How finance works
Markets, banks and instruments
Follow savings to the businesses that use them, through a bank and through a bond and share issue, and see how debt and equity claims differ.
Learning objectives
- Identify who supplies capital, who uses it, and the two routes it travels: banks and markets
- Calculate a bank's net interest income and net interest margin from its funding and lending
- Distinguish debt from equity by what the investor is promised, who is paid first and who carries the risk
- Calculate what bondholders and shareholders each receive as a company's profit changes
Households earn more than they spend in some years and save the difference. Companies want to build warehouses, buy trucks and open branches before the revenue arrives. Governments borrow to fund roads and schools. The financial system is the plumbing that moves money from the first group to the second, and prices the trade.
Every finance job sits somewhere on that plumbing: a credit analyst decides which borrowers a bank funds, a treasurer decides whether to borrow or issue shares, a fund manager decides which bonds and shares to buy. This lesson follows the money with real numbers, so you can see what each party gives up and what it gets back.
Who supplies capital and who uses it
- Suppliers (savers): households (salaries put aside, end-of-service savings, pension contributions), companies with surplus cash, and investors from abroad.
- Users (borrowers and issuers): companies funding investment, governments funding budgets and projects, and households buying homes and cars.
Two routes from saver to user
- Through an intermediary (indirect finance). A saver deposits money in a bank. The bank pools many deposits, screens borrowers, lends, and carries the risk that a borrower fails. The saver's claim is on the bank, not on the borrower.
- Through markets (direct finance). A company sells bonds (a promise to pay interest and repay the amount borrowed) or shares (part-ownership) to investors, usually with an investment bank arranging the sale. The investor's claim is on the company itself.
The first sale of a new bond or share is the primary market: that is when the company receives money. Later trades between investors, for example on a stock exchange, are the secondary market: the security changes hands but the company receives nothing. Secondary markets still matter, because investors will only buy in the primary market if they know they can sell later.
Included with a Formula Quest membership
The rest of this lesson is for members. Members get the full lesson, including its 3 graded exercises, and every other Finance Quest lesson.