Investment Risk & Its Types.

Smart investing includes risk management. For each stock, bond, mutual fund or other investment you purchase, there are three distinct risks you must guard against; they are business risk, valuation risk, and force of sale risk. In this article, we are going to examine each type and discover ways you can protect yourself from financial disaster. Investment Risk #1: Business Risk:
Business risk is, perhaps, the most familiar and easily understood. It is the potential for loss of value through competition, mismanagement, and financial insolvency. There are a number of industries that are predisposed to higher levels of business risk (think airlines, railroads, steel, etc).
The biggest defense against business risk is the presence of franchise value. Companies that possess franchise value are able to raise prices to adjust for increased labor, taxes or material costs. The stocks and bonds of commodity-type businesses do not have this luxury and normally decline significantly when the economic environment turns south.
Investment Risk #2: Valuation Risk:
Recently, I found a company I absolutely love (said company will remain nameless). The margins are excellent, growth is stellar, there is little or no debt on the balance sheet and the brand is expanding into a number of new markets. However, the business is trading at a price that is so far in excess of it’s current and average earnings, I cannot possibly justify purchasing the stock.
Why? I’m not concerned about business risk. Instead, I am concerned about valuation risk. In order to justify the purchase of the stock at this sky-high price, I have to be absolutely certain that the future growth prospects will increase my earnings yield to a more attractive level than all of the other investments at my disposal.
The danger of investing in companies that appear overvalued is that there is normally little room for error. The business may indeed be wonderful, but if it experiences a significant sales decline in one quarter or does not open new locations as rapidly as it originally projected, the stock will decline significantly. This is a throw-back to our basic principle that an investor should never ask "Is company ABC a good investment"; instead, he should ask, "Is company ABC a good investment at this price."
Investment Risk #3: Force of Sale Risk:
You’ve done everything right and found an excellent company that is selling far below what it is really worth, buying a good number of shares. It’s January, and you plan on using the stock to pay your April tax bill.
By putting yourself in this position, you have bet on when your stock is going to appreciate. This is a financially fatal mistake. In the stock market, you can be relatively certain of what will happen, but not when. You have turned your basic advantage (the luxury of holding permanently and ignoring market quotations), into a disadvantage.
Consider the following: If you had purchased shares of great companies such as Coca-Cola, Berkshire Hathaway, Gillette and Washington Post at a decent price in 1987 yet had to sell the stock sometime later in the year, you would have been devastated by the crash that occurred in October. Your investment analysis may have been absolutely correct but because you imposed a time limit, you opened yourself up to a tremendous amount of risk.

Types of Investments

The term "investment" is used differently in economics and in finance. Economists refer to a real investment (such as a machine or a house), while financial economists refer to a financial asset, such as money that is put into a bank or the market, which may then be used to buy a real asset.

Business management:
The investment decision (also known as capital budgeting) is one of the fundamental decisions of business management: Managers determine the investment value of the assets that a business enterprise has within its control or possession. These assets may be physical (such as buildings or machinery), intangible (such as patents, software, goodwill), or financial (see below). Assets are used to produce streams of revenue that often are associated with particular costs or outflows. All together, the manager must determine whether the net present value of the investment to the enterprise is positive using the marginal cost of capital that is associated with the particular area of business.
In terms of financial assets, these are often marketable securities such as a company stock (an equity investment) or bonds (a debt investment). At times the goal of the investment is for producing future cash flows, while at others it may be for purposes of gaining access to more assets by establishing control or influence over the operation of a second company (the investee). Economics:
In economics, investment is the production per unit time of goods which are not consumed but are to be used for future production. Examples include tangibles (such as building a railroad or factory) and intangibles (such as a year of schooling or on-the-job training). In measures of national income and output, gross investment (represented by the variable I) is also a component of Gross domestic product (GDP), given in the formula GDP = C + I + G + NX, where C is consumption, G is government spending, and NX is net exports. Thus investment is everything that remains of production after consumption, government spending, and exports are subtracted.
Both non-residential investment (such as factories) and residential investment (new houses) combine to make up I. Net investment deducts depreciation from gross investment. It is the value of the net increase in the capital stock per year.
Investment, as production over a period of time ("per year"), is not capital. The time dimension of investment makes it a flow. By contrast, capital is a stock, that is, an accumulation measurable at a point in time (say December 31).
Investment is often modeled as a function of Income and Interest rates, given by the relation I = f(Y, r). An increase in income encourages higher investment, whereas a higher interest rate may discourage investment as it becomes more costly to borrow money. Even if a firm chooses to use its own funds in an investment, the interest rate represents an opportunity cost of investing those funds rather than lending out that amount of money for interest.
Finance:
In finance, investment is the commitment of funds by buying securities or other monetary or paper (financial) assets in the money markets or capital markets, or in fairly liquid real assets, such as gold, real estate, or collectibles. Valuation is the method for assessing whether a potential investment is worth its price. Returns on investments will follow the risk-return spectrum.
Types of financial investments include shares, other equity investment, and bonds (including bonds denominated in foreign currencies). These financial assets are then expected to provide income or positive future cash flows, and may increase or decrease in value giving the investor capital gains or losses.
Trades in contingent claims or derivative securities do not necessarily have future positive expected cash flows, and so are not considered assets, or strictly speaking, securities or investments. Nevertheless, since their cash flows are closely related to (or derived from) those of specific securities, they are often studied as or treated as investments.
Investments are often made indirectly through intermediaries, such as banks, mutual funds, pension funds, insurance companies, collective investment schemes, and investment clubs. Though their legal and procedural details differ, an intermediary generally makes an investment using money from many individuals, each of whom receives a claim on the intermediary.
Personal finance:
Within personal finance, money used to purchase shares, put in a collective investment scheme or used to buy any asset where there is an element of capital risk is deemed an investment. Saving within personal finance refers to money put aside, normally on a regular basis. This distinction is important, as investment risk can cause a capital loss when an investment is realized, unlike saving(s) where the more limited risk is cash devaluing due to inflation.
In many instances the terms saving and investment are used interchangeably, which confuses this distinction. For example many deposit accounts are labeled as investment accounts by banks for marketing purposes. Whether an asset is a saving(s) or an investment depends on where the money is invested: if it is cash then it is savings, if its value can fluctuate then it is investment.
Real estate:
In real estate, investment money is used to purchase property for the purpose of holding or leasing for income and there is an element of capital risk.
Residential real estate:
The most common form of real estate investment as it includes property purchased as a primary residence. In many cases the buyer does not have the full purchase price for a property and must engage a lender such as a bank, finance company or private lender. Different countries have their individual normal lending levels, but usually they will fall into the range of 70-90% of the purchase price. Against other types of real estate, residential real estate is the least risky.
Commercial real estate:
Commercial real estate consists of multifamily apartments, office buildings, retail space, hotels and motels, warehouses, and other commercial properties. Due to the higher risk of commercial real estate, loan-to-value ratios allowed by banks and other lenders are lower and often fall in the range of 50-70%..

Investment

Investment or investing is a term with several closely-related meanings in busines management, finance and economics, related to saving or deferring consumption. Investing is the active redirecting resources from being consumed today so that they may create benefits in the future; the use of assets to earn income or profit.
An investment is the choice by the individual to risk his savings with the hope of gain. Rather than store the good produced, or its money equivalent, the investor chooses to use that good either to create a durable consumer or producer good, or to lend the original saved good to another in exchange for either interest or a share of the profits.
In the first case, the individual creates durable consumer goods, hoping the services from the good will make his life better. In the second, the individual becomes an entrepreneur using the resource to produce goods and services for others in the hope of a profitable sale. The third case describes a lender, and the fourth describes an investor in a share of the business.
In each case, the consumer obtains a durable asset or investment, and accounts for that asset by recording an equivalent liability. As time passes, and both prices and interest rates change, the value of the asset and liability also change.
An asset is usually purchased, or equivalently a deposit is made in a bank, in hopes of getting a future return or interest from it. The word originates in the Latin "vestis", meaning garment, and refers to the act of putting things (money or other claims to resources) into others' pockets. See Invest. The basic meaning of the term being an asset held to have some recurring or capital gains. It is an asset that is expected to give returns without any work on the asset per se.

Islamic Finance news.

Islamic finance has come a long way since its active re-introduction about 25 years ago. Presently, it is estimated that Islamic banks and financial institutions manage some US$200 billion of funds all over the world. Although small in terms of the total global assets managed by financial intermediaries, the growth rate is impressive by any standards.
Over the last few years the whole Islamic finance movement has been given a major boost by the rise of Bahrain as a key intermediation centre in this market and by Malaysia’s decision to adopt Shari’a compliant financial instruments as an integral component of its growing market.
As a result of these developments Islamic financial institutions have developed a vast range of products designed to serve the growing market. These cater for housing and consumer finance, business loans and project funding. Lately, Malaysia and Bahrain have been instrumental in launching tradeable securities. These should create much needed liquidity and a secondary market for institutional investors in the Islamic finance market. Several “Islamic equity” investment funds have also been launched, with both FTSE and Dow Jones providing indices to monitor this growing market.
Bodies have already sprung up to address issues of accounting and auditing standards, Shari’a compliance, and central bank regulation. In the beginning of November the Islamic Financial Services Board (IFSB) will be launched in Malaysia. This initiative of D-8 countries will lay the foundation of the regulation of the Islamic Finance market on a consistent basis.
As was to be expected the major instruments utilised by the Islamic banks are those which approximate closely to those in the conventional banking market. In particular, there is still a dearth of pure risk sharing instruments where gains and losses are shared equitably between investors and operators. With the emergence of quoted tradeable instruments this anomaly is expected to be addressed in the next generation of products.
Finally, in countries like the United Kingdom, much progress has been made towards launching mainstream housing and other consumer finance products compliant with the Sha’ria. Following a long period of consultation and advocacy, agreement is close to allow such products to be launched on a competitive basis. It is expected that within the next six months one will see many such products being marketed from high street financial institutions in the UK. This is expected to be followed by similar initiatives amongst the twenty million Muslims in Europe and the United States.
As Islamic finance will arrive on the high streets of many countries, the challenge would be to operationalise the equity considerations of the Sha’ria and make this mode of financing widely accepted amongst a constituency which transcends Muslim communities.

International Finance. .

International Finance can be defined as the branch of economics which studies the dynamics of exchange rates and foreign investment and studies how these affect international trade. Financing is defined as the methodology of allocating financial resources or funds to maximize returns on a productive enterprise. It can also be dealt as a study of the ways individuals, businesses and organizations raise, allocate and manage monetary resources over time taking into account the associated risks. Financing can also be labeled as effective management of wealth and other assets. In terms of corporate or business finance, financing is known as the science of allocating financial resources such as stocks, bonds and other portfolio investments in an optimal manner to maximize the wealth or income of the business unit. The major decisions undertaken for the successful allocation process takes into account capital budgeting, financing and dividend policy. While capital budgeting takes into account the Internal Rate of Return (IRR) on the invested capital, the financing decisions are rested on the financing options available to a company to raise resources for the organization or company in question. In terms of the IRR or the Net Present Value (NPV), the capital invested is said to give a positive yield or return if the IRR or NPV is found to be greater than the cost of invested capital defined as the total financial resources in vested in a business. Financing deals with investing in debts (bonds or loans from lending institutions) or equities (common stock or preferred stock) and dividend policy is concerned with dividing the gains through corporate finance among the stockholders of the company in terms of dividends.
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International Finance is concerned with the same methodology of allocating financial resources and about international trade but is constrained by the movements of capital and currencies between countries and the difference in the exchange rates between different currencies. The capital budgeting techniques used in this case as against traditional finance entails international cash flows and local tax rates and the required return on investment or the cost of capital adjusted for the degree of risk in that country or the sensitivity of the project. Foreign capital markets are a major source of equity and debts for most domestic and foreign subsidiary operations. International trade is heavily influenced by the volatility in the foreign capital markets and the limited steps to full capital account convertibility undertaken by many countries. Exchange rates, as mentioned previously, are a predominant factor in determining international finance as international exports or imports can suffer losses in earnings as a result of exchange rate fluctuations. Forward Currency Contracts between the two concerned parties can help to somewhat avert this possibility. One of the leading international bodies promoting sustainable private sector investment in developing countries thereby increasing its growth potential and the possibility of trade interactions with the developed world is the International Finance Corporation (IFC). Established in 1956, IFC is a member of the World Bank Group and is the largest multilateral source of loan and equity financing for private sector projects in the developing countries. In addition to providing technical assistance to businesses and governments in the developing world, it helps private companies in the developing nations mobilize resources in the international financial markets. International Finance is now becoming all the more encompassing with issues such as fair trade, globalization, Multi-national corporations and multinational banking coming under its ambit. With globalization becoming the buzz word of the modern era, rapidly integrating world production, consumption markets and the widespread diffusion of modern technology has contributed to the widening of the sphere of international finance. International Finance should effectively address these issues and the problem of exploitation by MNC’s of the physical and human resources of poor developing countries can also be ameliorated by the principles of International Finance.

Financial Intermediary

A financial intermediary is an individual, or, more often, a financial institution that mediates between two or more parties in a financial context. Through the process of financial intermediation, certain assets or liabilities are transformed into different assets or liabilities. The classic example of a financial intermediary is a bank that transforms bank deposits into bank loans. As such, financial intermediaries channel funds from people who have extra money (savers) to those who do not have enough money to carry out a desired activity (borrowers). Typically the first party is a provider of a product or service and the second party is a consumer or customer.
In the U.S., a financial intermediary is typically an institution that facilitates the channelling of funds between lenders and borrowers indirectly. That is, savers (lenders) give funds to an intermediary institution (such as a bank), and that institution gives those funds to spenders (borrowers). This may be in the form of loans or mortgages. Alternatively, they may lend the money directly via the financial markets, which is known as financial disintermediation.
>Functions performed by financial intermediaries:
Financial intermediaries perform five major functions
(1) they facilitate the acquisition of payment for goods and services, e.g. through the use of cheques;
(2) the financial system provides economies of scale and economies of scope that allow an individual to invest in a portfolio of assets, which would be much more difficult in the absence of financial intermediaries;
(3) they ease the liquidity constraint on households and firms which arises when the liquidity available for certain purchases is at variance with the immediate flow of income available; e.g. the use of mortgages allows households to purchase homes today instead of thirty years from now when they have saved up enough money to pay for it;
(4) they allow for the spreading of risk e.g. bank loans spread the costs over all customers in the event of default;
(5) they can reduce the risk of moral hazard and adverse selection created by the information asymmetry that exists between lender and borrower (the lender usually has incomplete information about how the borrower will use the money loaned) because financial intermediaries can develop expertise in things like monitoring borrowers' activities and market conditions.
>Types of financial intermediary:
-Financial intermediaries include:
-Banks
-Building societies
-Credit unions
-Financial advisers or brokers
-Insurance companies
-Collective investment schemes
-Pension funds

Raising Capital.

To understand financial markets, let us look at what they are used for, i.e. what is their purpose? Without financial markets, borrowers would have difficulty finding lenders themselves. Intermediaries such as banks help in this process. Banks take deposits from those who have money to save. They can then lend money from this pool of deposited money to those who seek to borrow. Banks popularly lend money in the form of loans and mortgages.
More complex transactions than a simple bank deposit require markets where lenders and their agents can meet borrowers and their agents, and where existing borrowing or lending commitments can be sold on to other parties. A good example of a financial market is a stock exchange. A company can raise money by selling shares to investors and its existing shares can be bought or sold.

financial markets fit in the relationship between lenders and borrowers:
>Lenders:
1.Individuals.
Many individuals are not aware that they are lenders, but almost everybody does lend money in many ways. A person lends money when he or she:
-Puts money in a savings account at a bank;
-Contributes to a pension plan;
-Pays premiums to an insurance company;
-Invests in government bonds; or
-Invests in company shares.
2.Companies.
Companies tend to be borrowers of capital. When companies have surplus cash that is not needed for a short period of time, they may seek to make money from their cash surplus by lending it via short term markets called money markets.
There are a few companies that have very strong cash flows. These companies tend to be lenders rather than borrowers. Such companies may decide to return cash to lenders (e.g. via a share buyback.) Alternatively, they may seek to make more money on their cash by lending it (e.g. investing in bonds and stocks.)
>Borrowers:
Individuals borrow money via bankers' loans for short term needs or longer term mortgages to help finance a house purchase.
Companies borrow money to aid short term or long term cash flows. They also borrow to fund modernisation or future business expansion.
Governments often find their spending requirements exceed their tax revenues. To make up this difference, they need to borrow. Governments also borrow on behalf of nationalised industries, municipalities, local authorities and other public sector bodies. In the UK, the total borrowing requirement is often referred to as the Public sector net cash requirement (PSNCR).
Governments borrow by issuing bonds. In the UK, the government also borrows from individuals by offering bank accounts and Premium Bonds. Government debt seems to be permanent. Indeed the debt seemingly expands rather than being paid off. One strategy used by governments to reduce the value of the debt is to influence inflation.
Municipalities and local authorities may borrow in their own name as well as receiving funding from national governments. In the UK, this would cover an authority like Hampshire County Council.
Public Corporations typically include nationalised industries. These may include the postal services, railway companies and utility companies.
Many borrowers have difficulty raising money locally. They need to borrow internationally with the aid of Foreign exchange markets.

Financial Market.

In economics, typically, the term market means the aggregate of possible buyers and sellers of a thing and the transactions between them.
The term "market" is sometimes used for what are more strictly exchanges, organizations that facilitate the trade in financial securities, e.g., a stock exchange or commodity exchange. This may be a physical location (like the NYSE) or an electronic system (like NASDAQ). Much trading of stocks takes place on an exchange; still, corporate actions (merger, spinoff) are outside an exchange, while any two companies or people, for whatever reason, may agree to sell stock from the one to the other without using an exchange.
Trading of currencies and bonds is largely on a bilateral basis, although some bonds trade on a stock exchange, and people are building electronic systems for these as well, similar to stock exchanges.
Financial markets can be domestic or they can be international.

Types of financial markets:
The financial markets can be divided into different subtypes:
>Capital markets which consist of:
1.Stock markets, which provide financing through the issuance of shares or common stock, and enable the subsequent trading thereof.
2.Bond markets, which provide financing through the issuance of bonds, and enable the subsequent trading thereof.
>Commodity markets which facilitate the trading of commodities.
>Money markets which provide short term debt financing and investment.
>Derivatives markets which provide instruments for the management of financial risk. =Futures markets which provide standardized forward contracts for trading products at some future date; see also forward market.
>Insurance markets which facilitate the redistribution of various risks.
>Foreign exchange markets which facilitate the trading of foreign exchange.
The capital markets consist of primary markets and secondary markets. Newly formed (issued) securities are bought or sold in primary markets. Secondary markets allow investors to sell securities that they hold or buy existing securities.

Financial Institution.

In financial economics, a financial institution is an institution that provides financial services for its clients or members. Probably the most important financial service provided by financial institutions is acting as financial intermediaries. Most financial institutions are highly regulated by government bodies. Broadly speaking, there are three major types of financial institution:
Deposit-taking institutions that accept and manage deposits and make loans (this category includes banks, credit unions, trust companies, and mortgage loan companies);
Insurance companies and pension funds; and
Brokers, underwriters and investment funds.

>Function:
Financial institutions provide service as intermediaries of the capital and debt markets. They are responsible for transferring funds from investors to companies, in need of those funds. The presence of financial institutions facilitate the flow of money through the economy. To do so, savings are pooled to mitigate the risk brought to provide funds for loans. Such is the primary means for depository institutions to develop revenue. Should the yield curve become inverse, firms in this arena will offer additional fee-generating services including securities underwriting, and prime brokerage.

>Corporate valuation:
Relative metrics : Price/Equity Price/Book Value
Use Equity Multiples (as opposed to Enterprise Multiples). In order to consider how valuing a Financial Institution's balance sheet is different from a non-Financial firm. Consider how an industrials firm wields capital machinery (asset) and the loans (liabilities) it used to finance that asset. The line is blurred in Financial Institutions, which must hold deposit accounts (liabilities) to fuel the issuance of loans (assets). The same accounts are considered loans as they are held in ownership not of the bank, but of the individual client.
Dividend Discount Model : Earnings-per-share
Dividends-per-share
Discounted Cash Flow (DCF) Model : You'll need the FCFE (Free Cash Flow for Equity), which is the amount of money that is returned to shareholders. Calculate an FCFF (Free Cash Flow to the Firm): EBIT (1-tax rate) -Capital Expenditures+ (Depreciation & Amortization) - (Net increase in working capital)= FCFF
FCFF-Debt+Cash=FCFE
Use the Capital Asset Pricing Model, not the Weighted Average Cost of Capital (for the same reasons one uses Equity Multiples in relative valuation) to determine the cost of equity (the return required by shareholders in order to make the decision to invest in a financial institutions)
Excess Return Model : A model where valuation is expressed as the sum of capital invested currently in the firm and the present value of dollar excess returns that the firm expects to make in the future

>Governance:
Governance is a critical issue for financial institutions as they operate in a substantially regulated environment. Some of the key governing bodies are: In the United States: FFIEC, Comptroller of the Currency- National Banks, FDIC-State "non-member" banks, NCUA-Credit Unions, Federal Reserve- Fed "member" Banks, Office of Thrift Supervision - National Savings & Loan Association, State governments each often regulate and charter financial institutions. In Norway, Financial Supervisory Authority of Norway. In Hong Kong, Hong Kong Monetary Authority. In Russia, Central Bank of Russia.

Financial Economics

Financial economics is the branch of economics concerned with "the allocation and deployment of economic resources, both spatially and across time, in an uncertain environment". It is additionally characterised by its "concentration on monetary activities", in which "money of one type or another is likely to appear on both sides of a trade". The questions within financial economics are typically framed in terms of "time, uncertainty, options and information".
Time: money now is traded for money in the future.
Uncertainty (or risk): The amount of money to be transferred in the future is uncertain.
options: one party to the transaction can make a decision at a later time that will affect subsequent transfers of money.
Information: knowledge of the future can reduce, or possibly eliminate, the uncertainty associated with future monetary value (FMV).

Subject matter:
Financial economics is the branch of economics studying the interrelation of financial variables, such as prices, interest rates and shares, as opposed to those concerning the real economy. Financial economics concentrates on influences of real economic variables on financial ones, in contrast to pure finance.
It studies:
>Valuation - Determination of the fair value of an asset
-How risky is the asset? (identification of the asset appropriate discount rate)
-What cash flows will it produce? (discounting of relevant cash flows)
-How does the market price compare to similar assets? (relative valuation)
-Are the cash flows dependent on some other asset or event? (derivatives, contingent claim valuation)
>Financial markets and instruments:
-Commodities

-Stocks
-Bonds
-Money market instruments
-Derivatives

>Financial institutions and regulation

Models in Financial economics:
Financial economics is primarily concerned with building models to derive testable or policy implications from acceptable assumptions. Some fundamental ideas in financial economics are portfolio theory, the Capital Asset Pricing Model. Portfolio theory studies how investors should balance risk and return when investing in many assets or securities. The Capital Asset Pricing Model describes how markets should set the prices of assets in relation to how risky they are. The Modigliani-Miller Theorem describes conditions under which corporate financing decisions are irrelevant for value, and acts as a benchmark for evaluating the effects of factors outside the model that do affect value.
A common assumption is that financial decision makers act rationally (see Homo economicus; efficient market hypothesis). However, recently, researchers in experimental economics and experimental finance have challenged this assumption empirically. They are also challenged - theoretically - by behavioral finance, a discipline primarily concerned with the limits to rationality of economic agents.
Other common assumptions include market prices following a random walk, or asset returns being normally distributed. Empirical evidence suggests that these assumptions may not hold, and in practice, traders and analysts, and particularly risk managers, frequently modify the "standard models".

Financial Risk Management.

Financial risk management is the practice of creating economic value in a firm by using financial instruments to manage exposure to risk, particularly credit risk and market risk. Other types include Foreign exchange, Shape, Volatility, Sector, Liquidity, Inflation risks, etc. Similar to general risk management, financial risk management requires identifying its sources, measuring it, and plans to address them. Financial risk management can be qualitative and quantitative. As a specialization of risk management, financial risk management focuses on when and how to hedge using financial instruments to manage costly exposures to risk.
In the banking sector worldwide, the Basel Accords are generally adopted by internationally active banks for tracking, reporting and exposing operational, credit and market risks.

When to use financial risk management:
Finance theory (i.e., financial economics) prescribes that a firm should take on a project when it increases shareholder value. Finance theory also shows that firm managers cannot create value for shareholders, also called its investors, by taking on projects that shareholders could do for themselves at the same cost. When applied to financial risk management, this implies that firm managers should not hedge risks that investors can hedge for themselves at the same cost. This notion is captured by the hedging irrelevance proposition: In a perfect market, the firm cannot create value by hedging a risk when the price of bearing that risk within the firm is the same as the price of bearing it outside of the firm. In practice, financial markets are not likely to be perfect markets. This suggests that firm managers likely have many opportunities to create value for shareholders using financial risk management. The trick is to determine which risks are cheaper for the firm to manage than the shareholders. A general rule of thumb, however, is that market risks that result in unique risks for the firm are the best candidates for financial risk management.

Financial Risk.

Financial risk is normally any risk associated with any form of financing.

>Investment related:
Depending on the nature of the investment, the type of 'investment' risk will vary. High risk investments have greater potential rewards, but also have greater potential consequences.
A common concern with any investment is that the initial amount invested may be lost - or the capital. This risk is therefore often referred to as capital risk.
If the invested assests are being held in another currency, there is a risk that currency movements alone may affect the value. This is referred to as currency risk.
Many forms of investment may not be readily salable on the open market (e.g. commercial property) or the market has a small capacity and may therefore take time to sell. Assets that are easily sold are termed liquid: therefore this type of risk is termed liquidity risk.
>Business related:
The risk that a company or project will not have adequate cash flow to meet financial obligations; thus causing the business to file for bankruptcy.
Financial risk is the additional risk a shareholder bears when a company uses debt in addition to equity financing. Companies that issue more debt instruments would have higher financial risk than companies financed mostly or entirely by equity.
Bilateral barter can depend upon a mutual coincidence of wants. Before any transaction can be undertaken, each party must be able to supply something the other party demands. To overcome this mutual coincidence problem, some communities had developed a system of intermediaries who can warehouse and trade goods. However, intermediaries often suffered from financial risk.
Whilst higher risk normally implies higher overall rewards, this is not always the case. For example a high risk mortgage client may be required to pay a higher interest rate on their mortgage repayments in order to be accepted as a bank's customer. However, this higher mortgage rate will in itself increase the risk to the bank that the customer cannot meet their interest payments, further increasing the risk.
This circular risk problem can lead to markets not existing for high risk borrowers. The 2007/8 sub-prime crisis may have some links to this argument. Higher interest rates for high risk borrowers make the borrowers even less likely to be able to pay back the loan, further increasing the default risk.
There many other risks aswell.
>Credit Risk:
Default risk
Loan level migration risk
>Insurance related:
Insurance industry
>Market risk;
Interest rate risk
Foreign exchange risk
Equity price risk
Commodity risk
>Liquidity risk:
Liquidity risk
Solvency risk
>Operational Risk:
Operational risk
Information technology risk
Reputation risk
Legal risk

Financial Instrument

Financial instruments are cash, evidence of an ownership interest in an entity, or a contractual right to receive, or deliver, cash or another financial instrument.

Categorization:
Financial instruments can be categorized by form depending on whether they are cash instruments or derivative instruments:
>Cash instruments are financial instruments whose value is determined directly by markets. They can be divided into securities, which are readily transferable, and other cash instruments such as loans and deposits, where both borrower and lender have to agree on a transfer.
>Derivative instruments are financial instruments which derive their value from the value and characteristics of one or more underlying assets. They can be divided into exchange-traded derivatives and over-the-counter (OTC) derivatives.
Alternatively, financial instruments can be categorized by "asset class" depending on whether they are equity based (reflecting ownership of the issuing entity) or debt based (reflecting a loan the investor has made to the issuing entity). If it is debt, it can be further categorised into short term (less than one year) or long term.

Corporate finance.

Corporate finance is an area of finance dealing with the financial decisions corporations make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to maximize corporate value while managing the firm's financial risks. Although it is in principle different from managerial finance which studies the financial decisions 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.
The discipline can be divided into long-term and short-term decisions and techniques. Capital investment decisions are long-term choices about which projects receive investment, whether to finance that investment with equity or debt, and when or whether to pay dividends to shareholders. On the other hand, the short term decisions can be grouped under the heading "Working capital management". This subject deals with the short-term balance of current assets and current liabilities; the focus here is on managing cash, inventories, and short-term borrowing and lending (such as the terms on credit extended to customers).
The terms Corporate finance and Corporate financier are also associated with investment banking. The typical role of an investment banker is to evaluate company's financial needs and raise the appropriate type of capital that best fits those needs.

Public finance (over view)

Public finance is a field of economics concerned with paying for collective or governmental activities, and with the administration and design of those activities. The field is often divided into questions of what the government or collective organizations should do or are doing, and questions of how to pay for those activities. The broader term (public economics) and the narrower term (government finance) are also often used.

Overview:
The proper role of government provides a starting point for the analysis of public finance. In theory, private markets will allocate goods and services among individuals efficiently (in the sense that no waste occurs and that individual tastes are matching with the economy's productive abilities). If private markets were able to provide efficient outcomes and if the distribution of income were socially acceptable, then there would be little or no scope for government. In many cases, however, conditions for private market efficiency are violated. For example, if many people can enjoy the same good at the same time (non-rival, non-excludable consumption), then private markets may supply too little of that good. National defense is one example of non-rival consumption, or of a public good.
"Market failure" occurs when private markets do not allocate goods or services efficiently. The existence of market failure provides an efficiency-based rationale for collective or governmental provision of goods and services. Externalities, public goods, informational advantages, strong economies of scale, and network effects can cause market failures. Public provision via a government or a voluntary association, however, is subject to other inefficiencies, termed "government failure."
Under broad assumptions, government decisions about the efficient scope and level of activities can be efficiently separated from decisions about the design of taxation systems (Diamond-Mirlees separation). In this view, public sector programs should be designed to maximize social benefits minus costs (cost-benefit analysis), and then revenues needed to pay for those expenditures should be raised through a taxation system that creates the fewest efficiency losses caused by distortion of economic activity as possible. In practice, government budgeting is substantially more complicated and often results in inefficient practices.
Government can pay for spending by borrowing (borrowing), although borrowing is a method of distributing tax burdens through time rather than a replacement for taxes. A deficit is the difference between government spending and revenues. The accumulation of deficits over time is the total public debt. Deficit finance allows governments to smooth tax burdens over time, and gives governments an important fiscal policy tool. Deficits can also narrow the options of successor governments.
Public finance is closely connected to issues of income distribution and social equity. Governments can reallocate income through transfer payments or by designing tax systems that treat high-income and low-income households differently.
The "Public Choice" approach to public finance seeks to explain how self-interested voters, politicians, and bureaucrats actually operate, rather than how they should operate.

Personal finance & Its Planning.

Personal finance is the application of the principles of finance to the monetary decisions of an individual or family unit. It addresses the ways in which individuals or families obtain, budget, save, and spend monetary resources over time, taking into account various financial risks and future life events. Components of personal finance might include checking and savings accounts, credit cards and consumer loans, investments in the stock market, retirement plans, social security benefits, insurance policies, and income tax management.

Personal financial planning:

A key component of personal finance is financial planning, a dynamic process that requires regular monitoring and reevaluation. In general, it has five steps:
1.Assessment: One's personal financial situation can be assessed by compiling simplified versions of financial balance sheets and income statements. A personal balance sheet lists the values of personal assets (e.g., car, house, clothes, stocks, bank account), along with personal liabilities (e.g., credit card debt, bank loan, mortgage). A personal income statement lists personal income and expenses.
2.Setting goals: Two examples are "retire at age 65 with a personal net worth of $200,000" and "buy a house in 3 years paying a monthly mortgage servicing cost that is no more than 25% of my gross income". It is not uncommon to have several goals, some short term and some long term. Setting financial goals helps direct financial planning.
3.Creating a plan: The financial plan details how to accomplish your goals. It could include, for example, reducing unnecessary expenses, increasing one's employment income, or investing in the stock market.
4.Execution: Execution of one's personal financial plan often requires discipline and perseverance. Many people obtain assistance from professionals such as accountants, financial planners, investment advisers, and lawyers.
5.Monitoring and reassessment: As time passes, one's personal financial plan must be monitored for possible adjustments or reassessments.
Typical goals most adults have are paying off credit card and or student loan debt, retirement, college costs for children, medical expenses, and estate planning.

Types Of Money

In economics, money is a broad term that refers to any financial instrument that can fulfill the functions of money (detailed above). Modern monetary theory distinguishes among different types of monetary aggregates, using a categorization system that focuses on the liquidity of the financial instrument used as money.
1. Commodity money:

Commodity money value comes from the commodity out of which it is made. The commodity itself constitutes the money, and the money is the commodity.Examples of commodities that have been used as mediums of exchange include gold, silver, copper, rice, salt, peppercorns, large stones, decorated belts, shells, alcohol, cigarettes, cannabis, candy, barley, etc. These items were sometimes used in a metric of perceived value in conjunction to one another, in various commodity valuation or Price System economies. Use of commodity money is similar to barter, but a commodity money provides a simple and automatic unit of account for the commodity which is being used as money.

2. Representative money: Representative money is money that consists of token coins, other physical tokens such as certificates, and even non-physical "digital certificates" (authenticated digital transactions) that can be reliably exchanged for a fixed quantity of a commodity such as gold, silver or potentially water, oil or food. Representative money thus stands in direct and fixed relation to the commodity which backs it, while not itself being composed of that commodity.

3. Credit money:Credit money is any claim against a physical or legal person that can be used for the purchase of goods and services. Credit money differs from commodity and fiat money in two ways: It is not payable on demand (although in the case of fiat money, "demand payment" is a purely symbolic act since all that can be demanded is other types of fiat currency) and there is some element of risk that the real value upon fulfillment of the claim will not be equal to real value expected at the time of purchase.
This risk comes about in two ways and affects both buyer and seller.
First it is a claim and the claimant may default (not pay). High levels of default have destructive supply side effects. If manufacturers and service providers do not receive payment for the goods they produce, they will not have the resources to buy the labor and materials needed to produce new goods and services. This reduces supply, increases prices and raises unemployment, possibly triggering a period of stagflation. In extreme cases, widespread defaults can cause a lack of confidence in lending institutions and lead to economic depression. For example, abuse of credit arrangements is considered one of the significant causes of the Great Depression of the 1930s.
The second source of risk is time. Credit money is a promise of future payment. If the interest rate on the claim fails to compensate for the combined impact of the inflation (or deflation) rate and the time value of money, the seller will receive less real value than anticipated. If the interest rate on the claim overcompensates, the buyer will pay more than expected.

4. Fiat money:Fiat money is any money whose value is determined by legal means. The terms fiat currency and fiat money relate to types of currency or money whose usefulness results not from any intrinsic value or guarantee that it can be converted into gold or another currency, but instead from a government's order (fiat) that it must be accepted as a means of payment.Fiat money is created when a type of credit money (typically notes from a central bank, such as the Federal Reserve System in the U.S.) is declared by a government act (fiat) to be acceptable and officially-recognized payment for all debts, both public and private. Fiat money may thus be symbolic of a commodity or a government promise, though not a completely specified amount of either of these. Fiat money is thus not technically fungible or tradable directly for fixed quantities of anything, except more of the same government's fiat money. Fiat moneys usually trade against each other in value in an international market, as with other goods. An exception to this is when currencies are locked to each other, as explained below. Many but not all fiat moneys are accepted on the international market as having value. Those that are trade indirectly against any internationally available goods and services. Thus the number of U.S. dollars or Japanese yen which are equivalent to each other, or to a gram of gold metal, are all market decisions which change from moment to moment on a daily basis. Occasionally, a country will peg the value of its fiat money to that of the fiat money of a larger economy: for example the Belize dollar trades in fixed proportion (at 2:1) to the U.S. dollar, so there is no floating value ratio of the two currencies.
Fiat money, if physically represented in the form of currency (paper or coins) can be easily damaged or destroyed. However, here fiat money has an advantage over representative or commodity money, in that the same laws that created the money can also define rules for its replacement in case of damage or destruction. For example, the U.S. government will replace mutilated federal reserve notes (U.S. fiat money) if at least half of the physical note can be reconstructed, or if it can be otherwise proven to have been destroyed. By contrast, commodity money which has been destroyed or lost is gone.

Economic Characteristics Of Money.

Money is generally considered to have the following characteristics, which are summed up in a rhyme found in older economics textbooks: "Money is a matter of functions four, a medium, a measure, a standard, a store." That is, money functions as a medium of exchange, a unit of account, a standard of deferred payment, and a store of value.There have been many historical arguments regarding the combination of money's functions, some arguing that they need more separation and that a single unit is insufficient to deal with them all. One of these arguments is that the role of money as a medium of exchange is in conflict with its role as a store of value: its role as a store of value requires holding it without spending, whereas its role as a medium of exchange requires it to circulate. Others argue that storing of value is just deferral of the exchange, but does not diminish the fact that money is a medium of exchange that can be transported both across space and time. 'Financial capital' is a more general and inclusive term for all liquid instruments, whether or not they are a uniformly recognized tender.
1. Medium of exchange:

Money is used as an intermediary for trade, in order to avoid the inefficiencies of a barter system, which are sometimes referred to as the 'double coincidence of wants problem'. Such usage is termed a medium of exchange.
2. Unit of account:
A unit of account is a standard numerical unit of measurement of the market value of goods, services, and other transactions. Also known as a "measure" or "standard" of relative worth and deferred payment, a unit of account is a necessary prerequisite for the formulation of commercial agreements that involve debt.
Divisible into small units without destroying their value; precious metals can be coined from bars, or melted down into bars again.
Fungible: that is, one unit or piece must be perceived as equivalent to any other, which is why diamonds, works of art or real estate are not suitable as money.
A specific weight, or measure, or size to be verifiably countable. For instance, coins are often made with ridges around the edges, so that any removal of material from the coin (lowering its commodity value) will be easy to detect.
3. Store of value:
To act as a store of value, a commodity, a form of money, or financial capital must be able to be reliably saved, stored, and retrieved — and be predictably useful when it is so retrieved. Fiat currency like paper or electronic currency no longer backed by gold in most countries is not considered by some economists to be a store of value.

Money & Its HIstory

To understand finance we must know what is money...

Money is anything that is generally accepted as payment for goods and services and repayment of debts. The main uses of money are as a medium of exchange, a unit of account, and a store of value. Some authors explicitly require money to be a standard of deferred payment. The dominant form of money is currency. The term "price system" is sometimes used to refer to methods using commodity valuation or money accounting systems.
The word "money" is believed to originate from a temple of Hera, located on Capitoline, one of Rome's seven hills. In the ancient world Hera was often associated with money. The temple of Juno Moneta at Rome was the place where the mint of Ancient Rome was located. The name "Juno" may derive from the Etruscan goddess Uni (which means "the one", "unique", "unit", "union", "united") and "Moneta" either from the Latin word "monere" (remind, warn, or instruct) or the Greek word "moneres" (alone, unique).
History.
The use of barter like methods may date back to at least 100,000 years ago. Trading in red ochre is attested in Swaziland, shell jewellery in the form of strung beads also dates back to this period, and had the basic attributes needed of commodity money. To organize production and to distribute goods and services among their populations, before market economies existed, people relied on tradition, top-down command, or community cooperation.
The Shekel referred to an ancient unit of weight and currency. The first usage of the term came from Mesopotamia circa 3000 BC. and referred to a specific mass of barley which related other values in a metric such as silver, bronze, copper etc. A barley/shekel was originally both a unit of currency and a unit of weight
According to Herodotus, and most modern scholars, the Lydians were the first people to introduce the use of gold and silver coin. It is thought that these first stamped coins were minted around 650-600 BC. A stater coin was made in the stater (trite) denomination. To complement the stater, fractions were made: the trite (third), the hekte (sixth), and so forth in lower denominations.
The name of Croesus of Lydia became synonymous with wealth in antiquity. Sardis was renowned as a beautiful city. Around 550 BC, Croesus contributed money for the construction of the temple of Artemis at Ephesus, one of the Seven Wonders of the ancient world.
The first banknotes were used in China in the 7th century, and the first in Europe issued by Stockholms Banco in 1661.
In the Western world, a prevalent term for coin-money has been specie, stemming from Latin in specie "in kind".

Finance

The field of finance refers to the concepts of time, money and risk and how they are interrelated. Banks are the main facilitators of funding through the provision of credit, although privat equity, mutual funds, hedge funds, and other organizations have become important. Financial assets, known as investments, are financially managed with careful attention to financial risk management to control financial risk. Financial instruments allow many forms of securitized assets to be traded on securities exchanges such as stock exchanges, including debt such as bonds as well as equity in publicly-traded corporations.

The main techniques and sectors of the financial industry:

An entity whose income exceeds its expenditure can lend or invest the excess income. On the other hand, an entity whose income is less than its expenditure can raise capital by borrowing or selling equity claims, decreasing its expenses, or increasing its income. The lender can find a borrower, a financial intermediary such as a bank, or buy notes or bonds in the bond market. The lender receives interest, the borrower pays a higher interest than the lender receives, and the financial intermediary pockets the difference.
A bank aggregates the activities of many borrowers and lenders. A bank accepts deposits from lenders, on which it pays the interest. The bank then lends these deposits to borrowers. Banks allow borrowers and lenders, of different sizes, to coordinate their activity. Banks are thus compensators of money flows in space.
A specific example of corporate finance is the sale of stock by a company to institutional investors like investment banks, who in turn generally sell it to the public. The stock gives whoever owns it part ownership in that company. If you buy one share of XYZ Inc, and they have 100 shares outstanding (held by investors), you are 1/100 owner of that company. Of course, in return for the stock, the company receives cash, which it uses to expand its business; this process is known as "equity financing". Equity financing mixed with the sale of bonds (or any other debt financing) is called the company's capital structure.
Finance is used by individuals (personal finance), by governments (public finance), by businesses (corporate finance), as well as by a wide variety of organizations including schools and non-profit organizations. In general, the goals of each of the above activities are achieved through the use of appropriate financial instruments and methodologies, with consideration to their institutional setting.
Finance is one of the most important aspects of business management. Without proper financial planning a new enterprise is unlikely to be successful. Managing money (a liquid asset) is essential to ensure a secure future, both for the individual and an organization.

Bank account.

A bank account is a financial account with a banking institution, recording the financial transactions between the customer and the bank and the resulting financial position of the customer with the bank.
Bank accounts may have a positive, or debit balance, where the bank owes money to the customer; or a negative, or credit balance, where the customer owes the bank money.
Broadly, accounts opened with the purpose of holding credit balances are referred to as deposit accounts; whilst accounts opened with the purpose of holding debit balances are referred to as loan accounts.
Some accounts are defined by their function rather than nature of the balance they hold. Bank accounts designed to process large numbers of transactions may offer credit and debit facilities and therefore do not sit easily with a polarised definition. These transactional accounts are called by different names in different countries: in the U.S. and Canada, they are called "checking accounts"; in the UK, they are termed "current accounts".

Other account types:
-Savings account
-Transactional account
-Joint account
-Low-cost account
-Time deposit / certificate of deposit
-Numbered bank account
-Negotiable Order of Withdrawal account
-Automatic transfer service account
-Money market deposit account
-Individual Savings Account
-Tax-Exempt Special Savings Account
-Transaction deposit
-Nostro and vostro accounts
-personal account
-ATM