FUNDAMENTALS OF FINANCE
Fundamentals of Finance has an effect on both corporate and personal finance. The word “Finance” commonly means “the management of large amounts of money, especially by the government or big companies”. But this is just a basic definition. Let us first see what finance comprises when used in the corporate world.
General Background
Finance is not limited to companies or governments. Every household has to manage its finance, which means they have to consider the expenses, know where the money will come from and how much to spend at what time. They should as well know what assets they have created. This could be generally called financial management. Corporate finance comprises of two other segments – capital markets and investments.
Financial management is all about deciding on what assets to build, how to fund the purchase of these assets. It includes the management of the functioning of the company with an aim to maximize its value, too.
Capital Markets
Capital markets, in this case, this means the space where the interest rates and the prices of stocks and bonds are decided. Capital Markets is also about knowledge of those who have money to invest – like the banks, investment institutions, mutual funds, insurance companies and stock brokers.
Another important segment is the study of companies who may require funds for various purposes and the interest they may be willing to pay for this capital. Then there are the government entities like the Federal Reserve System which control the banks, and the SEC which regulates the sale and purchase of stocks and bonds.
Study of Investment means the study of stock and bonds and how they should be combined for investment for it to be profitable for the company. It also involves a close monitoring of the stock markets to study the movement of stocks and bonds.
Although they are three branches, the study of one is incomplete without the study of the other two. Any student of finance is taught all the three and is prepared for jobs in any of the various positions that deal with these.
What Is Interest Payment
Interest payment generally means paying a percentage of the total sum that may be collected or paid, for using that money.
For a borrower, interest would mean the percentage he will be paying for the money to be lent to him for a specific period. At the end of this period, he has to pay both the money borrowed along with the interest at the rate fixed at the time of borrowing.
For an investor, it would mean the percentage of the amount he will gain by using this money he has parked in banks or invested in other financial instruments like insurance and mutual funds.
As a corporate financial manager, he needs to know both. The company will be borrowing money for its expansion or purchase of capital goods, which will incur an interest. The company will also be investing money in various institutions that may gain it an interest. He has to arrive at a balance between the two values.
What Is The Theory Of Finance?
The theory of finance involves the study of different ways by which businesses and individuals raise money for their use. It also studies how money is to be allocated to various projects or investments, taking into account the risks involved in such investments. It also explores the ways to manage assets, assessing the risks and managing money.
Present Value
The present value defines the value of amount we need to invest today to get the required amount at a future date. Knowing the interest rates and the period for which this money is going to be invested, we can know what we will get in future. In the same way, the reverse can be calculated. If we know the amount of money we will require at a future date, we can calculate the amount that has to be invested today.
Knowing the present value is important when considering investment options. It is also useful in deciding whether to discount a bill or not. Discounting a bill will allow the seller to get immediate money even when the maturity date of the bill will be at a future date. The formula to calculate present value is given below
PV = CF /(1+r)n
Here “PV” is Present Value.
“CF” refers to the cash receivable in future.
“r” is the periodic rate of interest and
“n” is the number of periods.
