finance
According to the Merriam Webster's definition. It is the management or science of monetary affairs as of a country, business, or individual. Or simply to supply the money for or manage the finances of certain valuables or services. Collier's Encyclopedia states that it is simply the transmission of funds from savers to users. The net also gave a special overview of what finance is. It is the study of the creation and management of wealth. Finance major learns how to evaluate and control risk. The finance program prepares students for a variety of positions in financial and non-financial enterprises. |
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the four financial areas
Personal Finance
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.
Questions in personal finance revolve around:
- Protection against unforeseen personal events, as well as events in the wider economy
- Transference of family across generations (bequests and inheritance)Effects of tax policies (tax subsidies and/or penalties) on management of personal finances
- Effects of credit on individual financial standing
- Planning a secure financial future in an environment of economic instability
Corporate Finance
Corporate finance deals with the sources of funding and the capital structure of corporations and the actions that managers take to increase the value of the firm to the shareholders, as well as the tools and analysis used to allocate financial resources.
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 is 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 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.
Investments
Broadly speaking this deals with financial assets such as stocks and bonds. Some important questions include:
1. What determines the price of a financial asset such as a share of stock?
2. What are the potential risks and rewards associated with investing financial assets?
3. What is the best mixture of the different types of financial assets to hold?
Financial Institutions
Financial institutions are basically businesses that deal primarily in financial matters. Banks and insurance companies would probably be the most familiar to you. Institutions such as these employ people to perform a wide variety of finance-related tasks. For example, a commercial loan officer at a bank would evaluate whether a particular business has a strong enough financial position to warrant extending a loan. At an insurance company, an analyst would decide whether a particular risk was suitable for insuring and what the premium should be.
why study finance?
Since Finance plays a role in many of the stories in the news every day, which means that those who understand finance have a better grasp on how the events of the world affect them.
You will learn about the capital markets and the financing decisions that businesses and organizations need to make. You will learn about the commercial activity of providing funding and capital through the use of financial instruments in financial and capital markets.
Marketing and Finance
If you are interested in marketing, you need to know finance because, for example, marketers constantly work with budgets, and they need to understand how to get the greatest payoff from marketing expenditures and programs. Analyzing costs and benefits of projects of all types is one of the most important aspects of finance, so the tools you learn in finance are vital in marketing research, the design of marketing and distribution channels, and product pricing, just to name a few areas. Financial analysts rely heavily on marketing analysts, and the two frequently work together to evaluate the profitability of proposed projects and products. To work in this area, you obviously need to understand financial products.
Accounting and Finance
For accountants, finance is required reading. In smaller businesses in particular, accountants are often required to make financial decisions as well as perform traditional accounting duties. Further, as the financial world continues to grow more complex, accountants have to know finance to understand the implications of many of the newer types of financial contracts and the impact they have on financial statements. Beyond this, cost accounting and business finance are particularly closely related, sharing many of the same subjects and concerns. Financial analysts make extensive use of accounting information; they are some of the most important end users. Understanding finance helps accountants recognize what types of information are particularly valuable and, more generally, how accounting information is actually used (and abused) in practice.
Management and Finance
One of the most important areas in management is strategy. Thinking about business strategy without simultaneously thinking about financial strategy is an excellent recipe for disaster, and, as a result, management strategists must have a very clear understanding of the financial implications of business plans. In broader terms, management employees of all types are expected to have a strong understanding of how their jobs impact profitability, and they are also expected to be able to work within their areas to improve profitability. This is precisely what studying finance
teaches you: What are the characteristics of activities that create value?
You and Finance
Perhaps the most important reason to know finance is that you will have to make financial decisions that will be very important to you personally. Today, for example, when you go to work for almost any type of company, you will be asked to decide how you want to invest your retirement funds. We’ll see in a later chapter that what you choose to do can make an enormous difference in your future financial well-being. On a different note, is it your dream to start your own business? Good luck if you don’t understand basic finance before you start; you’ll end up learning it the hard way. Want to know how big your student loan payments are going to be before you take out that next loan? Maybe not, but we’ll show you how to calculate them anyway. These are just a few of the ways that finance will affect your personal and business lives. Whether you want to or not, you are going to have to examine and understand financial issues, and you are going to have to make financial decisions.
Application to Business
Of course, finance is an important field of study for those who have a desire of working in finance or accounting. Finance is heavily used in jobs ranging from investment banker to CFO to venture capitalist. However, finance is not segmented from the other functions in business. Every job from marketing to engineering has to be able to manage a budget and make a business case that it should get funding for a project. This is especially true higher up in the organizational hierarchy: managers, directors, and vice presidents need to be able to articulate why their departments should get financial support from the company.
Finance is a field of both hard analytical skill and personal judgement. There are set processes and theories for determining which financial option is best, but in the real world, it is rare to have all of the information needed to be absolutely certain about what to do. Finance develops strong analytical skills, but also the degree of finesse required to operate in an environment of uncertainty.
Studying finance at postgraduate level can lead you to more senior or specialized career roles such as academic, chief financial officer, corporate advisor or valuer, multinational funds manager, or portfolio manager.
Finance plays an involved role in the health of the overall economy, which impacts everyone, regardless of whether or not they have studied finance. Like companies, individuals are faced with investment and financing decisions. Having a firm grasp of finance will help individuals make those decisions. All businesses functions deal with finance because they need to be able to make the financial argument for the funding of their projects and to manage their budgets.
You will learn about the capital markets and the financing decisions that businesses and organizations need to make. You will learn about the commercial activity of providing funding and capital through the use of financial instruments in financial and capital markets.
Marketing and Finance
If you are interested in marketing, you need to know finance because, for example, marketers constantly work with budgets, and they need to understand how to get the greatest payoff from marketing expenditures and programs. Analyzing costs and benefits of projects of all types is one of the most important aspects of finance, so the tools you learn in finance are vital in marketing research, the design of marketing and distribution channels, and product pricing, just to name a few areas. Financial analysts rely heavily on marketing analysts, and the two frequently work together to evaluate the profitability of proposed projects and products. To work in this area, you obviously need to understand financial products.
Accounting and Finance
For accountants, finance is required reading. In smaller businesses in particular, accountants are often required to make financial decisions as well as perform traditional accounting duties. Further, as the financial world continues to grow more complex, accountants have to know finance to understand the implications of many of the newer types of financial contracts and the impact they have on financial statements. Beyond this, cost accounting and business finance are particularly closely related, sharing many of the same subjects and concerns. Financial analysts make extensive use of accounting information; they are some of the most important end users. Understanding finance helps accountants recognize what types of information are particularly valuable and, more generally, how accounting information is actually used (and abused) in practice.
Management and Finance
One of the most important areas in management is strategy. Thinking about business strategy without simultaneously thinking about financial strategy is an excellent recipe for disaster, and, as a result, management strategists must have a very clear understanding of the financial implications of business plans. In broader terms, management employees of all types are expected to have a strong understanding of how their jobs impact profitability, and they are also expected to be able to work within their areas to improve profitability. This is precisely what studying finance
teaches you: What are the characteristics of activities that create value?
You and Finance
Perhaps the most important reason to know finance is that you will have to make financial decisions that will be very important to you personally. Today, for example, when you go to work for almost any type of company, you will be asked to decide how you want to invest your retirement funds. We’ll see in a later chapter that what you choose to do can make an enormous difference in your future financial well-being. On a different note, is it your dream to start your own business? Good luck if you don’t understand basic finance before you start; you’ll end up learning it the hard way. Want to know how big your student loan payments are going to be before you take out that next loan? Maybe not, but we’ll show you how to calculate them anyway. These are just a few of the ways that finance will affect your personal and business lives. Whether you want to or not, you are going to have to examine and understand financial issues, and you are going to have to make financial decisions.
Application to Business
Of course, finance is an important field of study for those who have a desire of working in finance or accounting. Finance is heavily used in jobs ranging from investment banker to CFO to venture capitalist. However, finance is not segmented from the other functions in business. Every job from marketing to engineering has to be able to manage a budget and make a business case that it should get funding for a project. This is especially true higher up in the organizational hierarchy: managers, directors, and vice presidents need to be able to articulate why their departments should get financial support from the company.
Finance is a field of both hard analytical skill and personal judgement. There are set processes and theories for determining which financial option is best, but in the real world, it is rare to have all of the information needed to be absolutely certain about what to do. Finance develops strong analytical skills, but also the degree of finesse required to operate in an environment of uncertainty.
Studying finance at postgraduate level can lead you to more senior or specialized career roles such as academic, chief financial officer, corporate advisor or valuer, multinational funds manager, or portfolio manager.
Finance plays an involved role in the health of the overall economy, which impacts everyone, regardless of whether or not they have studied finance. Like companies, individuals are faced with investment and financing decisions. Having a firm grasp of finance will help individuals make those decisions. All businesses functions deal with finance because they need to be able to make the financial argument for the funding of their projects and to manage their budgets.
principles
courtesy: (http://smallbusiness.chron.com/business-finance-concepts-710.html)
The Power of Cash Flow
Cash flow is simply the amount of cash coming into a business via revenue versus the amount that is leaving in the form of payments. The higher the amount of revenue that is entering as opposed to the amount of cash being paid out, the healthier a company's financial picture. One common method of improving cash flow is to wait to pay bills until their final due date.
Risk vs. Reward
The greatest gains in business often are made by those who are willing to take a calculated financial risk. A common example involves the decision to expand a business. While your present business location may be doing well, it may have reached its saturation point. In order for your business to grow, you may have to undertake the risk involved with taking on the expense of expanding your current location or building a larger facility.
Time Value
Just as waiting to pay your bills can improve your cash flow, receiving money sooner can also aid in business finance. The more quickly you receive a payment, the sooner you can use the money for your company's benefit. You should also implement an aggressive collection policy to avoid the expenses associated with delinquent accounts.
Equity vs. Debt Financing
If you need to obtain financing for your business, you'll need to decide whether debt financing or equity financing is right for you. With debt financing, you borrow money that you'll need to repay, such as a bank loan. With equity financing, you take on investors who supply the necessary capital. However, you may also need to relinquish partial control of your operation to the investors.
Opportunity Cost
Opportunity cost is the cost associated with taking one action over another. Using the example of a business expansion, the business owner has to evaluate the costs associated with funding the expansion and eventually generating increased revenues, as opposed to continuing her current method of operation.
concepts
(http://www.investopedia.com/university/concepts/ by: Investopedia Staff)
The RISK/RETURN TRADEOFF
... could easily be called the "ability-to-sleep-at-night test." While some people can handle the equivalent of financial skydiving without batting an eye, others are terrified to climb the financial ladder without a secure harness. Deciding what amount of risk you can take while remaining comfortable with your investments is very important.In the investing world, the dictionary definition of risk is the chance that an investment's actual return will be different than expected. Technically, this is measured in statistics by standard deviation. Risk means you have the possibility of losing some, or even all, of our original investment. Low levels of uncertainty (low risk) are associated with low potential returns. High levels of uncertainty (high risk) are associated with high potential returns. The risk/return tradeoff is the balance between the desire for the lowest possible risk and the highest possible return. This is demonstrated graphically in the chart below. A higher standard deviation means a higher risk and higher possible return.
DIVERSIFICATION
This is a risk-management technique that mixes a wide variety of investments within a portfolio in order to minimize the impact that any one security will have on the overall performance of the portfolio. Diversification lowers the risk of your portfolio. Academics have complex formulas to demonstrate how this works, but we can explain it clearly with an example:
Suppose that you live on an island where the entire economy consists of only two companies: one sells umbrellas while the other sells sunscreen. If you invest your entire portfolio in the company that sells umbrellas, you'll have strong performance during the rainy season, but poor performance when it's sunny outside. The reverse occurs with the sunscreen company, the alternative investment; your portfolio will be high performance when the sun is out, but it will tank when the clouds roll in. Chances are you'd rather have constant, steady returns. The solution is to invest 50% in one company and 50% in the other. Because you have diversified your portfolio, you will get decent performance year round instead of having either excellent or terrible performance depending on the season. There are three main practices that can help you ensure the best diversification:
Diversification is the most important component in helping you reach your long-range financial goals while minimizing your risk. At the same time, diversification is not an ironclad guarantee against loss. No matter how much diversification you employ, investing involves taking on some risk.
Another question that frequently baffles investors is how many stocks should be bought in order to reach optimal diversification. According to portfolio theorists, adding about 20 securities to your portfolio reduces almost all of the individual security risk involved. This assumes that you buy stocks of different sizes from various industries.
ASSET ALLOCATION
It is an investment portfolio technique that aims to balance risk and create diversification by dividing assets among major categories such as bonds, stocks, real estate, and cash. Each asset class has different levels of return and risk, so each will behave differently over time. At the same time that one asset is increasing in value, another may be decreasing or not increasing as much. The underlying principle of asset allocation is that the older a person gets, the less risk he or she should take on. After you retire, you may have to depend on your savings as your only source of income. It follows that you should invest more conservatively because asset preservation is crucial at this time in life.
DOLLAR COST AVENGING
(DCA) Dollar cost averaging is the process of buying, regardless of the share price, a fixed dollar amount of a particular investment on a regular schedule. The picking bottoms and tops in the market. More shares are purchased when prices are low, and fewer shares are purchased when prices are high. The cost per share over time eventually averages out. This reduces the risk of investing a large amount in a single investment at the wrong time. Keep in mind that dollar cost averaging doesn't prevent a loss in a steadily declining market, but it is quite effective in taking advantage of growth over the long term.
RANDOM WALK THEORY
Popularized thru a book that is now regarded as an investment classic, “A Random Walk Down Walk Street” made by Burton Malkiel. Random walk is a stock market theory that states that the past movement or direction of the price of a stock or overall market cannot be used to predict its future movement. This
EFFICIENT MARKET HYPOTHESIS
(EMH) is an idea partly developed in the 1960s by Eugene Fama. It states that it is impossible to beat the market because prices already incorporate and reflect all relevant information. Under the efficient market hypothesis, any time you buy and sell securities, you're engaging in a game of chance, not skill. If markets are efficient and current, it means that prices always reflect all information, so there's no way you'll ever be able to buy a stock at a bargain price. This theory has been met with a lot of opposition, especially from the technical analysts. Their argument against the efficient market theory is that many investors base their expectations on past prices, past earnings, track records and other indicators. Because stock prices are largely based on investor expectation, many believe it only makes sense to believe that past prices influence future prices.
OPTIMAL PORTFOLIO
The theory assumes (among other things) that investors fanatically try to minimize risk while striving for the highest return possible. The theory states that investors will act rationally, always making decisions aimed at maximizing their return for their acceptable level of risk. Each investor must decide how much risk they can handle and than allocate (or diversify) their portfolio according to this decision. The optimal-risk portfolio is usually determined to be somewhere in the middle of the curve because as you go higher up the curve, you take on proportionately more risk for a lower incremental return. On the other end, low risk/low return portfolios are pointless because you can achieve a similar return by investing in risk-free assets, like government securities.
You can choose how much volatility you are willing to bear in your portfolio by picking any other point that falls on the efficient frontier. This will give you the maximum return for the amount of risk you wish to accept. Optimizing your portfolio is not something you can calculate in your head. There are computer programs that are dedicated to determining optimal portfolios by estimating hundreds (and sometimes thousands) of different expected returns for each given amount of risk.
CAPITAL ASSET PRICING MODEL (CAPM)
This describes the relationship between risk and expected return, and it serves as a model for the pricing of risky securities. CAPM says that the expected return of a security or a portfolio equals the rate on a risk-free security plus a risk premium. If this expected return does not meet or beat our required return, the investment should not be undertaken.
FORMULA:
Required (or expected) Return = RF Rate + (Market Return - RF Rate)*Beta
The RISK/RETURN TRADEOFF
... could easily be called the "ability-to-sleep-at-night test." While some people can handle the equivalent of financial skydiving without batting an eye, others are terrified to climb the financial ladder without a secure harness. Deciding what amount of risk you can take while remaining comfortable with your investments is very important.In the investing world, the dictionary definition of risk is the chance that an investment's actual return will be different than expected. Technically, this is measured in statistics by standard deviation. Risk means you have the possibility of losing some, or even all, of our original investment. Low levels of uncertainty (low risk) are associated with low potential returns. High levels of uncertainty (high risk) are associated with high potential returns. The risk/return tradeoff is the balance between the desire for the lowest possible risk and the highest possible return. This is demonstrated graphically in the chart below. A higher standard deviation means a higher risk and higher possible return.
DIVERSIFICATION
This is a risk-management technique that mixes a wide variety of investments within a portfolio in order to minimize the impact that any one security will have on the overall performance of the portfolio. Diversification lowers the risk of your portfolio. Academics have complex formulas to demonstrate how this works, but we can explain it clearly with an example:
Suppose that you live on an island where the entire economy consists of only two companies: one sells umbrellas while the other sells sunscreen. If you invest your entire portfolio in the company that sells umbrellas, you'll have strong performance during the rainy season, but poor performance when it's sunny outside. The reverse occurs with the sunscreen company, the alternative investment; your portfolio will be high performance when the sun is out, but it will tank when the clouds roll in. Chances are you'd rather have constant, steady returns. The solution is to invest 50% in one company and 50% in the other. Because you have diversified your portfolio, you will get decent performance year round instead of having either excellent or terrible performance depending on the season. There are three main practices that can help you ensure the best diversification:
- Spread your portfolio among multiple investment vehicles such as cash, stocks, bonds, mutual funds and perhaps even some real estate.
- Vary the risk in your securities. You're not restricted to choosing only blue chip stocks. In fact, it would be wise to pick investments with varied risk levels; this will ensure that large losses are offset by other areas.
- Vary your securities by industry. This will minimize the impact of industry-specific risks.
Diversification is the most important component in helping you reach your long-range financial goals while minimizing your risk. At the same time, diversification is not an ironclad guarantee against loss. No matter how much diversification you employ, investing involves taking on some risk.
Another question that frequently baffles investors is how many stocks should be bought in order to reach optimal diversification. According to portfolio theorists, adding about 20 securities to your portfolio reduces almost all of the individual security risk involved. This assumes that you buy stocks of different sizes from various industries.
ASSET ALLOCATION
It is an investment portfolio technique that aims to balance risk and create diversification by dividing assets among major categories such as bonds, stocks, real estate, and cash. Each asset class has different levels of return and risk, so each will behave differently over time. At the same time that one asset is increasing in value, another may be decreasing or not increasing as much. The underlying principle of asset allocation is that the older a person gets, the less risk he or she should take on. After you retire, you may have to depend on your savings as your only source of income. It follows that you should invest more conservatively because asset preservation is crucial at this time in life.
DOLLAR COST AVENGING
(DCA) Dollar cost averaging is the process of buying, regardless of the share price, a fixed dollar amount of a particular investment on a regular schedule. The picking bottoms and tops in the market. More shares are purchased when prices are low, and fewer shares are purchased when prices are high. The cost per share over time eventually averages out. This reduces the risk of investing a large amount in a single investment at the wrong time. Keep in mind that dollar cost averaging doesn't prevent a loss in a steadily declining market, but it is quite effective in taking advantage of growth over the long term.
RANDOM WALK THEORY
Popularized thru a book that is now regarded as an investment classic, “A Random Walk Down Walk Street” made by Burton Malkiel. Random walk is a stock market theory that states that the past movement or direction of the price of a stock or overall market cannot be used to predict its future movement. This
EFFICIENT MARKET HYPOTHESIS
(EMH) is an idea partly developed in the 1960s by Eugene Fama. It states that it is impossible to beat the market because prices already incorporate and reflect all relevant information. Under the efficient market hypothesis, any time you buy and sell securities, you're engaging in a game of chance, not skill. If markets are efficient and current, it means that prices always reflect all information, so there's no way you'll ever be able to buy a stock at a bargain price. This theory has been met with a lot of opposition, especially from the technical analysts. Their argument against the efficient market theory is that many investors base their expectations on past prices, past earnings, track records and other indicators. Because stock prices are largely based on investor expectation, many believe it only makes sense to believe that past prices influence future prices.
OPTIMAL PORTFOLIO
The theory assumes (among other things) that investors fanatically try to minimize risk while striving for the highest return possible. The theory states that investors will act rationally, always making decisions aimed at maximizing their return for their acceptable level of risk. Each investor must decide how much risk they can handle and than allocate (or diversify) their portfolio according to this decision. The optimal-risk portfolio is usually determined to be somewhere in the middle of the curve because as you go higher up the curve, you take on proportionately more risk for a lower incremental return. On the other end, low risk/low return portfolios are pointless because you can achieve a similar return by investing in risk-free assets, like government securities.
You can choose how much volatility you are willing to bear in your portfolio by picking any other point that falls on the efficient frontier. This will give you the maximum return for the amount of risk you wish to accept. Optimizing your portfolio is not something you can calculate in your head. There are computer programs that are dedicated to determining optimal portfolios by estimating hundreds (and sometimes thousands) of different expected returns for each given amount of risk.
CAPITAL ASSET PRICING MODEL (CAPM)
This describes the relationship between risk and expected return, and it serves as a model for the pricing of risky securities. CAPM says that the expected return of a security or a portfolio equals the rate on a risk-free security plus a risk premium. If this expected return does not meet or beat our required return, the investment should not be undertaken.
FORMULA:
Required (or expected) Return = RF Rate + (Market Return - RF Rate)*Beta