1.1 The Subspecialties within Finance
There are three primary areas in the world of finance. These so-called mainline finance disciplines are (1) corporate finance, (2) investments, and (3) institutions. Although these areas sometimes overlap, they are considered to be the standard subfields within finance. Within the three areas of finance, there are various fields or specialties. Some examples of these fields include insurance, personal finance, financial planning, asset management, financial engineering, real estate, and entrepreneurial finance.
Corporate Finance
Corporate finance
The financial manager works toward this goal by managing the investing and financing functions of a firm. Here is an example. Suppose you and your brother-in-law decide to start your own lawn care business. Because you’re enrolled in this class, you volunteer to serve as the financial manager. Your first analysis will be on what equipment you must purchase to run your business. After some careful research, you decide on a John Deere riding lawn mower, a gas-operated weed eater, and a gas-operated blower. You will also need a trailer to transport the equipment and a truck to pull the trailer. Your brother-in-law has a pickup truck, so you won’t have to buy that, but you’ll have to buy a trailer. After carefully shopping around, you determine you will need $6,000 to invest
Now that you know how much you need to invest, you must determine how to finance the investment. If the funds are available, you and your brother-in-law could each give $3,000 and have enough to cover the cost. However, you may be able to borrow the money from a local bank. As the financial manager, you are the one to determine which is the best form of financing. We have simplified this example by assuming you will buy the equipment. However, you would also have the option to lease (rent) the equipment. As the financial manager, you would need to decide which option—purchasing or leasing—would be better. You would also need to conduct a capital budgeting analysis
Remember, investing and financing decisions are the heart of corporate finance. There are other issues as well, which we will cover in this course. As you work through this class, you will learn the methods needed to analyze and decide whether you should buy or lease in situations like the lawn care business described above. You will also learn whether you should finance your firm with your own money (equity
If you’ve ever taken an accounting class, you may remember talking a lot about equity and about short- and long-term assets and liabilities. The chart below (known as a balance sheet) provides a visual of how assets, liabilities, and equity look in the corporate finance arena.
Assets | Liabilities and Equity |
Short-Term Assets | Short-Term Liabilities |
Long-Term Liabilities | |
Long-Term Assets | Owner’s Equity |
In corporate finance, the left side of the balance sheet deals with your investment decisions, such as what assets the firm should acquire. The right side of the balance sheet deals with your financing decisions, such as how the firm should finance the assets desired. As the financial manager, you would conduct the necessary analyses to make these choices.
Investments
Investments
Another major subdiscipline of investments is asset pricing
The main objective of someone who works within the investments arena is to identify assets that are mispriced. These professionals use asset pricing models and other methods to estimate what an asset is worth. They then compare this estimated amount to the current market value. If there is a big enough difference between the estimated price and the current market price, the investor will either buy the asset (if the analysis indicates the asset is underpriced) or sell the asset (if it is overpriced). We will get into the technicalities of longing
Within the financial services sector is the field of personal financial investments. This field covers individuals (like you and us) who want to invest their own money as well as professionals who make their living investing their clients’ money. Often, personal finance does not involve searching for mispriced assets. Rather, it consists of a more passive investment strategy, where the investors buy assets that they feel are fairly priced but that will provide a fair return
Institutions
The field of institutions
Both consumer and commercial banking are included under the institutions umbrella. Insurance companies and pension companies are typically included as part of institutions as well. Here you can see how some of the fields intermix. For example, a life insurance company is considered a financial institution, but many of the professionals who work for the life insurance company will specialize in the investments discipline. When consumers buy insurance policies, professional investors who work for the insurance company invest that money so the insurance benefits can be paid out in the future (and so the insurance company makes a profit). Likewise, pension companies are considered institutions, but the pension funds they run are typically considered an investment. In a pension setting, professional investors invest the pension fund so beneficiaries will have retirement checks to collect in the future.
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