Introduction and overview of money and finance
Webster’s dictionary defines finance as “the science of managing money.” Because we all manage money, at least our own. A day rarely passes for most of us without some contact with finance. We get paid in money. We spend money to buy goods and services. We save the money we do not want to spend immediately on goods and services for later use by lending it to someone or some institution that either spend it or, in turn, relends it to a third party. In return for the temporary use of our money, the borrower gives us an IOU in the form of a financial security---for example, a deposit, note or bond--- which generally promises to pay us interest until the money is returned. We borrow money against income we have not yet earned by creating our own IOU. The IOU commits us to repay the money in the future and in the meantime pay interest to the lender. Borrowing permits us to spend before we have earned the necessary income. Because of our everyday use of money, money has been a subject of fascination throughout history.
Financial terms such as money, checking accounts, banks, savings and loan associations, interest rates, foreign exchange rates, stocks, bonds, mortgagees, credit cards, money-market funds, and monetary policy are part of everyday language. Financial events are in the news daily---bank failures, savings and loan crises, junk bond crises, changes in the rate of inflation, changes in the interest rates, changes in stock prices (including stock market crashes and meltdowns), new types of securities, and pronouncements by the chairman of the Board of Governors of the Federal Reserve System.
Although important, and the focus of much study, money still remains a mystery to many of us. Money has been accused of being the root, alternately, of all happiness and of all evil, the source of power, and the cause of corruption. Critics have suggested that it be abolished, and societies have at times tried to operate without it. Yet it exists in all modern economies. As the famous economist John Stuart Mill wrote almost 200years ago:
Confusion…envelopes the whole matter; partly from a lingering remnant of …misleading associations, and partly from the mass of vapory and baseless speculation with which this, more than any other topic of political economy, has in later times become surrounded.
Managing money and finance is important at the personal, business, international, and government levels. At these levels, it is referred to as personal finance, business finance, international finance, and public finance, respectively. The better we understand finance and how to manage money, the better off we will be as individuals, organizations, and societies. Good financial management is important at all levels. If we mismanage our personal finances, primarily we harm ourselves. If we mismanagement the finances of a firm, we harm not only the owners but also the employees, suppliers, and customers. If we mismanage the finances of a governmental unit, including the federal government, we harm all its citizens.
The object of financial management at all four levels is both to meet payments in full when due---that is, to avoid default and bankruptcy; and to manage money efficiently until the time it is needed to meet future payments. If the funds are available before the scheduled payment date, the money may be invested in financial securities or real assets in such a way that the expected rate of return for a given level of risk of loss, or failure to receive payment in full, will be maximized (or the risk for an expected rate of return will be minimized, the interest cost of the risk the lender assumes that you may not make the required payments on the securities in full and on time.)