Banking and Finance
Overview
Finance is the process by which agents in the economy that have a surplus of funds lend those funds to agents who have a shortage.
The agents who have a surplus of funds could just save that money by saving it in a safe or proverbially stashing it underneath
the mattress. However, this method of saving does not generate any return, and in fact, in the presence of inflation, will
lose value over time. Hence, savers are motivated to find other agents in the economy who can find productive uses for the funds
for which the saver can pocket a portion of the return.
Instruments
One of the primary ways that saving agents save their funds is through the purchase of
securities. A security is an financial instrument that represents a ownership claim in some asset.
There are a multitude of financial instruments (for a more comprehensive list, see
financial analysis corner),
from an economic perspective the basic savings instruments usually fall within the following
categories.
- Bond: is a
debt instrument
that specifies a series of payments that occur
over the future. A standard bond represents a loan where interest payments are made periodically and the loan
principal is returned at the maturity of the bond.
- Stock: is a share of ownership in a corporation.
(see equities)
Markets
There is a lengthy legal process by which a security is created. This is usually done with the help of an
investment bank, who then sells those securities to its clients. This is called the primary market. Securities
can then be made available to the public through what is known as the secondary market.
The
Efficient Markets Hypothesis
is thought to guarantee that the prices in the market are fair and representative of the underlying assets true value.
Financial Intermediaries
