How does finance create value?
o Well-functioning financial markets facilitate
Storage and exchange of value
Inter-temporal matching of consumption and productivity
Efficient risk sharing
Separation of ownership and management
o Finance Work involves intermediation
Matching savers with spenders
- Storage and exchange of value
o Need money for exchange, need a currency as a means of exchange and store wealth
o Financial assets; no financial market = not efficient way to store wealth
o E.g. poor country unfinished houses, no bank so you build a house and acts as the security
o Making wealth easier and more secure to store, transport and exchange facilities economic activity and growth
o Standardizing makes exchange easier, reducing the need for trust
Facilitates trade -> ensures trade occurs quicker
Creating a convenient, reliable store of wealth that can be used in exchange is a significant component to the value generated by Finance
- Inter-temporal matching of consumption and productivity
o Finance is the bridge between your current wealth and future wealth
Allows you to consume your future wealth in present time
• Ie. A loan
• Can immediately start living a lifestyle similar to that of much wealthier people
o Able to borrow against your future wealth
Facilitates projects with negative consequences
• War
Can borrow more than you can afford
• Ethics
• Finance intermediaries only wish to make a quick buck?
- Efficient risk sharing
o A project requires a mix of skills and capital -> even if you have all the skills and sufficient capital -> unlikely to risk everything on one project
o An efficient financial system brings the skills and capital of different people together
Creating a control and bearing the right amount of risk and reward
o Risk of loss is borne by the entities that best be able to bear that loss
If designed properly
o If it is not designed properly -> losses borne by people not able to bear them
Loss of wealth
- Separation of ownership and management
o Many people generate wealth not only from their salary but from investments they make
Require opportunities to invest
E.g. China investing in one child’s education
o Sustainable standard of living people can afford depends on the rates of return that can be earned on that wealth
- What kind of work is ‘finance work’?
Matching savers with those who spend
Analysis
• Pricing risk
• Designing, advising, selling products to protect against risk
• Monitoring and enforcing contractual obligations
- Providing access across a barrier – Bridge
- Providing access across a barrier – Bridge
- Guaranteeing Quality – A certifier
- Guaranteeing Quality – A certifier
- Monitoring and enforcing contracts- Enforcers
- Monitoring and enforcing contracts- Enforcers
- Matching savers with spenders
- Matching savers with spenders
- Providing information – Conciege
- Providing information – Conciege
- Take the heat – Insulator
- Take the heat – Insulator
