The Basic Idea of Finance and Financial System


Definition of Finance: Finance is a common term you must have heard in the day to day life. But many do not know the actual meaning of this common word. The name “Finance” reflects the creation, study and management of investment and money. Specifically, it answers the questions of why and how a government and individual obtains the required money (known as capital in the context of a firm) and how they invest it.

The Main Divisions of Finance are:

  1. Personal Finance
  2. Corporate Finance
  3. Public Finance

At the same time, finance is all about the financial market system, which facilitates the cash flow through investment tools and instruments within and between these fields. The financial service sector is responsible for facilitating this cash flow. Thus the significant focus in finance is on money management, also known as investment management for an individual. Along with this, the focus also lies on asset management for organizations. It further includes financial engineering, share broking, risk management and investment banking.

As you can see, finance is a broad topic; therefore, the various institutions provide financial education and employ it as the main subject in the curriculum.

Financial System

As discussed above in the article, the commercial system establishes the flow of capital or money between governments (known as public Finance), individuals (known as personal finance) and firms (known as corporate Finance).

Though the methods and process of Finance and economics are different still, they are closely related. The “economy” refers to the civil organization that distributes society’s production and utilization of goods and services. All of these services are financed.

Talking about an entity whose income exceeds its total expenditure can invest or lend the excess amount to earn a good return. Correspondingly, if its income is less than its total spending, can raise money in one of the two ways:

  1. Borrowing money from private individuals in the form of a loan, or by selling corporate bonds or government bonds.
  2. By selling corporate equity popularly known as shares or stocks. It has two forms: common stock and preferred stock. The owner of both stock and bonds can be either institutional creditor (financial institution) including pension funds and investment banks or private investors also known as retail investors.


The lending is carried through a monetary intermediary (such as banking institutions), by the buying of bonds (government bonds, mutual bonds and corporate bonds) or notes in the commercial market. The lender gets the interest; the borrower gives higher money (as interest) than that received by a lender. The monetary intermediary receives the difference as profit for arranging the loan.

Banking Institution

The function of a bank is to aggregate all the activities of lenders and borrowers. It accepts interest from lenders and lends the money to borrowers. It allows the lenders and borrowers of various sizes to regulate its activity.

Investing requires the buying of shares either by the mutual fund or individual securities. Organizations generally sell shares to traders to raise the required money. It is equity financing different from the debt financing discussed above.

In this case, the monetary intermediaries are the investment banks, which search for the initial traders and promote the listing of securities exchanges and securities such as equity and debt.