What is Finance: Types of Finance and Financial Instruments?

Finance is a major and vast topic to cover. Accounting and Finance are often used together, and some even deem it to be similar. But there is a significant difference between the two. The article will cover what is finance, what are the types of finance, and the different classes of financial instruments. So, let us understand what is finance?

What is Finance?

Finance is the allocation of assets, liabilities, and funds over time, process, mediums to reap the most out of the activity. In other words, managing or multiplying funds to the best in interest while tackling the risks and uncertainties. Finance is majorly divided into three segments: Personal Finance, Corporate Finance, and Public Finance.

What is Personal Finance?

Personal Finance is managing the finance or funds of an individual and helping them achieve the desired goals in terms of savings and investments. Personal Finance is specific to individuals and the strategies depend on the individuals earning potential, requirements, goals, time frame, etc. Personal finance includes investment in education, assets like real estate, cars, life insurance policies, medical and other insurance, saving and expense management.

Personal Finance includes:

• Protection against unforeseen and uncertain personal events
• Transfer of wealth across generations of the family
• Managing taxes and complying with tax policies (tax subsidies or penalties)
• Preparing for retirement
• Preparing for long term expenses or purchases involving a huge amount
• Paying for a loan or debt obligations
• Investment and wealth accumulation goals

What is Corporate Finance?

Corporate Finance is about funding the company expenses and building the capital structure of the company. It deals with the source of funds and the channelization of those funds like the allocation of funds for resources and increasing the value of the company by improving the financial position. Corporate finance focuses on maintaining a balance between the risk and opportunities and increasing the asset value.

Corporate Finance Includes:

• Capital budgeting
• Employing standard business valuation techniques or real options valuation
• Identifying the source of funding in the form of equity, shareholders’ funds, creditors, debts
• Determining the utility of unappropriated profits for future investment, operational utilization, or distribution to the shareholders
• Acquisition and investment in stock or other assets
• Identifying relevant objectives, opportunities, and constraints
• Risk management and tax considerations
• Stock issuance while going public and listing on the Stock exchange

What is Public Finance?

This type of finance is related to states, municipalities, provinces in short government required finances. It includes long term investment decisions related to public entities. Public finance takes factors like distribution of income, resource allocation, economic stability in consideration. Funds are obtained majorly from taxes, borrowing from banks or insurance companies.

Public Finance includes:

• Identifying the expenditure required by the public entity
• The sources of revenue for the public entity
• Determining the budgeting process and source of funds
• Issuing debts for public projects
• Tax management

The other two famous terms in Finance are the Microfinance and Trade Finance

What Is Microfinance?

Microfinance is also known as microcredit. This type of finance is specifically designed for individuals who do not have easy access to financial services. These individuals include unemployed and lower-income group individuals. Banks may even offer additional services like saving accounts, microinsurance, and trainings. The main motive behind providing microfinance is to provide an opportunity for these individuals to become self-reliant. Lenders often grant loans after pooling borrowers to ensure better repayment probability. The repayment amount on such microloans is higher than that of conventional financing due to the risk involved.

Microfinance includes:

• Bank checking and savings account
• Educational programs on the principles of investing
• Training on skills like accounting and bookkeeping including cash flow management, profit and loss statements, etc.
• Basic money management training
• Lessons on financial terms and concepts like interest rate, cash flow, budget, debt, etc.

What is Trade Finance?

Trade Finance includes financial services and instruments that enable and facilitate trade internationally. Trade finance is ideal for importers and exporters to carry on smooth international transactions by reducing risk in global trade. Trade finance can help reduce the risk associated with global trade by reconciling the divergent needs of an exporter and importer. Unlike conventional finance, trade finance is used to protect the two parties from the various risks involved in international trade and does not mean that the parties lack funds or liquidity. The risks involved in international trade are currency fluctuations, non-payment by the party, political instability, creditworthiness of the parties, etc. Trade finance involves a third party for conducting a transaction thus eliminating the risk of supply and payment. In trade finance, the exporter is provided with the payment as per the agreement and the importer can avail of a credit facility to fulfill the trade order. Apart from protecting against the risks, non-payment, and non-receipt of goods, trade finance also improves the efficiency and revenue. It enables the company to receive a cash payment based on the accounts receivables as the buyer’s bank guarantees payment. This also ensures timely payments and assured shipment of goods. The different parties involved in trade finance are importer, exporter, banks, insurers, credit agencies, trade finance companies.

What are Instruments in Finance?

For availing financial services an individual or company needs financial instruments. A Financial Instrument is a contract between two parties and involves monetary activities. Financial instruments can be used for investment purpose or lending and borrowing purpose. Financial instruments are either classified as Cash Instruments or Derivative Instruments:

What are Cash Instruments?

The value of Cash Instruments is determined by market forces. Cash instruments involve instruments that are easily transferable by the parties. It could be in the form of securities, loans or deposits. The different types of cash instruments available in the market are certificates of deposits, repurchase agreements like the Repos, bills of exchange, interbank loans, commercial papers, e securities and many more.

What are Derivative Instruments?

The value of Derivative Instruments is derived from the valuation of another entity which can be an asset, or an index, or any other factor that can influence the value of the derivatives. The different types of derivative instruments available in the market are futures, forwards, swaps, and options. Financial instruments are also classified based on their asset class. Financial instruments can be debt-based or equity-based. A debt-based instrument is in the form of loans that the issuing party avails from the investors. Whereas, equity-based instruments reflect ownership based on the share of equity an investor holds. Debt-based financial instruments include bonds, bond futures and options, Interest rate swaps, Treasury bills, Interest rate futures and forward rate agreements. Another type of asset class is the Forex Instruments which includes forex futures, forex options, currency swaps and more.

Finance is a very different domain when compared to accounting. But a lot of time the two are considered to be similar. There are a lot of courses that train the candidate completely on finance while covering the basic accounting topics and concepts. A bachelor’s degree in finance helps students gain a good understanding of the concepts and build a strong foundation in finance. Candidates who want to excel in the field of Finance can opt to pursue an advanced course in finance. There are numerous master’s level or professional courses that cater to the training and learning needs of the students as well as the industry. These certification courses are very much in demand in all the industries since every organization needs a finance team that possesses all the required skills in the domain. Some of the professional certification courses that a candidate can pursue are:

Chartered Financial Analyst course (CFA)

To know more about the CFA course details like the CFA course eligibility, CFA course duration, CFA course scope, please visit our center or contact our career counsellors.

Financial Risk Manager course (FRM)

To know more about the FRM course details like the FRM course eligibility, FRM course duration, FRM course scope, please visit our center or contact our career counsellors. Career in Finance after B. Com CFA Vs MBA Finance more related links – Career in Finance What is CFA