The financial system[edit]

Main articles: Financial services, financial market, and Circular flow of income

As above, the financial system constitutes the flow of capital, between individuals (personal finance),
governments (public finance), and businesses (corporate finance). Although they are 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.
Generalizing, 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 bonds (may be government bonds or corporate bonds); (ii) by a corporate selling equity,
also called stock or shares (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 fund – 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, which find the initial investors and facilitate the listing
of the securities (equity and debt); and the securities exchanges, which allow their trade thereafter,
as well as the various service providers which manage the performance or risk of these investments.

Areas of finance[edit]
Personal finance[edit]
Main article: Personal finance

Personal finance[8] is defined as "the mindful planning of monetary spending and saving, while also
considering the possibility of future risk". 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.[9] Personal finance may also involve paying for a loan,
or 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:

 Purchasing insurance to ensure protection against unforeseen personal events

 Understanding the effects of tax policies (tax subsidies or penalties) management of
personal finances
 Understanding the effects of credit on individual financial standing
 Developing of a savings plan or financing for large purchases (auto, education, home)
 Planning a secure financial future in an environment of economic instability
 Pursuing a checking and/or a savings account
 Preparing for retirement/ long term expenses[12]
Corporate finance[edit]
Main article: Corporate finance

Corporate finance deals with the sources of 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. Short term financial management is often termed
"working capital management", and relates to cash-, inventory- and debtors management. In
the longer term, 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: (i) "capital budgeting", selecting
which projects to invest in; (ii) dividend policy, the use of "excess" capital; and (iii) "sources of
capital", i.e. which funding is to be used. The latter creates the link with investment
banking and securities trading, in that the capital raised will (generically) comprise debt,
i.e. corporate bonds, and equity, often listed shares.
Although "corporate finance" 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. Further, although
financial management overlaps with the financial function of the accounting profession, financial
accounting is the reporting of historical financial information, whereas as discussed, financial
management is concerned with increasing the firm's Shareholder value and increasing their rate of
return on the investment. Financial risk management, in this context, is about protecting the
firm's economic value using financial instruments to manage exposure to risk, particularly credit
risk and market risk, often arising from the firm's funding structures.

Public finance[edit]
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.[13] These long-term strategic periods usually encompass five or more years.
[14]
 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 banks in the United States and 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. [15]

Financial theory[edit]
Finance theory is studied and developed within the disciplines
of management, (financial) economics, accountancy and applied mathematics. Abstractly,
[2]
 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 risk and uncertainty
of future outcomes, incorporating the time value of money (determining the present value of these
future values, "discounting", requires a risk-appropriate discount rate). Since the debate to whether
finance is an art or a science is still open, [16] there have been recent efforts to organize a list of
unsolved problems in finance.

Financial economics[edit]
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 pricing and managing risk management in the financial markets, and thus produces
many of the and financial models commonly employed.
The discipline essentially explores how rational investors would apply risk and return to the problem
of investment. 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", 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.

Financial mathematics[edit]
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.
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 and Outline of finance #Derivatives pricing.
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 modeling and derivation (see: Quantitative
analyst). There is also a significant overlap with financial risk management.

Experimental finance[edit]
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.

Behavioral finance[edit]
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.[17]
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.