Why study Finance?

You might be wondering… “why should I pursue a Finance Masters?” or alternatively… “why should I pursue a Finance Masters at Hanken?”. If you had any of those questions in mind, congratulations, you have come to the right place! This blog post aims to give you a brief insight into the world of Finance and then goes on to explain why Hanken is the best choice for a Finance career.

A quick Google search will tell you – ‘Finance is the study of money and how it is used.’ but really, is it just this, or does it get deeper than that? In all fairness, the answer is: it is a lot more. We can go about understanding this social science by decomposing it into its fields – economics, statistics, management, and at the very basic level: human behavior. Yes, my Hankiets (and future Hankiets), at grass root level, Finance is all about how an individual makes choices given limited resources.

As humans, (on average) we are innately driven by rational decision-making which ultimately desires maximum utility or, in simple words, satisfaction. Professor Gonul explained this concept in layman terminology – consider the following simple example: Robinson Crusoe is stuck on an island and all that he owns is an apple tree (think of apples as wealth). For the purpose of this example, we assume that apples provide satisfaction to him. Because he is a rational decision-maker, Rob knows that he can water his tree (think of this as investment) and grow more apples for tomorrow. At the same time, he also wants to eat a share of those apples today as he is hungry (think of this as consumption). His combination of investment and consumption will define how much he owns today and tomorrow.

So, what will Rob want? Economics shows that he would want to consume/invest up to the point where the additional satisfaction from consuming an apple today, is equal to the additional satisfaction from consuming an apple tomorrow. This is because, at this point, Rob would be maximizing his overall satisfaction level.

But all this while we have been assuming that Rob knows how to water/fertilize his apple tree. What if he doesn’t? Now, let us introduce Alice Liddell, a professional arborist. Rob appoints Alice to grow his tree. So now, Alice is responsible for his Rob’s resources and is also expected to grow at least some apples that Rob wants to consume tomorrow. We cannot say with certainty how many apples these would be because there is uncertainty in how much fruit the tree will bear.

As the day changes, Alice reports to Rob that she has successfully grown 10 apples. Rob believes that 5 apples are more than enough for his consumption today. What do we do with the 5 extra ones? Let us introduce Homer Simpson, another individual like Rob, who grows oranges. Assuming that Homer has a surplus of oranges, Rob can exchange apples for oranges and achieve higher satisfaction today.

In an alternate scenario, we assume that Homer wants to borrow the apples from Rob. This means that Rob will receive a greater number of apples when Homer repays. Therefore, Rob will still achieve a higher overall satisfaction. Hurrah! He has successfully maximized his wealth, and his utility!

The real essence of this example is as follows: Finance enables efficient transfer of funds from individuals with few productive opportunities to others with less wealth and more opportunities. So, at the end of it, everybody is better off than before! A win-win situation indeed.

Believe it or not, this crash course is all what Finance is about. So, to answer the first question: Finance is intuitive to human nature. Every day we make countless decisions that require principles of Finance but because they are so ingrained in human nature, we tend to look past their importance. And this is the very reason we should study this field – so that we can leverage the knowledge of Finance to create better investments and reap even better returns.

To answer the second part of the discussion, we shall briefly touch upon the various topics in Finance that each situation (in the example) corresponds to.

  • Behavioral Finance deals in individual’s subjective preferences which govern decisions. This comes into play when Robinson Crusoe has to choose between consuming today and consuming tomorrow. Sub-topics include: utility theory, mean-variance utility and risk aversion.
  • Investment Finance deals in how investors generate returns for their investment. This comes into play when Alice invests in Rob’s tree to produce apples (return). Sub-topics include: factor investing, value investing, strategic growth investing, portfolio management, debt and derivative trading.
  • Corporate Finance deals in how corporations that govern production decisions, owe a fiduciary duty to their shareholders. This comes into play when Rob appoints Alice to produce apples on his behalf. Sub-topics include: agency theory, corporate social responsibility, mergers & acquisitions, corporate law
  • International Finance deals in the economics behind international trade between countries. This comes into play when Rob exchanges apples for oranges. Sub-topics include: international relations, macroeconomic policy, exchange rate determination.