Principles of Finance © Wikibooks This work is licensed under a Creative Commons-ShareAlike 4.0 International License Original source: Principles of Finance, Wikibooks http://en.wikibooks.org/wiki/Principles_of_Finance Contents Chapter 1 Introduction ..................................................................................................1 1.1 What is Finance? ................................................................................................................1 1.2 History .................................................................................................................................1 1.2.1 Introduction to Finance ..........................................................................................1 1.2.1.1 Return on Investments ...............................................................................2 1.2.1.2 Debt Finance and Equity Finance - The Two Pillars of Modern Finance ....................................................................................................................................3 1.2.1.2.1 Debt Financing .................................................................................3 1.2.1.2.2 Equity Financing ...............................................................................3 1.2.1.3 Ratio Analysis ...............................................................................................4 1.2.1.3.1 Liquidity Ratios .................................................................................4 Chapter 2 The Basics ......................................................................................................6 2.1 An Overview on Money .....................................................................................................6 2.1.1 What is Money? .......................................................................................................6 2.1.2 Role of a CFO and Finance Managers ..................................................................6 Chapter 3 Financial Markets and Institutions ............................................................7 3.1 Stock Markets......................................................................................................................7 3.1.1 Trading......................................................................................................................8 3.1.2 Market participants...............................................................................................10 3.1.3 History ....................................................................................................................10 3.1.4 Importance of stock market ................................................................................13 3.1.4.1 Function and purpose ...............................................................................13 3.1.4.2 Relation of the stock market to the modern financial system ............14 3.1.4.3 United States S&P stock market returns.................................................15 3.1.4.4 The behavior of the stock market ............................................................16 3.1.4.5 Irrational behavior .....................................................................................19 3.1.4.6 Crashes........................................................................................................19 3.1.5 Stock market index ...............................................................................................22 3.1.6 Derivative instruments ........................................................................................23 3.1.7 Leveraged strategies ............................................................................................23 3.1.7.1 Short selling ...............................................................................................23 3.1.7.2 Margin buying ............................................................................................23 3.1.8 New issuance ........................................................................................................24 3.1.9 Investment strategies ..........................................................................................24 3.1.10 Taxation ...............................................................................................................25 3.1.11 References ..........................................................................................................25 3.1.12 Further reading ...................................................................................................26 3.2 Bond Markets....................................................................................................................26 3.2.1 Types of bond markets ........................................................................................27 3.2.2 Bond market participants ...................................................................................27 3.2.3 Bond market size...................................................................................................28 3.2.3.1 U.S. bond market size................................................................................28 3.2.4 Bond market volatility ..........................................................................................29 3.2.5 Bond market influence .........................................................................................29 3.2.6 Bond investments .................................................................................................30 3.2.7 Bond indices ..........................................................................................................30 3.2.8 References .............................................................................................................30 3.3 Money Markets .................................................................................................................31 3.3.1 History ....................................................................................................................31 3.3.2 Participants ...........................................................................................................31 3.3.3 Functions of the money market ..........................................................................32 3.3.4 Common money market instruments ...............................................................32 3.3.5 Discount and accrual instruments ......................................................................33 3.3.6 References .............................................................................................................33 3.3.7 External links .........................................................................................................33 3.4 Derivatives Markets .........................................................................................................34 3.4.1 Futures markets ....................................................................................................34 3.4.2 Over-the-counter markets ...................................................................................34 3.4.3 Netting ....................................................................................................................35 3.4.4 Controversy about the financial crisis ...............................................................35 3.4.5 Further reading .....................................................................................................36 3.4.6 External links .........................................................................................................36 3.5 Foreign Exchange Markets ..............................................................................................36 3.5.1 History ....................................................................................................................37 3.5.1.1 Ancient.........................................................................................................37 3.5.1.2 Medieval and later .....................................................................................38 3.5.1.3 Early modern ..............................................................................................39 3.5.1.4 Modern to post-modern ..........................................................................39 3.5.1.4.1 Before WWII.....................................................................................39 3.5.1.4.2 After WWII ........................................................................................40 3.5.1.4.3 -markets close .................................................................................41 3.5.1.4.4 after 1973.........................................................................................42 3.5.2 Market size and liquidity ......................................................................................43 3.5.3 Market participants...............................................................................................45 3.5.3.1 Commercial companies ............................................................................46 3.5.3.2 Central banks .............................................................................................46 3.5.3.3 Foreign exchange fixing ............................................................................47 3.5.3.4 Hedge funds as speculators ....................................................................47 3.5.3.5 Investment management firms ...............................................................47