Finance (Part 1)

This article is geared towards introducing the finance industry to relative new comers who are interested in learning more before signing over hard earned capital to investment fund managers. The article is divided into two sections: the first article will look specifically at the idea of capital investment and capital borrowing, and focuses on the question why someone would choose to invest. The second article is a development on the first, but looks at how interest is determined, and why investment is considered a vital component of both the macro and micro economies.

The basic concept of finance used in this article essentially refers to the dynamic in which money saved by individuals is collated into a fund from which borrowers may borrow funds that they need for business start-ups or personal assets. Hence, the fund of money saved finances business investment and personal assets like home loans for those who would like, for example, to purchase some of the property for sale in Bloemfontein.

The world of investment and financing isn’t restricted to national boundaries: indeed, businesses in one country may borrow capital from financing institutions that operate from foreign countries. For example, Angolan businesses could look towards South African institutions for capital investments, or, in the inverse situation, South Africans could look towards international funds if local investment cannot best meet their needs.

In terms of international financing, the single biggest borrowers of capital are Governments. In the above scenario, what is happening (in a general sense) is that the citizenry of one nation, through their savings, finance governmental investment in another nation. National governments invest heavily in infrastructure development (the construction of railways, sea ports, airports, roads, telecommunications networks, etc.) which in turn is designed to develop the national economy.

To iterate and expand our basic definition of “finance”, we could now say that finance is the means by which capital is collected from those who have the ability to save a certain amount of it, and then distributed to those who need to borrow capital and are willing to pay a price (in the form of interest) for it. In this light, finance is the industry of sourcing and selling capital to those who would like to purchase it. The purchasing of the capital is either meant to generate more, new capital, or give the borrower utility through their purchasing of assets. Perhaps it would be prudent to put this in different terms: lenders (those who have saved money) lend money to borrowers who pay interest on the amount borrowed. The interest is the price of borrowing money, and the opportunity for a lender to earn more money from money already saved incentivises lending. If you are planning to borrow money from a financial institution be sure to compare prices by comparing interest rates

Lenders thus profit from the process as they are selling funds. The borrower expects to gain some form of benefit (in economic terms described as “utility”) from the transaction, too: s/he expects to use the capital to build a sustainable business or to buy a house/asset. This is to say that they are willing to pay the price (interest) at which the lender is willing to sell money/capital. Business ventures need more than domain registration and user friendly websites to get off of the ground: start up capital is needed to finance the initial stages of value creation.

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