BUS202: Principles of Finance

Finance is the study of fund management and asset allocation over time.

Learning Objective

• Explain the importance of time to the discipline of finance

Key Points

• The two main drivers of finance are the time value of money and risk.
• Since the value of assets changes over time, finance seeks to ensure the change is beneficial for the organization or individual.
• Financial professionals generally operate in an environment of uncertainty where they must make forecasts about future events.

Terms

• debtor

A person or firm that owes money, one in debt, or one who owes a debt.

• asset

Something or someone of any value; any portion of one's property or effects so considered.

• investment

A placement of capital in expectation of deriving income or profit from its use.

Overview

Finance is the study of fund management and asset allocation over time. Funds consist of money and other assets. There are many different types of finance, but all are fundamentally concerned with studying how best to allocate assets in different conditions over time.

Importance of Time

The underlying driver behind all of finance is time. There are two reasons why time is so important to finance:

Time value of money: For a number of reasons, money today is worth more than the same amount of money in the future. For example, you would rather have 100 today than100todaythan100 in 10 years – the money is worth more to you now than it would be in the distant future. We will explore this concept in greater depth later on.

Risk: Making an investment does not guarantee a return. When a bank makes a loan, they're not sure the debtor will pay it back. There is a risk that the person will just take the money and run, the debtor will file for bankruptcy, or, for dozens of other reasons, the bank will not get the money they lent back.

The field of finance, however, embraces time. Finance says, "Since I know assets change value over time, how do I use that to cause my assets to change value in the direction I want? How do I manage assets so that they're worth more in the future than they are today?"

Challenges in Finance

Figuring out what to do with assets is sometimes easy: all of the variables are known, and there is clearly an option that is better than all the others. However, most of the time, this is not the case. Finance generally operates with a lot of uncertainty. As a result, companies hire entire departments of people to help them figure out which option is best.

Source: Boundless
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