Finance is a field that deals with the study of investments. It
includes the dynamics of assets and liabilities over time under
conditions of different degrees of uncertainties and risks. Finance
can also be defined as the science of money management. Market
participants aim to price assets based on their risk level,
fundamental value, and their expected rate of return.
Finance can be
broken into three sub-categories: public finance, corporate finance
and personal finance.
1 Areas of finance
1.1 Personal finance
1.2 Corporate finance
1.2.1 Financial services
1.3 Public finance
3 Financial theory
3.1 Financial economics
3.2 Financial mathematics
3.3 Experimental finance
3.4 Behavioral finance
4 Professional qualifications
5 Unsolved problems in finance
6 See also
8 External links
Areas of finance
Stock Exchange, European Center of finance, Frankfurt am
Wall Street, American centre of finance.
Stock Exchange, British centre of finance.
Main article: Personal finance
Questions in personal finance revolve around:
Protection against unforeseen personal events, as well as events in
the wider economies
Transference of family wealth across generations (bequests and
Effects of tax policies (tax subsidies or penalties) management of
Effects of credit on individual financial standing
Development of a savings plan or financing for large purchases (auto,
Planning a secure financial future in an environment of economic
Warren Buffett is an American investor, business magnate, and
philanthropist. He is considered by some to be one of the most
successful investors in the world.
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.
Personal finance may also involve paying for a loan, or debt
obligations. The six key areas of personal financial planning, as
suggested by the Financial Planning Standards Board, are:
Financial position: is concerned with understanding the personal
resources available by examining net worth and household cash flows.
Net worth is a person's balance sheet, calculated by adding up all
assets under that person's control, minus all liabilities of the
household, at one point in time. Household cash flows total up all
from the expected sources of income within a year, minus all expected
expenses within the same year. From this analysis, the financial
planner can determine to what degree and in what time the personal
goals can be accomplished.
Adequate protection: the analysis of how to protect a household from
unforeseen risks. These risks can be divided into the following:
liability, property, death, disability, health and long term care.
Some of these risks may be self-insurable, while most will require the
purchase of an insurance contract. Determining how much insurance to
get, at the most cost effective terms requires knowledge of the market
for personal insurance.
Business owners, professionals, athletes and
entertainers require specialized insurance professionals to adequately
protect themselves. Since insurance also enjoys some tax benefits,
utilizing insurance investment products may be a critical piece of the
overall investment planning.
Tax planning: typically the income tax is the single largest expense
in a household. Managing taxes is not a question of if you will pay
taxes, but when and how much. Government gives many incentives in the
form of tax deductions and credits, which can be used to reduce the
lifetime tax burden. Most modern governments use a progressive tax.
Typically, as one's income grows, a higher marginal rate of tax must
be paid. Understanding how to take advantage of the myriad tax breaks
when planning one's personal finances can make a significant impact in
which it can later save you money in the long term.
Investment and accumulation goals: planning how to accumulate enough
money – for large purchases and life events – is what most people
consider to be financial planning. Major reasons to accumulate assets
include purchasing a house or car, starting a business, paying for
education expenses, and saving for retirement. Achieving these goals
requires projecting what they will cost, and when you need to withdraw
funds that will be necessary to be able to achieve these goals. A
major risk to the household in achieving their accumulation goal is
the rate of price increases over time, or inflation. Using net present
value calculators, the financial planner will suggest a combination of
asset earmarking and regular savings to be invested in a variety of
investments. In order to overcome the rate of inflation, the
investment portfolio has to get a higher rate of return, which
typically will subject the portfolio to a number of risks. Managing
these portfolio risks is most often accomplished using asset
allocation, which seeks to diversify investment risk and opportunity.
This asset allocation will prescribe a percentage allocation to be
invested in stocks (either preferred stock or common stock), bonds
(for example mutual bonds or government bonds, or corporate bonds),
cash and alternative investments. The allocation should also take into
consideration the personal risk profile of every investor, since risk
attitudes vary from person to person.
Retirement planning is the process of understanding how much it costs
to live at retirement, and coming up with a plan to distribute assets
to meet any income shortfall. Methods for retirement plans include
taking advantage of government allowed structures to manage tax
liability including: individual (IRA) structures, or employer
sponsored retirement plans, annuities and life insurance products.
Estate planning involves planning for the disposition of one's assets
after death. Typically, there is a tax due to the state or federal
government at one's death. Avoiding these taxes means that more of
one's assets will be distributed to one's heirs. One can leave one's
assets to family, friends or charitable groups.
Main article: Corporate finance
Jack Welch an American retired business executive, author, and
chemical engineer. He was chairman and CEO of
General Electric between
1981 and 2001. During his tenure at GE, the company's value rose
Corporate finance deals with the sources 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. Although it 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.
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. In the first, "capital budgeting", management
must choose which "projects" (if any) to undertake. The discipline of
capital budgeting may employ standard business valuation techniques or
even extend to real options valuation; see Financial modeling. The
second, "sources of capital" relates to how these investments are to
be funded: investment capital can be provided through different
sources, such as by shareholders, in the form of equity (privately or
via an initial public offering), creditors, often in the form of
bonds, and the firm's operations (cash flow). Short-term funding or
working capital is mostly provided by banks extending a line of
credit. The balance between these elements forms the company's capital
structure. The third, "the dividend policy", requires management to
determine whether any unappropriated profit (excess cash) is to be
retained for future investment / operational requirements, or instead
to be distributed to shareholders, and if so, in what form. Short term
financial management is often termed "working capital management", and
relates to cash-, inventory- and debtors management.
Corporate finance also includes within its scope business valuation,
stock investing, or investment management. An investment is an
acquisition of an asset in the hope that it will maintain or increase
its value over time that will in hope give back a higher rate of
return when it comes to disbursing dividends. In investment
management – in choosing a portfolio – one has to use
financial analysis to determine what, how much and when to invest. To
do this, a company must:
Identify relevant objectives and constraints: institution or
individual goals, time horizon, risk aversion and tax considerations;
Identify the appropriate strategy: active versus passive hedging
Measure the portfolio performance
James Harris Simons
James Harris Simons American mathematician, hedge fund manager, and
philanthropist. He is known as a quantitative investor and in 1982
founded Renaissance Technologies, a private hedge fund based in New
Financial management overlaps with the financial function of the
accounting profession. However, financial accounting is the reporting
of historical financial information, while financial management is
concerned with the allocation of capital resources to increase a
firm's value to the shareholders and increase their rate of return on
Financial risk management, an element of corporate finance, is the
practice of creating and protecting economic value in a firm by using
financial instruments to manage exposure to risk, particularly credit
risk and market risk. (Other risk types include foreign exchange,
shape, volatility, sector, liquidity, inflation risks, etc.) It
focuses on when and how to hedge using financial instruments; in this
sense it overlaps with financial engineering. Similar to general risk
management, financial risk management requires identifying its
sources, measuring it (see: Risk measure#Examples), and formulating
plans to address these, and can be qualitative and quantitative. In
the banking sector worldwide, the
Basel Accords are generally adopted
by internationally active banks for tracking, reporting and exposing
operational, credit and market risks.
Main article: Financial services
An entity whose income exceeds its expenditure can lend or invest the
excess income to help that excess income produce more income in the
future. Though 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 (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.
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.
Finance is used by individuals (personal finance), by governments
(public finance), by businesses (corporate finance) and by a wide
variety of other organizations such as schools and non-profit
organizations. In general, the goals of each of the above activities
are achieved through the use of appropriate financial instruments and
methodologies, with consideration to their institutional setting.
Finance is one of the most important aspects of business management
and includes analysis related to the use and acquisition of funds for
In corporate finance, a company's capital structure is the total mix
of financing methods it uses to raise funds. One method is debt
financing, which includes bank loans and bond sales. Another method is
equity financing – the sale of stock by a company to investors, the
original shareholders (they own a portion of the business) of a share.
Ownership of a share gives the shareholder certain contractual rights
and powers, which typically include the right to receive declared
dividends and to vote the proxy on important matters (e.g., board
elections). The owners of both bonds (either government bonds or
corporate bonds) and stock (whether its preferred stock or common
stock), may be institutional investors – financial institutions such
as investment banks and pension funds or private individuals,
called private investors or retail investors.
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. These long-term
strategic periods usually encompass five or more years. 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
Federal Reserve System banks in the United
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.
Main article: Financial capital
Capital, in the financial sense, is the money that gives the business
the power to buy goods to be used in the production of other goods or
the offering of a service. (Capital has two types of sources, equity
The deployment of capital is decided by the budget. This may include
the objective of business, targets set, and results in financial
terms, e.g., the target set for sale, resulting cost, growth, required
investment to achieve the planned sales, and financing source for the
A budget may be long term or short term. Long term budgets have a time
horizon of 5–10 years giving a vision to the company; short
term is an annual budget which is drawn to control and operate in that
Budgets will include proposed fixed asset requirements and how these
expenditures will be financed. Capital budgets are often adjusted
annually (done every year) and should be part of a longer-term Capital
A cash budget is also required. The working capital requirements of a
business are monitored at all times to ensure that there are
sufficient funds available to meet short-term expenses.
The cash budget is basically a detailed plan that shows all expected
sources and uses of cash when it comes to spending it appropriately.
The cash budget has the following six main sections:
Beginning cash balance – contains the last period's closing cash
balance, in other words, the remaining cash of the last year.
Cash collections – includes all expected cash receipts (all sources
of cash for the period considered, mainly sales)
Cash disbursements – lists all planned cash outflows for the period
such as dividend, excluding interest payments on short-term loans,
which appear in the financing section. All expenses that do not affect
cash flow are excluded from this list (e.g. depreciation,
Cash excess or deficiency – a function of the cash needs and cash
Cash needs are determined by the total cash disbursements
plus the minimum cash balance required by company policy. If total
cash available is less than cash needs, a deficiency exists.
Financing – discloses the planned borrowings and repayments of those
planned borrowings, including interest.
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 managing risk in the
context of the financial markets, and the resultant economic and
financial models. It essentially explores how rational investors would
apply risk and return to the problem of an investment policy. Here,
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",
at least formally, 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.
Although 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.
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. 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 modelling and derivation
(see: Quantitative analyst). 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; Outline of finance: Derivatives
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.
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.
Behavioral finance includes such topics as:
Empirical studies that demonstrate significant deviations from
Models of how psychology affects and impacts trading and prices
Forecasting based on these methods.
Studies of experimental asset markets and use of models to forecast
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. Some of
these endeavors has been led by
Gunduz Caginalp (Professor of
Mathematics and Editor of
Journal of Behavioral Finance during
2001-2004) and collaborators including Vernon Smith (2002 Nobel
Laureate in Economics), David Porter, Don Balenovich, Vladimira
Ilieva, Ahmet Duran). Studies by Jeff Madura, Ray Sturm and others
have demonstrated significant behavioral effects in stocks and
exchange traded funds. Among other topics, quantitative behavioral
finance studies behavioral effects together with the non-classical
assumption of the finiteness of assets.
There are several related professional qualifications, that can lead
to the field:
Master of Science in Finance (MSF), Master of Finance
(M.Fin), Master of Financial Economics, Master of Applied Finance,
Master of Liberal Arts
Master of Liberal Arts in
Chartered Financial Analyst
Chartered Financial Analyst (CFA), Certified Treasury
Professional (CTP), Certified Valuation Analyst (CVA), Certified
Patent Valuation Analyst (CPVA), Chartered
Business Valuator (CBV),
Investment Analyst (CIIA), Financial Risk
Professional Risk Manager
Professional Risk Manager (PRM), Association of
Corporate Treasurers (ACT),
Certified Market Analyst
Certified Market Analyst (CMA/FAD) Dual
Finance Qualification (CF), Chartered
Investment Analyst (CAIA), Chartered
Finance qualifications: Master of Financial Engineering
Master of Quantitative Finance (MQF), Master of Computational
Master of Financial Mathematics (MFM), Certificate in
Chartered Certified Accountant
Chartered Certified Accountant (ACCA, UK
Chartered Accountant (ACA – England & Wales
certification / CA – certification in Scotland and Commonwealth
Certified Public Accountant
Certified Public Accountant (CPA, US certification),
ACMA/FCMA (Associate/Fellow Chartered Management Accountant) from
Chartered Institute of Management Accountant (CIMA), UK. Certified
Management Accountant (CMA) from Institute of Management Accountants,
Chartered Cost Accountant CCA
Designation from AAFM
Business qualifications: Master of
Business Administration (MBA),
Master of Management
Master of Management (MM),
Master of Commerce (M.Comm), Master of
Science in Management (MSM), Doctor of
Business Administration (DBA)
Unsolved problems in finance
As the debate 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.
Outline of finance
Financial crisis of 2007–2010
List of unsolved problems in finance
^ "Financial Planning Curriculum Framework". Financial Planning
Standards Board. 2011. Archived from the original on 1 February 2012.
Retrieved 7 April 2012.
^ Doss, Daniel; Sumrall, William; Jones, Don (2012). Strategic Finance
for Criminal Justice Organizations (1st ed.). Boca Raton, Florida: CRC
Press. p. 23. ISBN 978-1439892237.
^ Doss, Daniel; Sumrall, William; Jones, Don (2012). Strategic Finance
for Criminal Justice Organizations (1st ed.). Boca Raton, Florida: CRC
Press. pp. 53–54. ISBN 978-1439892237.
^ Board of Governors of
Federal Reserve System
Federal Reserve System of the United States.
Mission of the Federal Reserve System. Federalreserve.gov Accessed:
2010-01-16. (Archived by
WebCite at Archived 2010-01-16 at WebCite)
^ Shefrin, Hersh (2002). Beyond greed and fear: Understanding
behavioral finance and the psychology of investing. New York, NY:
Oxford University Press. p. ix. ISBN 978-0195304213.
Retrieved 8 May 2017.
^ "Is finance an art or a science?". Investopedia. Retrieved
Look up finance in Wiktionary, the free dictionary.
Wikiquote has quotations related to: Finance
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Collier's Encyclopedia article
Finance Step by step with infographics tools
OECD work on financial markets Observation of UK
Finance Knowledge Project – aimed to offer free access to
finance knowledge for students, teachers, and self-learners.
Professor Aswath Damodaran (New York University Stern School of
Business) – provides resources covering three areas in finance:
corporate finance, valuation and investment management and syndicate
General areas of finance
Quantitative behavioral finance