Finance

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Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of financial economics bridges the two). Finance activities take place in financial systems at various scopes, thus the field can be roughly divided into personal, corporate, and public finance. [lower-alpha 1]

Contents

In a financial system, assets are bought, sold, or traded as financial instruments, such as currencies, loans, bonds, shares, stocks, options, futures, etc. Assets can also be banked, invested, and insured to maximize value and minimize loss. In practice, risks are always present in any financial action and entities.

A broad range of subfields within finance exist due to its wide scope. Asset, money, risk and investment management aim to maximize value and minimize volatility. Financial analysis is viability, stability, and profitability assessment of an action or entity. In some cases, theories in finance can be tested using the scientific method, covered by experimental finance.

Some fields are multidisciplinary, such as mathematical finance, financial law, financial economics, financial engineering and financial technology. These fields are the foundation of business and accounting .

The early history of finance parallels the early history of money, which is prehistoric. Ancient and medieval civilizations incorporated basic functions of finance, such as banking, trading and accounting, into their economies. In the late 19th century, the global financial system was formed.

It was in the middle of the 20th century that finance emerged as a distinct academic discipline, separate from economics. [1] (The first academic journal, The Journal of Finance , began publication in 1946.) The earliest doctoral programs in finance were established in the 1960s and 1970s. [2] Finance is widely studied at the undergraduate and masters level. [3]

The financial system

The Federal Reserve is the central bank of the US. Seal of the United States Federal Reserve System.svg
The Federal Reserve is the central bank of the US.
Bond issued by The Baltimore and Ohio Railroad. Bonds are a form of borrowing used by corporations to finance their operations. 1925.B&O.Railroad.Stock.Louis.Brandeis.jpg
Bond issued by The Baltimore and Ohio Railroad. Bonds are a form of borrowing used by corporations to finance their operations.
Share certificate dated 1913 issued by the Radium Hill Company Radium Hill share certificate.jpg
Share certificate dated 1913 issued by the Radium Hill Company
The floor of the New York Stock Exchange in 1908 Stockexchange.jpg
The floor of the New York Stock Exchange in 1908
NYSE's stock exchange traders floor c 1960, before the introduction of electronic readouts and computer screens NY stock exchange traders floor LC-U9-10548-6.jpg
NYSE's stock exchange traders floor c 1960, before the introduction of electronic readouts and computer screens
Chicago Board of Trade Corn Futures market, 1993 Chicago bot.jpg
Chicago Board of Trade Corn Futures market, 1993
Oil traders, Houston, 2009 A1 Houston Office Oil Traders on Monday.jpg
Oil traders, Houston, 2009

As above, the financial system consists of the flows of capital that take place between individuals and households (personal finance), governments (public finance), and businesses (corporate finance). "Finance" thus studies the process of channeling money from savers and investors to entities that need it. [lower-alpha 2] 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 expenditure can lend or invest the excess, intending to earn a fair return. Correspondingly, an entity where income is less than expenditure can raise capital usually in one of two ways: (i) by borrowing in the form of a loan (private individuals), or by selling government or corporate bonds; (ii) by a corporation selling equity, also called stock or shares (which may take various forms: preferred stock or common stock). The owners of both bonds and stock may be institutional investors   financial institutions such as investment banks and pension funds – or private individuals, called private investors or retail investors.

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

Investing typically entails the purchase of stock, either individual securities, or via a mutual fund for example. Stocks are usually sold by corporations to investors so as to raise required capital in the form of "equity financing", as distinct from the debt financing described above. The financial intermediaries here are the investment banks. 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, pension funds, 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 products, as well as specialized financing; this "financial engineering" is inherently mathematical, and these institutions are then the major employers of "quants" (see below). In these institutions, risk management, regulatory capital, and compliance play major roles.

Areas of finance

As outlined, finance comprises, broadly, the three areas of personal finance, corporate finance, and public finance. These, in turn, overlap and employ various activities and sub-disciplines  chiefly investments, risk management, and quantitative finance.

Personal finance

Wealth management consultation - here the financial advisor counsels the client on an appropriate investment strategy Wealth Management Consultation.jpg
Wealth management consultation  here the financial advisor counsels the client on an appropriate investment strategy

Personal finance is defined as "the mindful planning of monetary spending and saving, while also considering the possibility of future risk". [8] Personal finance may involve paying for education, financing durable goods such as real estate and cars, buying insurance, investing, and saving for retirement. [9] 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. [10] The following steps, as outlined by the Financial Planning Standards Board, [11] suggest that an individual will understand a potentially secure personal finance plan after:

Corporate finance

Founded in 1602, the Dutch East India Company (VOC), started off as a spice trader, "going public" in the same year, with the world's first IPO. Vereenigde Oostindische Compagnie spiegelretourschip Amsterdam replica.jpg
Founded in 1602, the Dutch East India Company (VOC), started off as a spice trader, "going public" in the same year, with the world's first IPO.

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 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 of all firms rather than corporations alone, the concepts are applicable to the financial problems of all firms, [13] 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, and its return to shareholders, while also balancing risk and profitability. This entails [14] three primary areas:

  1. Capital budgeting: selecting which projects to invest in  here, accurately determining value is crucial, as judgements about asset values can be "make or break" [15]
  2. Dividend policy: the use of "excess" funds  are these to be reinvested in the business or returned to shareholders
  3. 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

The latter creates the link with investment banking and securities trading, as above, in that the capital raised will generically comprise debt, i.e. corporate bonds, and equity, often listed shares. Re risk management within corporates, see below.

Financial managers  i.e. as opposed to corporate financiers  focus more on the short term elements of profitability, cash flow, and "working capital management" (inventory, credit and debtors), 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 operational expenses. See Financial management § Role and Financial analyst § Corporate and other.

Public finance

President George W. Bush, speaking on the Federal Budget in 2007, here requesting additional funds from Congress 20071203-Bush speech on budget Rose Garden.jpg
President George W. Bush, speaking on the Federal Budget in 2007, here requesting additional funds from Congress
2020 US Federal Revenues and Outlays 2020 US Federal Revenues and Outlays.png
2020 US Federal Revenues and Outlays

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. [16] These long-term strategic periods typically encompass five or more years. [17] Public finance is primarily concerned with: [18]

Central banks, such as the Federal Reserve System banks in the United States and the Bank of England in the 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. [19]

Development finance, which is related, concerns investment in economic development projects provided by a (quasi) governmental institution on a non-commercial basis; these projects would otherwise not be able to get financing. See Public utility § Finance. A public–private partnership is primarily used for infrastructure projects: a private sector corporate provides the financing up-front, and then draws profits from taxpayers and/or users.

Investment management

Share prices listed in a Korean Newspaper Stock Price Listing Numbers on a Korean Newspaper.jpg
Share prices listed in a Korean Newspaper
"The excitement before the bubble burst" - viewing prices via ticker tape, shortly before the Wall Street Crash of 1929 Stock ticker.jpg
"The excitement before the bubble burst"  viewing prices via ticker tape, shortly before the Wall Street Crash of 1929
Modern price-ticker. This infrastructure underpins contemporary exchanges, and allows, ultimately, for individual day trading, as well as wholesale computer-executed program trading and high-frequency trading. E-ticker.jpg
Modern price-ticker. This infrastructure underpins contemporary exchanges, and allows, ultimately, for individual day trading, as well as wholesale computer-executed program trading and high-frequency trading.

Investment management [20] [21] [13] is the professional asset management of various securities  typically shares and bonds, but also other assets, such as real estate, commodities and alternative investments   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, or REITs.

At the heart of investment management [13] is asset allocation   diversifying the exposure among these asset classes, and among individual securities within each asset class  as appropriate to the client's investment policy, in turn, a function of risk profile, investment goals, and investment horizon (see Investor profile). Here:

Overlaid is the portfolio manager's investment style   broadly, active vs passive , value vs growth, and small cap vs. large cap   and investment strategy.

In a well-diversified portfolio, achieved investment performance 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) instead of human judgment. The actual trading also, is typically automated via sophisticated algorithms.

Risk management

Crowds gathering outside the New York Stock Exchange after the Wall Street Crash of 1929 Crowds gathering outside New York Stock Exchange (4).jpg
Crowds gathering outside the New York Stock Exchange after the Wall Street Crash of 1929
Customers queuing outside a Northern Rock branch in the United Kingdom to withdraw their savings during the financial crisis of 2007-2008 Northern Rock Queue.jpg
Customers queuing outside a Northern Rock branch in the United Kingdom to withdraw their savings during the financial crisis of 2007–2008

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 management [22] [23] 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, through regulatory capital, includes operational risk.

Financial risk management is related to corporate finance [13] 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's credit policy and is often addressed through credit insurance and provisioning. Secondly, both disciplines share the goal of enhancing or at least preserving, the firm's economic value, and in this context [24] overlaps also enterprise risk management, typically the domain of strategic management. Here, businesses devote much time and effort to forecasting, analytics and performance monitoring. See also "ALM" and treasury management.

For banks and other wholesale institutions, [25] risk management focuses on managing, and as necessary hedging, the various positions held by the institution  both trading positions and long term exposures   and on calculating and monitoring the resultant economic capital, and regulatory capital under Basel III. The calculations here are mathematically sophisticated, and within the domain of quantitative finance as below. Credit risk is inherent in the business of banking, but additionally, these institutions are exposed to counterparty credit risk. Banks typically employ Middle office "Risk Groups" here, whereas front office risk teams provide risk "services" / "solutions" to customers.

Additional to diversification  the fundamental risk mitigant here  investment managers will apply various risk management techniques to their portfolios as appropriate: [13] these may relate to the portfolio as a whole or to individual stocks; bond portfolios are typically managed via cash flow matching or immunization. Re derivative portfolios (and positions), "the Greeks" is a vital risk management tool  it measures 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.

Quantitative finance

Quantitative finance  also referred to as "mathematical finance"  includes those finance activities where a sophisticated mathematical model is required, [26] and thus overlaps several of the above.

As a specialized practice area, quantitative finance comprises primarily three sub-disciplines; the underlying theory and techniques are discussed in the next section:

  1. Quantitative finance is often synonymous with financial engineering. This area generally underpins a bank's customer-driven derivatives business   delivering bespoke OTC-contracts and "exotics", and designing the various structured products and solutions mentioned  and encompasses modeling and programming in support of the initial trade, and its subsequent hedging and management.
  2. Quantitative finance also significantly overlaps financial risk management in banking, as mentioned, both as regards this hedging, and as regards economic capital as well as compliance with regulations and the Basel capital / liquidity requirements.
  3. "Quants" are also responsible for building and deploying the investment strategies at the quantitative funds mentioned; they are also involved in quantitative investing more generally, in areas such as trading strategy formulation, and in automated trading, high-frequency trading, algorithmic trading, and program trading.

Financial theory

DCF valuation formula widely applied in business and finance, since articulated in 1938. Here, to get the value of the firm, its forecasted free cash flows are discounted to the present using the weighted average cost of capital for the discount factor. For share valuation investors use the related dividend discount model.

Financial theory is studied and developed within the disciplines of management, (financial) economics, accountancy and applied mathematics. Abstractly, [13] [27] finance is concerned with the investment and deployment of assets and liabilities over "space and time"; i.e., it is about performing valuation and asset allocation today, based on the risk and uncertainty of future outcomes while appropriately incorporating the time value of money. Determining the present value of these future values, "discounting", must be at the risk-appropriate discount rate, in turn, a major focus of finance-theory. [28] Since the debate as to whether finance is an art or a science is still open, [29] there have been recent efforts to organize a list of unsolved problems in finance.

Managerial finance

Decision trees, a more sophisticated valuation-approach, sometimes applied to corporate finance "project" valuations (and a standard in business school curricula); various scenarios are considered, and their discounted cash flows are probability weighted. Manual decision tree.jpg
Decision trees, a more sophisticated valuation-approach, sometimes applied to corporate finance "project" valuations (and a standard in business school curricula); various scenarios are considered, and their discounted cash flows are probability weighted.

Managerial finance is the branch of management that concerns itself with the managerial application of finance techniques and theory, emphasizing the financial aspects of managerial decisions; the assessment is per the managerial perspectives of planning, directing, and controlling. The techniques addressed and developed relate in the main to managerial accounting and corporate finance: the former allow management to better understand, and hence act on, financial information relating to 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   is outlined above. Academics working in this area are typically based in business school finance departments, in accounting, or in management science.

Financial economics

The "efficient frontier", a prototypical concept in portfolio optimization. Introduced in 1952, it remains "a mainstay of investing and finance". Markowitz frontier.jpg
The "efficient frontier", a prototypical concept in portfolio optimization. Introduced in 1952, it remains "a mainstay of investing and finance".
Modigliani-Miller theorem, a foundational element of finance theory, introduced in 1958; it forms the basis for modern thinking on capital structure. Even if leverage (D/E) increases, the WACC (k0) stays constant. MM2.png
Modigliani–Miller theorem, a foundational element of finance theory, introduced in 1958; it forms the basis for modern thinking on capital structure. Even if leverage (D/E) increases, the WACC (k0) stays constant.

Financial economics [32] is the branch of economics that studies the interrelation of financial variables, such as prices, interest rates and shares, as opposed to real economic variables, i.e. goods and services. It thus centers on pricing, decision making, and risk management in the financial markets, [32] [27] and produces many of the commonly employed financial models. (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: [27] asset pricing and corporate finance; the first being the perspective of providers of capital, i.e. investors, and the second of users of capital; respectively:

Financial mathematics

The Black–Scholes formula for the value of a call option. Although lately its use is considered naive, it has underpinned the development of derivatives-theory, and financial mathematics more generally, since its introduction in 1973. [33]
"Trees" are widely applied in mathematical finance; here used in calculating an OAS. Other common pricing-methods are simulation and PDEs. These are used for settings beyond those envisaged by Black-Scholes. Post crisis, even in those settings, banks use local and stochastic volatility models to incorporate the volatility surface. OAS valuation tree (es).png
"Trees" are widely applied in mathematical finance; here used in calculating an OAS. Other common pricing-methods are simulation and PDEs. These are used for settings beyond those envisaged by Black-Scholes. Post crisis, even in those settings, banks use local and stochastic volatility models to incorporate the volatility surface.

Financial mathematics [34] is the field of applied mathematics concerned with financial markets; Louis Bachelier's doctoral thesis, defended in 1900, is considered to be the first scholarly work in this area. As above, in terms of practice, the field is referred to as quantitative finance and / or mathematical finance, and comprises primarily the three areas discussed.

The field is largely focused on the modeling of derivatives   with much emphasis on interest rate- and credit risk modeling   while other important areas include insurance mathematics and quantitative portfolio management. Relatedly, the techniques developed are applied to pricing and hedging a wide range of asset-backed, government, and corporate-securities. The main mathematical tools and techniques are:

Mathematically, these separate into two analytic branches: derivatives pricing uses risk-neutral probability (or arbitrage-pricing probability), denoted by "Q"; while risk and portfolio management generally use physical (or actual or actuarial) probability, denoted by "P". These are interrelated through the above "Fundamental theorem of asset pricing".

The subject has a close relationship with financial economics, which, as above, is concerned with much of the underlying theory that is involved in financial mathematics: generally, financial mathematics will derive and extend the mathematical models suggested. Computational finance is the branch of (applied) computer science that deals with problems of practical interest in finance, and especially [34] emphasizes the numerical methods applied here.

Experimental finance

Experimental finance [37] 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 [38] and is relevant when making a decision that can impact either negatively or positively on one of their areas. With more in-depth research into behavioral finance, it is possible to bridge what actually happens in financial markets with analysis based on financial theory. [39] Behavioral finance has grown over the last few decades to become an integral aspect of finance. [40]

Behavioral finance includes such topics as:

  1. Empirical studies that demonstrate significant deviations from classical theories;
  2. Models of how psychology affects and impacts trading and prices;
  3. Forecasting based on these methods;
  4. 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.

Quantum finance

Quantum finance is an interdisciplinary research field, applying theories and methods developed by quantum physicists and economists in order to solve problems in finance. It is a branch of econophysics. Finance theory is heavily based on financial instrument pricing such as stock option pricing. Many of the problems facing the finance community have no known analytical solution. As a result, numerical methods and computer simulations for solving these problems have proliferated. This research area is known as computational finance. Many computational finance problems have a high degree of computational complexity and are slow to converge to a solution on classical computers. In particular, when it comes to option pricing, there is additional complexity resulting from the need to respond to quickly changing markets. For example, in order to take advantage of inaccurately priced stock options, the computation must complete before the next change in the almost continuously changing stock market. As a result, the finance community is always looking for ways to overcome the resulting performance issues that arise when pricing options. This has led to research that applies alternative computing techniques to finance. Most commonly used quantum financial models are quantum continuous model, quantum binomial model, multi-step quantum binomial model etc.

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. [41] The Code of Hammurabi (1792-1750 BC) included laws governing banking operations. The Babylonians were accustomed to charging interest at the rate of 20 percent 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 practicing 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.) [42] [43]

The use of coins as a means of representing money began in the years between 600 and 570 BCE. Cities under the 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%. [44]

It's said Belgium is the place where the first exchange happened back in approximately 1531. [45] Since, popular exchanges such as the London Stock Exchange (founded in 1773) and the New York Stock Exchange (founded in 1793) were created. [46] [47]

See also

Notes

  1. The following are definitions of finance as crafted by the authors indicated:
    • Fama and Miller: "The theory of finance is concerned with how individuals and firms allocate resources through time. In particular, it seeks to explain how solutions to the problems faced in allocating resources through time are facilitated by the existence of capital markets (which provide a means for individual economic agents to exchange resources to be available of different points In time) and of firms (which, by their production-investment decisions, provide a means for individuals to transform current resources physically into resources to be available in the future)."
    • Guthmann and Dougall: "Finance is concerned with the raising and administering of funds and with the relationships between private profit-seeking enterprise on the one hand and the groups which supply the funds on the other. These groups, which include investors and speculators — that is, capitalists or property owners — as well as those who advance short-term capital, place their money in the field of commerce and industry and in return expect a stream of income."
    • Drake and Fabozzi: "Finance is the application of economic principles to decision-making that involves the allocation of money under conditions of uncertainty."
    • F.W. Paish: "Finance may be defined as the position of money at the time it is wanted".
    • John J. Hampton: "The term finance can be defined as the management of the flows of money through an organisation, whether it will be a corporation, school, or bank or government agency".
    • Howard and Upton: "Finance may be defined as that administrative area or set of administrative functions in an organisation which relates with the arrangement of each debt and credit so that the organisation may have the means to carry out the objectives as satisfactorily as possible".
    • Pablo Fernandez: “Finance is a profession that requires interdisciplinary training and can help the managers of companies make sound decisions about financing, investment, continuity and other issues that affect the inflows and outflows of money, and the risk of the company. It also helps people and institutions invest and plan money-related issues wisely.”
  2. Finance thus allows production and consumption in society to operate independently from each other. Without the use of financial allocation, production would have to happen at the same time and space as consumption. Through finance, distances in timespace between production and consumption are then posible. [4]

Related Research Articles

In economics and finance, arbitrage is the practice of taking advantage of a difference in prices in two or more markets; striking a combination of matching deals to capitalise on the difference, the profit being the difference between the market prices at which the unit is traded. When used by academics, an arbitrage is a transaction that involves no negative cash flow at any probabilistic or temporal state and a positive cash flow in at least one state; in simple terms, it is the possibility of a risk-free profit after transaction costs. For example, an arbitrage opportunity is present when there is the possibility to instantaneously buy something for a low price and sell it for a higher price.

<span class="mw-page-title-main">Fundamental analysis</span> Analysis of a businesss financial statements, health, and market

Fundamental analysis, in accounting and finance, is the analysis of a business's financial statements ; health; and competitors and markets. It also considers the overall state of the economy and factors including interest rates, production, earnings, employment, GDP, housing, manufacturing and management. There are two basic approaches that can be used: bottom up analysis and top down analysis. These terms are used to distinguish such analysis from other types of investment analysis, such as quantitative and technical.

<span class="mw-page-title-main">Capital market</span> Finance

A capital market is a financial market in which long-term debt or equity-backed securities are bought and sold, in contrast to a money market where short-term debt is bought and sold. Capital markets channel the wealth of savers to those who can put it to long-term productive use, such as companies or governments making long-term investments. Financial regulators like Securities and Exchange Board of India (SEBI), Bank of England (BoE) and the U.S. Securities and Exchange Commission (SEC) oversee capital markets to protect investors against fraud, among other duties.

<span class="mw-page-title-main">Financial market</span> Generic term for all markets in which trading takes place with capital

A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds, raw materials and precious metals, which are known in the financial markets as commodities.

Financial capital is any economic resource measured in terms of money used by entrepreneurs and businesses to buy what they need to make their products or to provide their services to the sector of the economy upon which their operation is based, e.g., retail, corporate, investment banking, etc. In other words, financial capital is internal retained earnings generated by the entity or funds provided by lenders to businesses in order to purchase real capital equipment or services for producing new goods and/or services.

Financial economics, also known as finance, is the branch of economics characterized by a "concentration on monetary activities", in which "money of one type or another is likely to appear on both sides of a trade". Its concern is thus the interrelation of financial variables, such as share prices, interest rates and exchange rates, as opposed to those concerning the real economy. It has two main areas of focus: asset pricing, commonly known as "Investments", and corporate finance; the first being the perspective of providers of capital, i.e. investors, and the second of users of capital. It thus provides the theoretical underpinning for much of finance.

The risk-free rate of return, usually shortened to the risk-free rate, is the rate of return of a hypothetical investment with scheduled payments over a fixed period of time that is assumed to meet all payment obligations.

<span class="mw-page-title-main">Valuation (finance)</span> Process of estimating what something is worth, used in the finance industry

In finance, valuation is the process of determining the present value (PV) of an asset. In a business context, it is often the hypothetical price that a third party would pay for a given asset. Valuations can be done on assets or on liabilities. Valuations are needed for many reasons such as investment analysis, capital budgeting, merger and acquisition transactions, financial reporting, taxable events to determine the proper tax liability.

<span class="mw-page-title-main">Fixed income</span> Type of investment

Fixed income refers to any type of investment under which the borrower or issuer is obliged to make payments of a fixed amount on a fixed schedule. For example, the borrower may have to pay interest at a fixed rate once a year and repay the principal amount on maturity. Fixed-income securities — more commonly known as bonds — can be contrasted with equity securities – often referred to as stocks and shares – that create no obligation to pay dividends or any other form of income. Bonds carry a level of legal protections for investors that equity securities do not — in the event of a bankruptcy, bond holders would be repaid after liquidation of assets, whereas shareholders with stock often receive nothing.

A financial analyst is a professional, undertaking financial analysis for external or internal clients as a core feature of the job. The role may specifically be titled securities analyst, research analyst, equity analyst, investment analyst, or ratings analyst. The job title is a broad one: in banking, and industry more generally, various other analyst-roles cover financial management and (credit) risk management, as opposed to focusing on investments and valuation; these are also discussed in this article.

In finance, a portfolio is a collection of investments.

Financial risk management is the practice of protecting economic value in a firm by using financial instruments to manage exposure to financial risk - principally operational risk, credit risk and market risk, with more specific variants as listed aside. As for risk management more generally, financial risk management requires identifying its sources, measuring it, and the plans to address them. See Finance § Risk management for an overview.

Investment management is the professional asset management of various securities, including shareholdings, bonds, and other assets, such as real estate, to meet specified investment goals for the benefit of investors. 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, or REITs.

A structured product, also known as a market-linked investment, is a pre-packaged structured finance investment strategy based on a single security, a basket of securities, options, indices, commodities, debt issuance or foreign currencies, and to a lesser extent, derivatives. Structured products are not homogeneous — there are numerous varieties of derivatives and underlying assets — but they can be classified under the aside categories. Typically, a desk will employ a specialized "structurer" to design and manage its structured-product offering.

<span class="mw-page-title-main">Bond market</span> Financial market where participants can issue new debt or buy and sell debt securities

The bond market is a financial market where participants can issue new debt, known as the primary market, or buy and sell debt securities, known as the secondary market.This is usually in the form of bonds, but it may include notes, bills, and so on for public and private expenditures. The bond market has largely been dominated by the United States, which accounts for about 39% of the market. As of 2021, the size of the bond market is estimated to be at $119 trillion worldwide and $46 trillion for the US market, according to Securities Industry and Financial Markets Association (SIFMA).

<span class="mw-page-title-main">Financial risk</span> Any of various types of risk associated with financing

Financial risk is any of various types of risk associated with financing, including financial transactions that include company loans in risk of default. Often it is understood to include only downside risk, meaning the potential for financial loss and uncertainty about its extent.

The following outline is provided as an overview of and topical guide to finance:

Quantitative analysis is the use of mathematical and statistical methods in finance and investment management. Those working in the field are quantitative analysts (quants). Quants tend to specialize in specific areas which may include derivative structuring or pricing, risk management, algorithmic trading and investment management. The occupation is similar to those in industrial mathematics in other industries. The process usually consists of searching vast databases for patterns, such as correlations among liquid assets or price-movement patterns. The resulting strategies may involve high-frequency trading.

<span class="mw-page-title-main">Mathematical finance</span> Application of mathematical and statistical methods in finance

Mathematical finance, also known as quantitative finance and financial mathematics, is a field of applied mathematics, concerned with mathematical modeling of financial markets.

<span class="mw-page-title-main">Corporate finance</span> Framework for corporate funding, capital structure, and investment decisions.

Corporate finance is the area of finance that deals with the sources of funding, 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. The primary goal of corporate finance is to maximize or increase shareholder value.

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Further reading