Capital, in the financial sense, is the money that gives the business the power to buy goods to be used in the production of other goods or the offering of a service. (The capital has two types of resources, Equity and Debt). The deployment of capital is decided by the budget. This may include the objective of business, targets set, and results in financial terms, e.g., the target set for sale, resulting cost, growth, required investment to achieve the planned sales, and financing source for the investment. A budget may be long term or short term. Long term budgets have a time horizon of 5-10 years giving a vision to the company; short term is an annual budget which is drawn to control and operate in that particular year. Budgets will include proposed fixed asset requirements and how these expenditures will be financed. Capital budgets are often adjusted annually and should be part of a longer-term Capital Improvements Plan. A cash budget is also required. The working capital requirements of a business are
monitored at all times to ensure that there are sufficient funds available to meet short-term expenses.
Financial economics is the branch of economics studying the interrelation of financial variables, such as prices, interest rates and shares, as opposed to those concerning the real economy. Financial economics concentrates on influences of real economic variables on financial ones, in contrast to pure finance. It centers on managing risk in the context of the financial markets, and the resultant economic and financial models. It essentially explores how rational investors would apply risk and return to the problem of an investment policy. Here, the twin assumptions of rationality and market efficiency lead to modern portfolio theory (the CAPM), and to the Black–Scholes theory for option valuation; it further studies phenomena and models where these assumptions do not hold, or are extended. “Financial economics”, at least formally, also considers investment under “certainty” (Fisher separation theorem, “theory of investment value”, Modigliani-Miller theorem) and hence also contributes to corporate finance theory. Financial econometrics is the branch of financial economics that uses econometric techniques to parametrize the relationships suggested. Although closely related, the disciplines of economics and finance are distinctive. The “economy” is a social institution that organizes a society’s production, distribution, and consumption of goods and services,” all of which must be financed.
Economists make a number of abstract assumptions for purposes of their analyses and predictions. They generally regard financial markets that function for the financial system as an efficient mechanism (Efficient-market hypothesis). Instead, financial markets are subject to human error and emotion. New research discloses the mischaracterization of investment safety and measures of financial products and markets so complex that their effects, especially under conditions of uncertainty, are impossible to predict. The study of finance is subsumed under economics as financial economics, but the scope, speed, power relations and practices of the financial system can uplift or cripple whole economies and the well-being of households, businesses and governing bodies within them, sometimes in a single day
Financial mathematics is a field of applied mathematics, concerned with financial markets. The subject has a close relationship with the discipline of financial economics, which is concerned with much of the underlying theory. Generally, mathematical finance will derive, and extend, the mathematical or numerical models suggested by financial economics. In terms of practice, mathematical finance also overlaps heavily with the field of computational finance (also known as financial engineering). Arguably, these are largely synonymous, although the latter focuses on application, while the former focuses on modelling and derivation (see: Quantitative analyst). The field is largely focused on the modelling of derivatives, although other important sub-fields include insurance mathematics and quantitative portfolio problems.
Experimental finance aims to establish different market settings and environments to observe experimentally and provide a lens through which science can analyze agents’ behavior and the resulting characteristics of trading flows, information diffusion and aggregation, price setting mechanisms, and returns processes. Researchers in experimental finance can study to what extent existing financial economics theory makes valid predictions, and attempt to discover new principles on which such theory can be extended. Research may proceed by conducting trading simulations or by establishing and studying the behavior of people in artificial competitive market-like settings.
Behavioral Finance studies how the psychology of investors or managers affects financial decisions and markets. Behavioral finance has grown over the last few decades to become central to finance.
Behavioral finance includes such topics as:
– Empirical studies that demonstrate significant deviations from classical theories.
– Models of how psychology affects trading and prices
– Forecasting based on these methods.
– Studies of experimental asset markets and use of models to forecast experiments.
A strand of behavioral finance has been dubbed Quantitative Behavioral Finance, which uses mathematical and statistical methodology to understand behavioral biases in conjunction with valuation. Among other topics, quantitative behavioral finance studies behavioral effects together with the non-classical assumption of the finiteness of assets.