People with the surname *Fred Below (1926–1988), American blues drummer *Fritz von Below (1853 ...
. Credit risk is inherent in the business of banking, but additionally, these institutions are exposed to counterparty credit risk. Investment managers will apply various risk management techniques to their portfolios: these may relate to the portfolio as a whole or to individual stocks; bond portfolios are typically managed via cashflow matching or
immunization Immunization, or immunisation, is the process by which an individual's immune system becomes fortified against an infectious agent (known as the antigen, immunogen). When this system is exposed to molecules that are foreign to the body, called ' ...
. Re derivative portfolios (and positions), "the Greeks" are a vital risk management tool - these measure sensitivity to a small change in a given underlying parameter, so that the portfolio can be rebalanced accordingly by including additional derivatives with offsetting characteristics.


Financial theory

Financial theory is studied and developed within the disciplines of
management Management (or managing) is the administration of an organization An organization, or organisation (Commonwealth English The use of the English language English is a West Germanic languages, West Germanic language first spok ...

management
, (financial)
economics Economics () is a social science Social science is the branch A branch ( or , ) or tree branch (sometimes referred to in botany Botany, also called , plant biology or phytology, is the science of plant life and a bran ...

economics
,
accountancy Accounting or Accountancy is the measurement Measurement is the quantification of attributes of an object or event, which can be used to compare with other objects or events. The scope and application of measurement are dependent on the ...
and
applied mathematics Applied mathematics is the application of mathematical methods by different fields such as physics Physics is the natural science that studies matter, its Elementary particle, fundamental constituents, its Motion (physics), motion and be ...
. Abstractly, ''finance'' is concerned with the investment and deployment of
asset In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such a ...
s and
liabilities Liability may refer to: Law * Legal liability, in both civil and criminal law ** Public liability, part of the law of tort which focuses on civil wrongs ** Product liability, the area of law in which manufacturers, distributors, suppliers, reta ...
over "space and time"; i.e., it is about performing valuation and
asset allocation Asset allocation is the implementation of an investment strategyIn finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management o ...

asset allocation
today, based on the risk and uncertainty of future outcomes while appropriately incorporating the
time value of money The time value of money is the widely accepted conjecture that there is greater benefit to receiving a sum of money Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, ...
. Determining the
present value In economics Economics () is a social science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services. Economics focuses on the behavi ...
of these future values, "discounting", must be at the risk-appropriate discount rate, in turn, a major focus of finance-theory. Since the debate as to whether finance is an art or a science is still open, there have been recent efforts to organize a
list of unsolved problems in finance This is a list of some of the major unsolved problems, puzzles, or questions in economics. Some of these are theoretical in origin and some of them concern the inability of orthodox economic theory to explain an empirical observation. Capital theo ...
.


Managerial finance

Managerial finance is the branch of
management Management (or managing) is the administration of an organization An organization, or organisation (Commonwealth English The use of the English language English is a West Germanic languages, West Germanic language first spok ...

management
that concerns itself with the managerial application of and theory, emphasizing the financial aspects of managerial decisions; the assessment is per the managerial perspectives of planning, directing, and controlling. The techniques addressed are drawn in the main from
managerial accounting In management accounting or managerial accounting, managers use the provisions of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic ...
and
corporate finance Corporate finance is the area of finance that deals with sources of funding, the capital structure of corporations, the actions that managers take to increase the Value investing, value of the firm to the shareholders, and the tools and analysis ...
: the former allow management to better understand, and hence act on, financial information relating to
profitability An economic profit is the difference between the revenue a has received from its outputs and the s of its inputs. Unlike an , an economic profit takes into account both a 's and costs, whereas an accounting profit only relates to the explici ...

profitability
and performance; the latter, as above, are about optimizing the overall financial structure, including its impact on working capital. The ''implementation'' of these techniques - i.e.
financial management Financial management may be defined as the area or function in an organization which is concerned with profitability, expenses, cash and credit, so that the "organization may have the means to carry out its objective as satisfactorily as possibl ...
- is described above. Academics working in this area are typically based in
business school A business school is a university-level institution that confers degrees in business administration Business administration (also known as business management) is the administration of a commercial enterprise. It includes all aspects of overse ...

business school
finance departments, in
accounting Accounting or Accountancy is the measurement ' Measurement is the number, numerical quantification (science), quantification of the variable and attribute (research), attributes of an object or event, which can be used to compare with other ob ...
, or in
management science Management science (MS) is the broad interdisciplinary study of problem solving and decision making in human organizations, with strong links to management Management (or managing) is the administration of an organization, whether it is a busin ...
.


Financial economics

Financial economics is the branch of
economics Economics () is a social science Social science is the branch A branch ( or , ) or tree branch (sometimes referred to in botany Botany, also called , plant biology or phytology, is the science of plant life and a bran ...

economics
that studies the interrelation of financial variables, such as
price A price is the (usually not negative) quantity Quantity is a property that can exist as a multitude or magnitude, which illustrate discontinuity and continuity. Quantities can be compared in terms of "more", "less", or "equal", or b ...

price
s,
interest rate An interest rate is the amount of interest In and , interest is payment from a or deposit-taking financial institution to a or depositor of an amount above repayment of the (that is, the amount borrowed), at a particular rate. It is disti ...
s and shares, as opposed to
real Real may refer to: * Reality Reality is the sum or aggregate of all that is real or existent within a system, as opposed to that which is only Object of the mind, imaginary. The term is also used to refer to the ontological status of things, ind ...
economic variables, i.e.
goods and services Goods are items that are usually (but not always) tangible According to the philosopher Piyush Mathur (2017), "''Tangibility is the property that a phenomenon exhibits if it has and/or transports mass and/or energy and/or momentum". Mathur, P ...
. It thus centers on pricing, decision making and risk management in the
financial market A financial market is a market Market may refer to: *Market (economics) *Market economy *Marketplace, a physical marketplace or public market Geography *Märket, an island shared by Finland and Sweden Art, entertainment, and media Films *Ma ...
s, and produces many of the commonly employed
financial model Financial modeling is the task of building an abstraction, abstract representation (a mathematical model, model) of a real world finance, financial situation. This is a mathematical model designed to represent (a simplified version of) the perform ...
s. ( Financial econometrics is the branch of financial economics that uses econometric techniques to parameterize the relationships suggested.) The discipline has two main areas of focus:
asset pricing :'' This article is theory focused: for the corporate finance Corporate finance is the area of finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with ...
and (theoretical) corporate finance; the first being the perspective of providers of capital, i.e. investors, and the second of users of capital. Respectively: * Asset pricing theory develops the models used in determining the risk appropriate discount rate, and in pricing derivatives. The analysis essentially explores how rational investors would apply risk and return to the problem of
investment Investment is the dedication of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In , the purpose of investing is to generate a from the inve ...

investment
under uncertainty. The twin assumptions of
rationality Rationality is the quality or state of being rational – that is, being based on or agreeable to reason Reason is the capacity of consciously applying logic Logic is an interdisciplinary field which studies truth and reasoning Reaso ...
and
market efficiency The efficient-market hypothesis (EMH) is a hypothesis in financial economics Financial economics is the branch of economics Economics () is the social science that studies how people interact with value; in particular, the Production (ec ...
lead to
modern portfolio theory Modern portfolio theory (MPT), or mean-variance analysis, is a mathematical framework for assembling a portfolio of assets such that the expected return is maximized for a given level of risk. It is a formalization and extension of Diversification ...
(the CAPM), and to the Black–Scholes theory for option valuation. At more advanced levels - and often in response to
financial crises A financial crisis is any of a broad variety of situations in which some financial assets suddenly lose a large part of their nominal value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and many ...
- the study these "Neoclassical" models to incorporate phenomena where their assumptions do not hold, or to more general settings. Asset pricing theory also includes the
investment theory To invest is to allocate money in the expectation of some benefit/return in the future. In other words, to invest means owning an asset or an item with the goal of generating income from the investment or the appreciation of your investment whic ...
and
portfolio theory Modern portfolio theory (MPT), or mean-variance analysis, is a mathematical framework for assembling a portfolio of assets such that the expected return is maximized for a given level of risk. It is a formalization and extension of diversificati ...
applied in portfolio management. * Much of corporate finance theory, by contrast, considers investment under "
certainty Certainty (also known as epistemic certainty or objective certainty) is the property of s which a person has no rational grounds for doubting. One standard way of defining epistemic certainty is that a belief is certain if and only if the per ...
" (
Fisher separation theorem In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods a ...
, "theory of investment value",
Modigliani–Miller theoremThe Modigliani–Miller theorem (of Franco Modigliani, Merton Miller) is an influential element of economic theory; it forms the basis for modern thinking on capital structure. The basic theorem states that in the absence of taxes, bankruptcy costs, ...
). Here theory and methods are developed for the decisioning about funding, dividends, and capital structure discussed above. A recent development is to incorporate uncertainty and contingency - and thus various elements of asset pricing - into these decisions, employing for example real options analysis.


Financial mathematics

Financial mathematics is a field of
applied mathematics Applied mathematics is the application of mathematical methods by different fields such as physics Physics is the natural science that studies matter, its Elementary particle, fundamental constituents, its Motion (physics), motion and be ...
concerned with
financial market A financial market is a market Market may refer to: *Market (economics) *Market economy *Marketplace, a physical marketplace or public market Geography *Märket, an island shared by Finland and Sweden Art, entertainment, and media Films *Ma ...
s. The field is largely focused on the modeling of derivatives, although other important subfields include insurance mathematics and quantitative portfolio management. Relatedly, the techniques developed are applied to pricing and hedging a wide range of asset-backed,
government A government is the system or group of people governing an organized community, generally a state State may refer to: Arts, entertainment, and media Literature * ''State Magazine'', a monthly magazine published by the U.S. Departmen ...
, and
corporate A corporation is an organization—usually a group of people or a company A company, abbreviated as co., is a Legal personality, legal entity representing an association of people, whether Natural person, natural, Legal person, legal ...

corporate
-securities. The main mathematical tools are Itô's stochastic calculus,
simulation A simulation is the imitation of the operation of a real-world process or system over time. Simulations require the use of models; the model represents the key characteristics or behaviors of the selected system or process, whereas the simulat ...
, and
partial differential equation In mathematics, a partial differential equation (PDE) is an equation which imposes relations between the various partial derivatives of a Multivariable calculus, multivariable function. The function is often thought of as an "unknown" to be sol ...
s. The subject has a close relationship with the discipline of
financial economics Financial economics is the branch of economics Economics () is a social science Social science is the Branches of science, branch of science devoted to the study of society, societies and the Social relation, relationships among i ...
, which is concerned with much of the underlying theory that is involved in financial mathematics: generally,
financial mathematics Mathematical finance, also known as quantitative finance and financial mathematics, is a field of applied mathematics, concerned with mathematical modeling of financial markets. See Quantitative analyst. In general, there exist two separate branch ...
will derive and extend the
mathematical model A mathematical model is a description of a system A system is a group of Interaction, interacting or interrelated elements that act according to a set of rules to form a unified whole. A system, surrounded and influenced by its environm ...
s suggested.
Computational finance 420px, Simulation of Brownian Motion sample paths is an important tool in calculating the price of financial instruments under the risk-neutral measure. Computational finance is a branch of applied computer science that deals with problems of pract ...
is the branch of (applied)
computer science Computer science deals with the theoretical foundations of information, algorithms and the architectures of its computation as well as practical techniques for their application. Computer science is the study of computation, automation, a ...
that deals with problems of practical interest in finance, and especially emphasizes the
numerical methods Numerical analysis is the study of algorithm In and , an algorithm () is a finite sequence of , computer-implementable instructions, typically to solve a class of problems or to perform a computation. Algorithms are always and are used as ...
applied here. In terms of practice, the field is referred to as quantitative finance and / or mathematical finance, and comprises primarily three areas: #Quantitative finance overlaps heavily with
financial engineering Financial engineering is a multidisciplinary field involving financial theory, methods of engineering Engineering is the use of scientific method, scientific principles to design and build machines, structures, and other items, including b ...

financial engineering
. This area generally underpins a bank's customer-driven derivatives business — delivering bespoke Over-the-counter_(finance)#Contracts, OTC-contracts and exotic derivative, "exotics", and Structured_product#Product_design_and_manufacture, designing the various structured products mentioned above — and encompasses modeling and programming in support of the initial trade, and its subsequent hedging and management. #Quantitative finance also significantly overlaps financial risk management, as #Risk management, mentioned above, both as regards this hedging, and as regards compliance with regulations and Basel IV, the Basel capital / liquidity requirements. The major tools employed are value at risk, stress test (financial), stress testing, PnL_Explained#Sensitivities_method, "sensitivities" analysis, and xVA. #Quants are also responsible for building and deploying the investment strategies at the quantitative funds #Investment management, mentioned above; they are also involved in Outline_of_finance#Quantitative_investing , quantitative investing more generally, in areas such as trading strategy formulation, and in automated trading, high-frequency trading, algorithmic trading, and program trading.


Experimental finance

Experimental finance aims to establish different market settings and environments to experimentally observe 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, as well as 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 of people in artificial, competitive, market-like settings.


Behavioral finance

Behavioral finance studies how the ''psychology'' of investors or managers affects financial decisions and markets, and is relevant 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 an integral aspect of finance. 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.


History of finance

The origin of finance can be traced to the start of civilization. The earliest historical evidence of finance is dated to around 3000 BC. Banking originated in the Babylonian empire, where temples and palaces were used as safe places for the storage of valuables. Initially, the only valuable that could be deposited was grain, but cattle and precious materials were eventually included. During the same period, the Sumerian city of Uruk in Mesopotamia supported trade by lending as well as the use of interest. In Sumerian, “interest” was ''mas'', which translates to "calf". In Greece and Egypt, the words used for interest, ''tokos'' and ''ms'' respectively, meant “to give birth”. In these cultures, interest indicated a valuable increase, and seemed to consider it from the lender's point of view. The Code of Hammurabi (1792-1750 BC) included laws governing banking operations. The Babylonians were accustomed to charging interest at the rate of 20 per cent per annum. Jews were not allowed to take interest from other Jews, but they were allowed to take interest from Gentiles, who had at that time no law forbidding them from practising usury. As Gentiles took interest from Jews, the Torah considered it equitable that Jews should take interest from Gentiles. In Hebrew, interest is ''neshek''. By 1200 BC, cowrie shells were used as a form of money in China. By 640 BC, the Lydians had 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, around 687 BC.) The use of coins as a means of representing money began in the years between 600 and 570 BCE. Cities under the Ancient Greece, Greek empire, such as Aegina (595 BCE), Athens (575 BCE) and Corinth (570 BCE), started to mint their own coins. In the Roman Republic, interest was outlawed altogether by the ''Lex Genucia'' reforms. Under 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%.


See also

*Outline of finance *Financial crisis of 2007–2010


Notes


References


External links


Wharton Finance Knowledge Project


(Campbell Harvey)
Corporate finance resources
(Aswath Damodaran)
Financial management resources
(James Van Horne)
Financial mathematics, derivatives, and risk management resources
(Don Chance)
Personal finance resources
(Financial Literacy and Education Commission, mymoney.gov)
Public Finance resources
(gsdrc.org) * {{Authority control Finance,