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When people first start studying finance, they usually have an idealized view (driven mainly by the movies they’ve seen and stories in the news about tycoons wheeling and dealing on the Wall Street) of just what finance and financial markets are. They come to the class eager to start trading stocks, pricing options, transacting in the currency forwards, or simply cornering the market on orange juice futures. Even if they’re lucky enough to have an introduction to finance which presents them with the correct “big picture”, they’re left feeling a little put out when they realize that the corporate finance they’ll be studying is (in their initial opinion, at least) the least sexy subfield of finance.

To understand what finance is, let’s envision the economy as being composed of four types of people, where the types are defined based upon whether the people have “extra” money to invest in speculative ventures and/or whether they have potentially lucrative ideas of their own (or the time to implement them):

1. People with no extra money and no ideas.
2. People with extra money but no ideas (or no time to implement any ideas).
3. People with ideas but not enough money.
4. People with both ideas and extra money.

The first type doesn’t really play a direct part in finance: they have just enough money to cover their needs, and have no ideas or time for investing in potential projects even if they did.

We also won’t normally talk much about the fourth type. They’re interesting enough, but the problems and decisions they face tend to be but a subset of those seen in the interaction between the second and third types, where we focus the vast majority of our concentration.

In such an economy, the second type, which we’ll call “investors” for reasons that will shortly be obvious, and the third type (”companies”) can enter into a mutually beneficial agreement whereby the investors lend their extra money to the companies, who will in turn invest that money in ventures or projects, using the potential proceeds from those projects to repay the investors.

Now, in the real world, the repayment of the investors is complicated by the presence of taxes and by the fact that the company may need to reinvest some of the proceeds of the projects to continue operation, so actual cash flows tend to more closely resemble those shown in this diagram below.

The study of this resulting system of cash flows is what finance is all about. The arrows in above diagram correspond to decisions or choices that the various participants in this system must make, and we can visualize the various subfields of finance by considering the perspectives from which those decisions must be made.