Chapter 1 - Introduction to Finance

Chapter 1: Introduction to Finance OUTLINE 1. Defining Finance 2. Five core principles of finance 3. Financial Decisions - Households 4. Financial Decisions - Firms 5. The Financial System 1. Defining Finance Finance is the study of how people allocate scarce resources over time (Bodie and Merton) 2. The Financial System 2.1. What is the Financial System? A Financial System is comprised of markets, intermediaries, service firms and other institutions used to carry out the financial decisions of households, business firms, and governments Market Participants Spending Sectors Household • SURPLUS SPENDING UNITS • DEFICIT SPENDING UNITS Business Firms Government Foreign Sector The household is the primary provider of funds to businesses and government. Households must accumulate financial resources throughout their working life times to have enough savings (pension) to live on in their retirement years a. Surplus Spending Unit • Has more cash income flow than expenditure on consumption and real investments in a period of time. The surplus is then allocated to the financial sector. • Other terms for surplus unit are saver, lender, buyer of financial assets, financial investor, supplier of loanable funds, buyer of securities. a. Surplus Spending Unit • The surplus unit may buy financial assets, hold more money, or pay off financial liabilities issued earlier when in a deficit situation • The household and foreign sectors are usually a surplus sector