Everything about Financial Capital totally explained
Financial capital is money used by
entrepreneurs and
businesses to buy what they need to make their products or provide their services.
Financial capital vs. real capital
Financial capital refers to the funds provided by lenders (and investors) to businesses to purchase real capital like equipment for producing goods/services. Real capital may include shovels for gravediggers, sewing machines for tailors, or machinery for manufacturing firms. Financial capital is provided by lenders for a price:
interest. Also see
time value of money for a more detailed description of how financial capital may be analyzed.
Furthermore,
financial capital, or
economic capital, is any liquid medium or mechanism that represents
wealth, or other styles of
capital. It is, however, usually purchasing power in the form of money available for the production or purchasing of goods, etcetera. Capital can also be obtained by producing more than what is immediately required and saving the surplus.
Instruments
A
contract regarding any combination of
capital assets is called a
financial instrument, and may serve as a
Most indigeneous forms of money (wampum, shells, tally sticks and such) and the modern fiat money is only a "symbolic" storage of value and not a real storage of value like commodity money.
Capital vs. money
Liquidity requirements of these vary significantly — leading to a diversity of
contracts and
financial markets to trade them on. When all four functions are served by one instrument, this is called
money, which doesn't need to be traded on financial markets since the risk of loss of value of money is uniform across the whole society. Where no one form of money is agreed to have reliable value, and
barter is undesirable, less liquid or more diverse instruments have served the four functions. This article focuses mostly on financial instruments which are not uniformly affected by native currency
inflation and which are not guaranteed by a state.
Own and borrowed capital
Capital contributed by the owner or entrepreneur of a business, and obtained, for example, by means of savings or inheritance, is known as own capital, whereas that which is granted by another person or institution is called borrowed capital, and this must usually be paid back with interest.
Issuing and trading
Like money, financial instruments may be "backed" by state
military fiat,
credit (for example
social capital held by banks and their depositors), or
commodity resources. Governments generally closely control the supply of it and usually require some "reserve" be held by institutions granting credit. Trading between various national
currency instruments is conducted on a
money market. Such trading reveals differences in probability of
debt collection or
store of value function of that currency, as assigned by traders.
When in forms other than money, financial capital may be traded on
bond markets or
reinsurance markets with varying degrees of trust in the
social capital (not just credits) of bond-issuers, insurers, and others who issue and trade in financial instruments. When payment is deferred on any such instrument, typically an interest rate is higher than the standard interest rates paid by banks, or charged by the central bank on its money. Often such instruments are called
fixed-income instruments if they've reliable payment schedules associated with the uniform rate of interest. A variable-rate instrument, such as many
consumer mortgages, will reflect the standard rate for deferred payment set by the
central bank prime rate, increasing it by some fixed percentage. Other instruments, such as
citizen entitlements, for example "
U.S. Social Security", or other pensions, may be indexed to the rate of inflation, to provide a reliable value stream.
Trading in
stock markets or
commodity markets is actually trade in underlying assets which are not wholly financial in themselves, although they often move up and down in value in direct response to the trading in more purely financial
derivatives. Typically commodity markets depend on politics that affect international trade, for example boycotts and embargoes, or factors that influence
natural capital, for example weather that affects food crops. Meanwhile, stock markets are more influenced by trust in corporate leaders, for example
individual capital, by consumers, for example
social capital or "brand capital" (in some analyses), and internal organizational efficiency, for example
instructional capital and
infrastructural capital. Some enterprises issue instruments to specifically track one limited division or brand. "
Financial futures", "
Short selling" and "
financial options" apply to these markets, and are typically pure financial bets on outcomes, rather than being a direct representation of any underlying asset.
Broadening the notion
The relationship between financial capital,
money, and all other styles of
capital, especially
human capital or
labor, is assumed in
central bank policy and regulations regarding instruments as above.
Such relationships and policies are characterized by a
political economy -
feudalist,
socialist,
capitalist,
green,
anarchist or otherwise. In effect, the means of
money supply and other regulations on financial capital represent the economic sense of the value system of the society itself, as they determine the allocation of labor in that society.
So, for instance, rules for increasing or reducing the money supply based on perceived
inflation, or on
measuring well-being, reflect some such
values, reflect the importance of using (all forms of) financial capital as a stable store of value. If this is very important, inflation control is key - any amount of money inflation reduces the value of financial capital with respect to all other types.
If, however, the medium of exchange function is more critical, new money may be more freely issued regardless of impact on either inflation or well-being.
Valuation
Normally, a financial instrument is priced accordingly to the perception by capital market players of its expected return and risk.
Unit of account functions may come into question if valuations of complex financial instruments vary drastically based on timing. The "
book value", "
mark-to-market" and "
mark-to-future" conventions are three different approaches to reconciling financial capital value units of account.
Economic role
Socialism,
capitalism,
feudalism,
anarchism, other
civic theories take markedly different views of the role of financial capital in social life, and propose various political restrictions to deal with that.
Finance capitalism is the production of profit from the manipulation of financial capital. It is held in contrast to
industrial capitalism, where profit is made from the manufacture of goods.
Further Information
Get more info on 'Financial Capital'.
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