M3 Finance: General Framework
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FINANCE
Finance is the study of funds management. The general areas of finance are personal finance and business finance (private finance), and public finance.
One facet of finance is through individuals and business organisations, which deposit money in a bank. The bank then lends the money out to other individuals or corporations for consumption or investment and charges interest on the loans.
Loans have become increasingly packaged for resale, meaning that an investor buys the loan (debt) from a bank or directly from a corporation. Bonds are debt instruments sold to investors for organisations such as companies, governments or charities. The investor can then hold the debt and collect the interest or sell the debt on a secondary market. Banks are the main facilitators of funding through the provision of credit, although investment funds, mutual funds, hedge funds, and other organisations have become important as they invest in various forms of debt. Financial assets, known as investments, are managed with careful attention to control financial risk. Financial instruments allow many forms of securitised assets to be traded on securities exchanges such as stock exchanges, including debt such as bonds as well as equity in publicly traded corporations.
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.
Corporate finance is the area of finance dealing with monetary decisions that business enterprises make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to maximize shareholder value while managing the company's financial risks. 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, short term decisions deal with the short-term balance of current assets and current liabilities; the focus here is on managing cash as well as short-term borrowing and lending.
Public finance consists of the collection of sufficient resources from the economy in an appropriate manner along with allocating and the use of these resources efficiently and effectively. Economists classify government expenditures into three main types. Government purchases of goods and services for current use are classed as government consumption. Government purchases of goods and services intended to create future benefits – such as infrastructure investment or research spending – are classed as government investment. Government expenditures that are not purchases of goods and services, and instead just represent transfers of money – such as social security payments – are called transfer payments. Government expenditures are financed in two ways: a) government revenue (taxes and non-tax revenue, like state-owned enterprises); and b) government borrowing (government debt).
Governments finance most of their expenditure by taxation. If they spend more than they levy or charge in taxes, they have to borrow money. Taxes are divided into two main groups: direct and indirect. Direct taxes are collected by the government from the income of individuals and businesses. Individuals pay income tax on their wages and salaries and most other money they receive. Most countries have a capital gains tax on profits made on the sale of assets such as stocks and shares. A capital transfer tax (inheritance tax) is imposed on inherited money or property. Companies pay corporation (corporate) tax on their profits. Companies and their employees also have to pay social security contribution and health insurance. Indirect taxes are levied on the production or sale of goods and services. They are included in the price paid by the final purchaser. Most countries levy VAT (value-added tax) or sales tax. Governments also levy excise taxes (excise duties) – additional sales taxes on commodities such as tobacco, alcoholic drinks, petrol, etc. Special taxes, called tariffs, are sometimes charged on goods imported from abroad.