ELEMENTS OF FINANCE

Prepared by
Ayobami Adeloye
Definitions of Finance
 The commercial activity of providing funds
and capital
 The branch of economics that studies the
management of money and other assets
 obtain or provide money for; "Can we
finance the addition to our home?"
 sell or provide on credit
 The management of money and credit and
banking and investments
Essential characteristics of
money
 It must be a medium of exchange

 It must be a unit of account

 It must be a store of value

Desirable features of money
 It must have a stable value.
 It must be difficult to counterfeit.
 It must be easily divisible and
transportable.
 It must be fungible. That is, one
artifact of the token or good must be
equivalent to another.
Modern forms of money
 When using money anonymously, the
most common methods are
 cash (either coin or banknotes)

 stored-value cards.
Banks
A Bank is basically a financial
intermediary that bridges the gap
between people with excess funds
and those in need of funds at a price
 The essential function of a bank is to
provide services related to the
storing of deposits and the extending
of credit.
Services typically offered by
banks
 Directly taking deposits from the
general public and issuing checking and
savings accounts
 Lending out money to companies and
individuals
 Cashing cheques
 Facilitating money transactions such as
wire transfers and cashiers checks
 Issuing credit cards, ATM, and
debit cards
 online banking
 Storing valuables, particularly in a
Types of banks
 Central banks usually control monetary policy and
may be the lender of last resort in the event of a
crisis. They are often charged with controlling the
money supply, including printing paper money.
Examples of central banks are the Central Bank of
Nigeria, Bank of England, the
European Central Bank and the
U.S. Federal Reserve Bank.
 Commercial bank, is the term used for a normal
bank to distinguish it from an investment bank.
Since the two no longer have to be under separate
ownership, some use the term "commercial bank"
to refer to a bank or a division of a bank that
mostly deals with corporations or large businesses.
 Community development bank are regulated banks
that provide financial services and credit to
underserved markets or populations.
 Investment banks "underwrite" (guarantee the sale
of) stock and bond issues and advise on mergers.
Examples of investment banks are IBTC of Nigeria,
Goldman Sachs of the USA or Nomura Securities of
Types of banks (Contd)
 Merchant banks were traditionally banks which
engaged in trade financing. The modern definition,
however, refers to banks which provides capital to
firms in the form of shares rather than loans.
Unlike Venture capital firms, they tend not to
invest in new companies.
 Universal banks, more commonly known as a
financial services company, engage in several of
these financial activities. Hence the term financial
supermarket
 Islamic Banks,Islamic banking revolves around
several well-established concepts - based on
Islamic canons. Concept of Interest, in Islam is
forbidden. Hence, all banking activities must avoid
interest. Instead of interest, the Bank earns profit
(mark-up) and fees on financing facilities it extends
to customers. Also, depositors earn a share of the
Role in the money supply
 A bank raises funds by attracting deposits,
borrowing money in the inter-bank market, or
issuing financial instruments in the money market
or a capital market. The bank then lends out most
of these funds to borrowers.
 However, it would not be prudent for a bank to lend
out all of its balance sheet. It must keep a certain
proportion of its funds in reserve so that it can
repay depositors who withdraw their deposits. Bank
reserves are typically kept in the form of a deposit
with a central bank.
 This behaviour is called fractional-reserve banking
and it is a central issue of monetary policy. Some
governments (or their central banks) restrict the
proportion of a bank's balance sheet that can be
lent out, and use this as a tool for controlling the
money supply. Even where the reserve ratio is not
controlled by the government, a minimum figure
will still be set by regulatory authorities as part of
Money supply
 Because (in principle) money is anything that
can be used in settlement of a debt, there are
varying measures of money supply. The
narrowest (ie. more restrictive) measures
count only those forms of money held for
immediate transactions.
 Broader measures include money held as a
store of value. Different measures of money
have different technical definitions. The most
common measures are named M0, M1, and M2
(from narrow to broadly defined). In the
United States, as defined by the
Federal Reserve System, they are as follows:
 M0: The total of all coins 'minted' and paper
'printed' cash in circulation. (ie Currency)
 M1: M0 + the amount in checking or
demand deposit accounts
 M2: M1 + other various savings account types,
money market accounts, and
Bank regulation
 Banks are subject to certain bank
regulations and requirements
that aim to uphold the soundness
and integrity of the financial system.
These are:
 Reserve requirements
 Capital requirements
Reserve requirements
 Reserve requirements, a tool of
monetary policy, are computed as
percentages of deposits that banks must
hold as vault cash or on deposit at the
central bank, rather than, perhaps, lend
out. Reserve requirements represent a
cost to the banking system. Bank reserves,
meanwhile, are used in the day-to-day
implementation of monetary policy by the
Central Bank
 As of 2005, in Nigeria, the reserve
requirement (Cash Reserve) are 10% on
all deposits, As "a tool of monetary policy",
they are one way of influencing the
country's financial behavior, borrowing,
and interest rates.
Reserve Requirements and
Money Creation
 Reserve requirements affect the potential of the
banking system to create transaction deposits.
If the reserve requirement is 10%, for example,
a bank that receives a N100 deposit may lend
out N90 of that deposit. If the borrower then
writes a check to someone who deposits the
N90, the bank receiving that deposit can lend
out N81. As the process continues, the banking
system can expand the initial deposit of N100
into a maximum of N1,000 of money
(N100+N90+81+N72.90+...=N1,000). In
contrast, with a 20% reserve requirement, the
banking system would be able to expand the
initial N100 deposit into a maximum of N500
(N100+N80+N64+N51.20+...=N500). Thus,
higher reserve requirements should result in