Course Overview (1 of 3)

Defining Finance

Broadly defined, finance is the study of how people manage scarce resources in general, and money and other financial resources in particular. There are two important features that distinguish financial decisions from other types of decisions. The benefits and costs of financial decisions are spread out over time and usually shrouded in uncertainty.

These decisions are made in a financial environment that includes the financial system, institutions, markets, and participants such as individual households, businesses, and governments. It is important to note that a well developed and properly functioning financial system enables the economy to operate efficiently and contributes to the economic growth and development of the country.

Brief History of Finance

Finance emerged as a separate field of study in the U.S. in the early 1900s. At that time finance was taught primarily as a descriptive subject using anecdotes and rules of thumb. The focus at that time was on the formation of new firms, the various types of securities firms can issue to raise funds and the legal aspects of mergers and acquisitions.  This continued to be the focus all through the 1920s.

However, during the 1930s the focus shifted to the study of bankruptcy and reorganization, corporate liquidity, and regulation of securities markets because of the Great Depression. During the depression era, there were an unprecedented number of business failures, which resulted in high unemployment rates and economic decline in the country. During the 1940s and early 1950s, finance continued to be taught as a descriptive subject.

Course Overview (2 of 3)

With the development of the portfolio theory by  Harry Markowitz  in 1952, finance started to become more quantitative. The evolution of the subject accelerated during the late 1950s and 1960s with the development of the Modigliani-Miller Theorems, the Capital Market Theory, and the Capital Asset Pricing Model. This era is generally considered the birth of modern finance, from which evolved many of the decision-making techniques used today.

During the 1970s the Option Pricing Model was developed. This is considered the most important development in finance. As a result of these developments, the emphasis of finance shifted to decisions regarding the choice of assets and liabilities to maximize the firm's value. The late 1970s and 1980s saw increased globalization of business and finance. Firms discovered innovative ways to manage risks and finance operations.

During the 1990s finance continued to evolve amidst fast-paced technological developments. Innovations in information technology led to a dramatic increase in online trading and online banking. These developments further increased the importance of global markets and global finance.

The most important trends in the new millennium include the following:

· Continued globalization of business

· Increase in the use of information technology

· The regulatory attitude of the government

As a result of these developments, finance today is a well-developed coherent body of professional knowledge that continues to evolve using scientific methods.

 Role of Finance in the Economy (1 of 2)

Economy refers to an organized system of production, distribution, and consumption of goods and services within the socio-economic system of a country.

Economics is the study of the economy of a society. Economics involves the study of resource allocation such as labor, capital, and natural resources, how income that is generated in the production and sale of goods and services is distributed among people, and how people allocate their income through spending, saving, borrowing, and lending decisions.

Economics can be divided into two branches—microeconomics andmacroeconomics. The former involves the study of causes and consequences of individual decision-making units such as households and business firms in a market. The latter involves the study of the causes and effects of decisions made by all firms and households in markets.

Finance is the study of various financial or monetary aspects of decisions made by the individuals and firms, governments, and other organizations. These decisions are generally about production, spending, saving, borrowing, and lending. Generally finance involves the study of how individuals, firms, governments, and foreign investors raise and use money.

Why Study Finance?

There are several reasons to study finance:

· You might be interested in a career in finance (visit www.monster.com andwww.efinancialcareers.com). There are many potentially rewarding jobs in the field of finance and many possible career paths for finance professionals.

· Basic knowledge of finance enables you to efficiently manage your resources. When you decide to seek advice from professionals such as bankers, stockbrokers, insurance brokers, or financial advisors, you will be better able to evaluate the advice.

· As a citizen of the USA or another country, you should make informed financial, economic, and political decisions. Regardless of your financial and economic goals, you need to be an informed participant in economic and political processes. The study of finance will provide a conceptual framework for making such informed decisions.

· Knowledge of finance is essential in the business world. Even if your interests lie in a field other than finance, you need to have a sound understanding of the concepts, techniques, and terminology used by finance professionals. This helps you communicate and understand the concepts in your field of study.

· On an intellectual level, finance can be an interesting field of study. It enhances your understanding of how the real world works.

 Role of Finance in the Economy (2 of 2)

The study of finance is broadly divided into three inter-related areas: financial institutions and markets, investments, and financial management.

The study of financial institutions involves learning how banks, thrifts, finance companies, and the Federal Reserve Bank facilitate financial transactions through the transfer of funds from surplus units to deficit units for investment purposes.

The study of investments involves learning how to increase wealth and assets in the future using available funds. The investment landscape has changed dramatically in the last 20 years and offers numerous options today.

Financial management is also referred to as business finance or corporate finance. It is the study of how businesses evaluate long-term projects for investment. Financial management also involves the study of how businesses acquire funds, and analysis of a firm's performance.

Types of Financial Decisions

Households and businesses make various types of financial decisions.

Financial Decisions Made in Households:

· Consumption and savings decisions: How much of the current wealth should households spend on consumption and how much of their current income should they save for the future? For example should they eat out or save and invest in an individual retirement arrangements (IRA) account?

· Investment decisions: How should households invest the money they have saved? For example should they invest the funds in an IRA account, stock fund, or bond fund?

· Financing decisions: When and how should households borrow money to implement their consumption and investment plans? Consider that you want to buy a new car. The dealership offers a loan. Your credit union is also willing to provide a loan. Which one would you select?

· Risk management decisions: How and on what terms should households seek to reduce financial uncertainties? For example what type of auto insurance should they buy for their cars? Should they buy a service warranty?

 Overview of the U.S. Financial System (1 of 5)

The Financial System

A financial system is a complex network of government and policy makers, the monetary system, financial institutions, and financial markets, which interact to facilitate the flow of funds in the economy.

· An effective financial system should have policy makers who pass laws and make decisions relating to fiscal and monetary policies. The policy makers are the president, Congress, the U.S. Treasury, and the Federal Reserve Board.

· An effective financial system needs an efficient monetary system to create and transfer money.

· An effective financial system requires financial institutions that facilitate capital formation through the savings-investment process. This process refers to the flow of funds from savers to investments in physical assets or to financial institutions and businesses, which in turn invest in physical assets.

· An effective financial system should have financial markets that facilitate the transfer of financial assets among individuals, institutions, businesses, and the government.

Individuals are the primary investors in an economy. Ultimately they own all the business assets. Individuals invest in the financial system with the expectation of converting them to savings in the future. (A basic axiom of finance is that the ultimate function of the system is to satisfy individuals' consumption preferences, including the basic necessities of life.  Organizations such as firm

s and the government exist in order to facilitate the achievement of this ultimate function.)

The financial system plays an important role in an individual's financial life cycle. Initially intermediaries and markets play a role, directly or indirectly, when there's a need to borrow. For example you deal with the mortgage market directly or indirectly when you borrow money to buy your first home. Similarly you deal with banks and other financial institutions in various ways and for various reasons.

Foundations of Financial MGMT

Author:

Block, Stanley|Hirt, Geoffrey

Edition / Copyright:

13th

Publisher:

Mcgraw-Hill