Part 1 Finance, the Big Picture
Chapter 2 The World of Finance
Let’s imagine a scenario where RJ has some left-over cash after spending, and Kevin needs more money to make purchase of goods.
In this case, we say RJ is in surplus and Kevin is in deficit. In order to make the purchase that Kevin wants, Kevin can borrow money from RJ and purchase a good that he wanted.
Although it is imaginary, similar situations may arise to you as well. Most of the times, you would try to spend less than what you make, and save some for the future.
However, sometimes you face situations where you are forced to borrow, as it requires a lump sum of money that is well over what you make. For example, when you try to buy a car, a house, or pay for medical checks, you probably can’t cover the entire costs at the moment.
Then you would have to borrow from someone, but borrowing directly from a person with excess cash just like in our scenario is very unlikely to happen in real life for the following reasons. First of all, it is simply not easy to find someone who has extra money to lend out. Also, even if the person has some excess cash, he may not want to lend out to you as he worries that he may not get paid back.
This is where financial institutions come in. Banks gather deposits from people with excess cash and lend out to the people who need. Now, people don’t need to directly search for someone to either lend or borrow, but just simply directly go to a bank.
Same story goes for companies. There are companies that need funding to expand their businesses, purchase machines, and develop new products to launch. On the other hand, there are companies that have excess cash sitting around and want to put somewhere to generate extra profits.
Financial institutions provide a channel where individuals and companies with different interests gather and find ways to meet their needs.
How about insurance companies? Very similar to financial institutions, but it is slightly different. You pay insurance fee monthly to be prepared for emergencies. And when something unexpected happens, such as getting into a car accident or getting sick, you would be compensated by insurance companies to cover the costs.
As the financial market develops and increases its size in volume, more and more players get involved in the market. In order for the system to be efficient, the market should develop along with better regulations to stay transparent and provide equal ground to all the players.
We will talk about how money works, the players in the financial markets, and how markets are regulated in the later chapter of Part 1.
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