The Financial Sector
The Financial Sector
The financial sector is an integral area of the economy that provides financial services to commercial and public sectors of the economy, as well as to private individuals too. It consists of important financial institutions such as banks, investment companies, and real estate firms…
As an industry, the financial sector consists of personal finance (involving households and individuals), public finance, (otherwise known as government finance), and corporate finance. Within this triumvirate of different private, public, and corporate entities, money is exchanged and sourced to individuals or households who may need it for any number of various reasons, or loaned to public and corporate entities that will use it to finance any number of different projects to help them maintain and expand their organisations. This is done through institutions like banks and investment companies, normally in the form of loans or in the release of equity offered through the sale of stock or bonds
The financial sector is primarily concerned with wealth generation for its clients. Although it also provides many other valuable services including the following:
Banking services
Foreign exchange services
Insurance
Tax and Accounting Services
As a sector, while it doesn’t offer the same kind of productivity found in other areas of the economy, it does provide one of the most highly valued services found anywhere throughout society today – in that it gives both people and businesses the facility to securely store, pay out, and access their money whenever and wherever they need to.
(This is done through the banking services the financial sector provides)
Although the generation of wealth doesn’t often translate into much in the way of tangible goods and services for most, as an industry, it is touted as not only highly beneficial, but also very necessary for countries that employ a capitalist economic model, as it allows for a more open flow of goods and services within the economy that can be purchased as a result of financing. Financing also provides another vital function too, in that it allows organisations to access additional capital when they need it most, making it easier for them to sustain and grow their organisations, as well as giving private individuals the chance to access additional money at the times when they need it most too
Financing
The financial sector is responsible for one of the most important dynamics within the free market economy of all. This is known as financing. Financing is regarded as essential by free market economists, because it affects the production, sale, and distribution of the goods and services that occurs within the economy as a whole. In a broader sense, financing is what enables capital to be provided to consumers so they can make important purchases like buying homes. Working from these same financing principles, it is also what enables businesses and other organisations, both public and private alike, to access the additional capital they need to sustain and grow their organisations at the times they need it most
There are 2 main forms of financing:
The first is known as ‘equity financing’.
This is a method used by companies to generate additional revenue for themselves. They can do this by making their companies public and offering others the chance to purchase equity in the form of shares within their organisations. It is referred to as equity financing because that business has released its equity in the form of shares in return for cash (obtained through the shares people buy in it), which that business can then use to sustain and grow itself with. Equity financing is preferred by many organisations because with it, the buyer takes all the risk, and if the business fails, the investors are the ones that lose out, because the company has no legal responsibility to repay them for any money they have invested
The second is known as ‘debt financing’.
This is where a person, public, or corporate body borrows money. It is referred to as debt financing because once the entity in question borrows the money, they take on a debt which they are obliged to pay back (usually with interest)
Who lends money
Money lending is done by banks and other companies (known as money lenders) who are authorised to lend money. When this happens, the organisation providing the loan will not only require repayment of the loan itself (referred to as the principal on the amount that is borrowed), but will also usually require that interest be paid on top of the initial amount that was borrowed as well. This is how companies that lend money make profit, and it provides benefits for both the party borrowing the money, as well as to the party lending it too. This is because it gives the borrower a means to access cash that would otherwise be inaccessible to them, and also gives them the ability to repay this money back in manageable amounts over a given period of time. At the same time, the lender also gets the opportunity to make a profit through the interest they charge on the principal amount borrowed
Lenders such as banks lend money not only to private individuals, but to corporate entities and even to government institutions too
There are 2 main types of loan available:
A secured loan – This is secured against a specific type of collateral; property is a very popular thing for a secured loan. Collateral is typically required with higher value loans. This protects the lending institution in an instance where you can’t pay the loan back. Secured loans normally come with lower interest repayment rates, and are easier to acquire than unsecured loans
An unsecured loan – Is a loan where a specific type of collateral is not required. The lending institution will accept your assets as protection against the loan itself. This means your credit score is the main thing the lender will look at when deciding on your suitability for the loan in question, but may go after any assets you hold in the event you can’t pay it back
Lending in finance
On a much broader scale, lending is not only limited to loaning money, but also to extending finance on goods and services too. The majority of businesses in the free-market economy offer finance to their customers today. This enables individuals and organisations to purchase the goods and services they need, and to spread the cost of these out over a manageable period of time. Financing provides a big advantage to the companies that offer it because it allows them to generate additional demand for their products and services that prospective customers otherwise would not be able to afford. While many companies will offer promotions and incentives that encourage people to make purchases on finance with them – such as interest free credit offers, another advantage financing holds is that it enables businesses to make additional profits by charging interest on the financing they offer to customers (although this is usually done at much lower rates of interest than monetary loans)
Risk mitigation and investment management strategies
By its very nature, the financial services industry is an uncertain area – that’s because the very concept of markets, how economies perform, and what goods and services will be in demand, can change at any time depending on any number of different factors. With that being said, one of the main goals of those involved in the financial services sector is to look for ways to make financial returns as predictable and as certain as possible. This is done through a range of strategies that revolve around investment management and risk mitigation. Such strategies are designed to increase returns and minimise volatility and loss within the range of financial transactions that are performed by institutions operating within the financial services sector itself.
A lot of these strategies focus heavily on financial analysis, which tries to predict the stability and profitability of various markets. To do this, a range of factors are evaluated using financial analytic tools such as the scientific equations found in quantitative financing, as well as other forms of financial analysis found in predictive modelling techniques. This enables those involved in the financial sector to analyse a range of different areas, such as the historical data that indicates how stock might do based on past performance, as well as to apply these same techniques to try and predict future performance too. On top of this, depending on the type of trading or investment involved, where appropriate, they will also use comparative analysis techniques as well – and this enables them to compare different companies, currencies, or even markets against one another to give them an understanding of how they might perform
As stated above, finance by its very nature can be unpredictable, that’s why one of the main focuses of those involved in the financial services industry is to try and mitigate risk as much as possible. This is done with a view to minimising loss and maximising profit, and it pertains to areas that concern both lending and investing. If considering a career in the financial sector, especially in corporate finance, then being aware of, and having an understanding of risk mitigation strategies is key.
Lenders use risk mitigation strategies when lending, and this is done to try and minimise the financial risk to themselves in the event they are unable to recoup the money they have lent. They do this primarily through the requirement of collateral in the case of secured loans, and in a broader sense, through the assessment criteria they set in place (including their requirements on credit ratings) when deciding on who to lend to, which is particularly relevant where unsecured loans are concerned.
Assessment criteria will vary from lender to lender, but will normally include things like assessing your earnings and outgoings, measuring what collateral you have at your disposal against the amount you attempting to borrow, and will usually take into consideration other factors as well, such as what will the loan be used for.
In the case of investments, risk mitigation strategies are heavily utilised too. This mainly concerns areas involving financial analysis – utilising strategies that involve forecasting the performance of markets as a means of predicting future share prices and the profit margins that might be obtained through certain types of investments. It also involves other financially analytical strategies too, such as quantitative finance and financial engineering, which utilise a more scientific approach where trying to predict future stock prices that revolve heavily around mathematical equations
Useful terms
The financial sector as a whole is concerned with creating profit and generating wealth for its clients. Such profits can be obtained in any number of different ways, through things like currencies, loans, bonds, shares, stocks, options, futures, banking investments, and savings
For anyone seriously considering a career in the financial services industry, it’s important to have an understanding of some of the key terms associated with the industry itself, such as the ones shown below
Bonds – A bond is known as a debt security. When someone buys a bond from a bond issuer, they are giving money to that organisation for a set period of time. In return, they will receive regular interest payments over that length of time. In this way it is very similar to a loan. When the bond reaches maturity (the end of that set period) the bond issuer returns the money paid for the bond initially
Capital – Any money or assets that a person or individual has at their disposal to spend
Currencies – Known as currency trading, currency is traded in pairs and money can be made from this by buying it low and it selling high
Commodities – Can pertain to both raw materials such as metals, oil, and diamonds, or agricultural products such as grain, wheat, and cattle, as well as to a subcategory of commodities known as soft commodities (which are commodities that can’t be stored for long periods of time such as sugar, cotton, cocoa, etc)
Common stock – A type of stock traded on stock exchanges (differentiated from preferred stock in that it is cheaper to purchase, but holders get less in return than they do with preferred stock)
Preferred stock – Gives holders more rights than those with common stock (this usually takes the form of higher dividend payments and increased claims on assets in the event that the company is liquidated)
Creditor – Party that has extended credit/money/finance to another party
Debtor – Person or organisation owing money to another
Dividends – Money paid to shareholders from company profits
Futures – A financial contract entered into where a party agrees to either buy or sell a specified asset at a set price on a date predetermined in the contract, irrespective of the actual price of the asset at that time
Hedge fund – Works on the same principles as a mutual fund in that it pools money from multiple investors in order to purchase more expensive forms of securities. Differs from a mutual fund in that it is only offered privately, and is further distinguished by the fact that it is a type of fund known not only for taking greater risks, but also for offering greater returns for investors too
Investment banking – This is a profession involved with wealth generation. As such, people working in this profession will be involved with things like mergers and acquisitions, as well as IPO underwriting involving the issuance of securities in the form of stocks and bonds, etc…
Investor – Person or entity that buys equity in an organisation through shares, with the intent of generating profit either through dividend payments, or by selling those shares on at a higher price than they were initially purchased for.
(Can also be defined as a person or entity that puts money into projects or businesses with the aim of generating a profit)
Loan – Money lent to a person or organisation. The sum borrowed is known as the principal amount. This principal sum is then paid back in increments with interest by the borrower
Mutual fund – Fund that enables multitudes of investors to invest in expensive types of securities they would not have been able to afford individually
Option – A contract involving a buyer and seller, where the purchaser (can either be the buyer or seller) pays a premium for the rights granted by purchasing the option. In doing so, this gives the purchaser the option, but not the obligation, to buy or sell a certain amount of something at a set price and by a set date specified in the contract
(Call options, are purchased when looking to buy an amount of something – Put options, are purchased when looking to sell an amount of something)
Quantitative finance – Analysis tool involving mathematical calculations used in finance to analyse and predict future market performance
Savings – The more money that is accessible in the economy in the form of savings, the greater the amount of finance that can be made available to people and organisations. This has a further knock-on effect because of the principles of supply and demand – increased availability of accessible credit will result in lower interest rates. Lower interest rates will have a further positive effect on the economy as it encourages spending, and more spending helps the economy, fuelling growth and giving people more disposable income to spend
Securities – Any tradeable financial asset such as stocks and bonds, (including, but not limited to, debt and equity securities)
Trader – Generalised term for anyone who buys and sells goods, products, commodities, shares, currency, etc (including investors)
What are Shares?
Shares are one of the things that people most commonly associate with the financial sector today – but what are they?
In their most basic form can, shares be described as a type of equity release
They can be purchased when a company offers a release of equity in its company, giving people the chance to buy into it through the purchase of its shares. When a company wants to try and generate income in this way, it will initiate a process called an initial public offering, (IPO). This will allow it to openly trade its shares on the stock exchange, and anyone who purchases these shares after that point will then have a percentage of ownership in that company. One of the things that happens when a company takes itself public is that a board of directors is set up. These are people elected by its shareholders, and it’s their job to ensure the company is being looked after properly, to convey the decisions and opinions of the board to the CEO and upper management of the company, and to ensure that the interests of shareholders are taken care of in the form of regular dividend payments
Shares give a company a means to generate large amounts of short term capital at no financial loss to themselves. With this being said, taking a company public is a huge risk for it, not least because it means relinquishing full control and involving shareholders in decisions that affect the running of its affairs. It also means relinquishing part of the profits to the shareholders too. The more of the company that is sold, the more those profits will have to be shared among the shareholders in the form of dividends
People can earn money through shares in two different ways
• Firstly, they can earn money through the payment of dividends – When a company makes a profit, some of this surplus is usually paid back to the shareholders in the form of a quarterly or yearly dividend. The more shares you hold, the more money you will receive each time a dividend is paid. It’s the CEO’s job to make sure that the company is not only successful, but that its shareholders receive regular dividend payments too. If they don’t, the board of directors might vote to replace the CEO
• Secondly, if the company continues to do well, its share price may rise, and this is the second way people can make money on their shares, because if they sell the shares for more than they initially purchased them for, they will make a profit
What is the difference between stocks and shares?
Stocks and shares are essentially the same thing. The word stock is more of a generalised term, used to describe the issuance of shares themselves, but shares are the thing that people actually buy
Dividends
With a commercial enterprise, profit (a surplus of money), is needed to sustain the enterprise itself. When a business makes profit, that money always tends to disappear pretty quickly though.
It either gets reinvested back into the business
(This is a healthy way to spend money, as it can not only help that organisation to offer better products and services, but also help it to increase its holdings, assets, and overall net worth. This form of spending is also usually good for the economy too, as it helps create new jobs which stimulates the economy and helps drive economic growth)
The second way this money can be spent is where it is paid out to those involved in the business itself, in the form of bonuses and the dividends paid out to its shareholders
Dividend Policies
While the main aim for shareholders is to make money from the business in the form of dividends, sometimes, withholding those dividends and reinvesting this money back into the company, creating new jobs and providing better goods and services, can be a more beneficial and fruitful long-term strategy. Such a strategy can make a company stronger, putting it in a better position to compete for more market share, helping to bolster its holdings and net worth, which in turn, can promote further growth and bigger profits that lead to increased shareholder dividends and a higher share price over the longer term. That’s why dividend policies are something that always have to be considered and balanced out by a company very carefully indeed
In a freemarket economy profit is what everyone strives for, and each year it seems companies need to make more and more of it, but so long as profits are being made, things are good. When a company fails to make a profit though, things start to unravel quite quickly…
In such a situation, all the money from the profits made in previous years has already been spent, and now the company no longer even has enough money to maintain its own operational costs. From here, jobs are lost, administrators are called in, and the remaining money that is left goes towards closing the company down. Creditors have to be contacted, and will try and recoup as much of their money as they can. In a situation where a large amount of money is owed to a creditor, this can actually cause further job losses – and the overall bureaucracy spent on this process – the resulting number of man hours that need to be paid for – culminate with nothing more meaningful or productive being accomplished than the closure of a business that had until recently been making a valued contribution to the economy
It’s for this reason that proposals have been put forward by some politicians that would mean whenever a corporation makes a profit, they would automatically have to set some of that money aside in a savings account (the percentage of which being based on the amount of profit itself. Current proposals have put this somewhere in the region of 5-10%). This would not only bolster the economy by giving it a larger accessible pool of savings finance, but would also ensure that when companies do hit hard times, they would have the savings to fall back on to keep themselves afloat. This would mean there would be much less chance of companies going through the wasteful process of administration, which would also help to avoid all of the resultant upheaval in the way of job losses that occurs as a result of this too
Trading, and investing, by its very nature, is a risky and uncertain endeavour. Stocks can either go up or down in price, and in this regard, investing is often likened by many outside of the industry to gambling – while this is not actually true (investing differs quite significantly in that it serves a moderately practical purpose by enabling companies to access additional capital when they need it most). However, because of the large returns it allows the parties involved to make, it has been suggested by some politicians that this is an area that should be getting taxed. Moreover, it has also been suggested that investors should have better protections against the huge losses that can occur too, as this can cause massive upheaval both for individuals and companies alike that can further undermine the economy. Some of the suggestions put forward to this effect have included some form of national investment insurance that would be able to protect individuals and companies against potentially huge losses, as well as perhaps a vetting system put in place to ensure that the parties involved are able to afford the loss of the capital they are investing in the first place. As of yet though, no such plans have been enacted, and this continues to be a free and open area. While investing is one of the areas most widely known to the public, the financial services industry consists of several other key elements too, and we will examine these in more depth below
CORPORATE FINANCE
Corporate finance is one of the biggest areas within the financial services sector today. As the name suggests, corporate finance is the part of the financial sector that pertains to corporate finance. People who work in this part of the financial sector deal with various aspects of financing that concern corporations – such as seeking out sources of funding to raise new capital for ventures, and many of their duties also revolve around aspects pertaining to the capital structure of corporations themselves. Corporate finance also pertains to roles and duties that revolve around capital budgeting. Capital budgeting concerns the fact that corporations are not only a major provider of goods and services, but are also a major source of investment within the economy too. Capital budgeting focuses on the corporate budgeting allocations that are put aside and how best to utilise these – by either reinvesting it in the company itself, (creating new jobs and building new infrastructure) – or investing this capital into outside projects as a means of generating new revenue and increasing the overall net worth of the company itself. Capital budgeting is always approached with the view of how best to maximise the value of the company and its assets with the long-term view in mind, and is separate from a company’s operational budget, which is concerned with running the business from the day to day side of things
Capital Structure
This pertains to the basic financial composition of the company. While the capital structure of a company will vary from enterprise to enterprise, those involved in corporate finance will always try to ensure the corporate structure is comprised in a way that will maximise the financial stability and minimise financial risk to the enterprise in question – and these factors are centrical to many roles within the financial sector today
In upper management, capital structure revolves around duties based on equity, (both debt and shareholder), and focuses heavily on mitigating the negative factors around any debt and equity that exists within an organisation
The makeup of a company’s capital structure is important because it affects the policies it enacts – this is particularly relevant as far as capital budgeting is concerned, both in terms of the decisions it makes to reinvest money back into the company, as well as the decisions it makes to pay out dividends. The capital structure of a business is also highly important because it is often something looked at when determining the rates and prices that it charges for its goods and services
PUBLIC FINANCE
Public finance pertains to finance that is owned by sovereign nations as regards its governmental institutions. Where corporate finance is primarily concerned with maximising profit, public finance is concerned with effective resource allocation and budgeting principles. Such principles are what those involved in public sector finance use as a basis to run and maintain the various organisations, departments, and agencies that comprise the public sector as a whole
Another area public finance is concerned with is how government at the macro level engages with the economy. It concerns when, and in what circumstances, the government will intervene in its economy, and to what extent, through the policies it enacts. While these policies will vary from country to country, those involved in public finance have a hand in influencing such policies. Market failure, investment policies, borrowing, public debt, deficits, budget allocations, and public revenue sources such as tax, are the sorts of areas those who work in public finance will deal with
Revenue sources are always vital wherever public finance is concerned . These sources are key where decisions to enact financial policies are made. The government can generate revenue in 5 different ways
Taxes – This is the main way in which governments generate revenue. Tax is essential for any government and is necessary to maintain a fully functional governmental infrastructure and the public services it provides
Non-tax revenue – This is generated from assets owned by the government such as businesses and other holdings. These can range to everything from the sale of the commodities within its sovereign territories, to the sale of arms and other technologies
Seigniorage – A process where a government generates money through the issuance of currency, based on the principal that the cost of producing a given currency is lower than its exchange value
Monetary creation – The government can create more money for itself, which is then distributed throughout the economy to help it generate an additional revenue stream. This is a financial strategy it uses sparing though, as the more money it generates, the more inflation rises, and the less value each unit of currency has
Borrowing – This is another means governments have at their disposal to obtain new finances. It is something else that is used sparingly though, as too much borrowing can cause it to fall into a deficit
There are many different types of roles available within the financial sector. Each one of these requires a different type of skillset and comes with its own unique rewards and challenges. Here is an overview of some of the main ones you will find in this sector today
Accountant – Responsible for keeping accurate financial records for businesses or individuals. Is also able to act in an advisory capacity and give financial advice
Salary £40,440 – £101,082, depending on the employer and years of experience
Account assistant – Responsible for administering or assisting with private and business accounts, will perform customer service or advisory functions in this capacity
Salary £22,005 – £37, 983, depending on the employer and years of experience
Account executive – Responsible for managing or administering private and business accounts, will perform customer service or advisory functions in this capacity
Salary £22,153 – £37, 497, depending on the employer and years of experience
Account manager – Responsible for managing or administering accounts, will perform customer service or advisory functions in this capacity
Salary £28,100 – £49,358, depending on the employer and years of experience
Corporate financer – Performs activities related to the pursuit of raising new capital for a business or organisation. This includes managing money, coordinating financing between departments, building effective relationships, and networking on behalf of an organisation as a means to secure new sources of funding
Salary £50,093 – £84,541, depending on employer, clients, and years of experience
Insurance Adjuster – Investigates claims against things like damages, theft, flood, fire, and accidents. Assesses these on-site if necessary. Liaises between the claimant and the insurance company. Liaises with other external parties involved in the claim as necessary. Collects information relevant to process claims including photographs, reports, and conducts interviews with the concerned parties if required. Writes up reports and recommends appropriate payouts for claims
Salary £42, 000 – £88,638, depending on the employer and years of experience
Investment banker – Assists companies with a range of important financial needs, such as mergers and acquisitions, IPO underwriting (like the issuance of securities in the form of stocks and bonds). Also advises clients on how to raise money, assists with the construction of financial models, and liaises with other persons including accountants, tax lawyers, finance managers, regulatory bodies, and others that operate within the financial sector on behalf of their clients as needed
Salary £46,984 – £187,209, depending on the employer and years of experience
Tax lawyers – Lawyer specialising in tax law. Assists clients with tax related matters. Has a strong legal background in accounting and business law.
Salary £46,198 – £81,700, depending on employer, clients, and years of experience