BASICS OF FINANCE

What is Finance?
Whenever the word finance strikes your ears, the very first thing that strikes your mind is money. But is the scope of finance merely related to money? Well for a layman, the answer may be yes. But all you need to do is a little pondering and you will easily understand that finance is something much more than money terminologies.
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What is Finance?
When people first hear the word finance, they usually have an idealized view of just what finance and financial markets are. They come to the level eager to start trading stocks, pricing options, transacting in the currency forwards, or simply cornering the market on orange juice futures apart from fund raising and project finance.
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What is Finance?
Four types of People:
People with no extra money and no ideas.

People with extra money but no ideas (or no time to implement any ideas). People with ideas but not enough money. People with both ideas and extra money.
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What is Finance?

The first type doesn't really play a direct part in finance: they have just enough money to cover their needs, and have no ideas or time for investing in potential projects even if they did. We also won't normally talk much about the fourth type. In such an economy, the second type, which we'll call "investors" for reasons that will shortly be obvious, and the third type ("companies") can enter into a mutually beneficial agreement whereby the investors lend their extra money to the companies, who will in turn invest that money in ventures or projects, using the potential proceeds from those projects to repay the investors, as shown in Figure 1.1.
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What is Finance?

Figure 1.1

What is Finance?

Now, in the real world, the repayment of the investors is complicated by the presence of taxes, dividends, etc and by the fact that the company may need to reinvest some of the proceeds of the projects to further continue and / or to expand its operations, so actual cash flows tend to more closely resemble to the one shown in Figure 1.2.
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What is Finance?

Figure 1.2

What is Finance?
The study of this resulting system of cash flows is what finance is all about. The arrows in Figure 1.2 correspond to decisions or choices that the various participants in this system must make, and we can visualize the various subfields of finance by considering the perspectives from which those decisions must be made.

What is Finance?
A very simple definition of finance is A branch of economics concerned with resource allocation as well as resource management, acquisition and investment in the form of decisions that bring value to the people associated with it.

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Value to whom?
Stake Holders

Employees

Descendents

Vendors

Partners

Prospective Buyers Investors

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The Subfields of Finance

Investment: For example, consider the decisions faced by one of the investors whose perspective is indicated by the box shown in Figure 1.3. They have to decide which company or companies to invest in, what form (for example, acquitions, buying stocks, bonds, and likewise) that investment will take, and in what manner they wish to be repaid. Looking at these decisions from this perspective is called the study of investments. Areas:

Capital Budgeting TVM Ratio Analysis Cost of Capital, etc.

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The Subfields of Finance

Figure 1.3

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Corporate Finance: Companies face decisions concerning how to raise capital, what projects to invest in, and how to go about paying investors back. Looking at these decisions from their perspective, as shown in Figure 1.4, is called the study of corporate finance (or, sometimes, "financial management").
Areas:

The Subfields of Finance

Project Finance, Trade Finance, WCM, MIS, Forex Mgmt, Capital Budgeting, Ratio Analysis, etc.

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The Subfields of Finance

Figure 1.4

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The Subfields of Finance

Financial Institutions & Markets: The other perspective that one can take when examining this system of cash flows is that of the financial institutions and markets (see Figure 1.5), which exist for the sole purpose of facilitating this flow of funds between the investors and the companies.
Areas:

Equity & Debt Financing. Portfolio / Fund Management. Risk Analysis. Cost of Capital, etc.
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The Subfields of Finance

Figure 1.5

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The Subfields of Finance

International Finance: The final subtopic of finance is one that considers the entire system of cash flows, but in a setting where the investors, companies, and/or projects involved are in different countries, as shown in Figure 1.6. Technically speaking, this study of international finance probably shouldn't be considered a separate subfield, but rather a group of situations best considered as part of the other three subfields.
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The Subfields of Finance

Figure 1.5

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Topics

Project Finance. Trade Finance. Ratio Analysis. Time Value of Money. Capital Budgeting. Portfolio Management. Foreign Exchange Management. Valuation. Working Capital Management. Management Control Systems. Investment Decisions. M&A.
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