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From Wikipedia, the free encyclopedia

Finance is the science of funds management.[1] The general areas of finance are business finance, personal finance, and public finance.[2] Finance includes saving money and often includes lending money. The field of finance deals with the concepts of time, money and risk and how they are interrelated. It also deals with how money is spent and budgeted.

Finance works most basically through individuals and business organizations depositing money in a bank. The bank then lends the money out to other individuals or corporations for consumption or investment, and charges interest on the loans.

Loans have become increasingly packaged for resale, meaning that an investor buys the loan (debt) from a bank or directly from a corporation. Bonds are debt instruments sold to investors for organisations such as companies, governments or charities [3]. The investor can then hold the debt and collect the interest or sell the debt on a secondary market. Banks are the main facilitators of funding through the provision of credit, although private equity, mutual funds, hedge funds, and other organizations have become important as they invest in various forms of debt. Financial assets, known as investments, are financially managed with careful attention to financial risk management to control financial risk. Financial instruments allow many forms of securitized assets to be traded on securities exchanges such as stock exchanges, including debt such as bonds as well as equity in publicly-traded corporations.

Central banks, such as the Federal Reserve System banks in the United States and Bank of England in the United Kingdom, are strong players in public finance, acting as lenders of last resort as well as strong influences on monetary and credit conditions in the economy.[4]

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The main techniques and sectors of the financial industry

An entity whose income exceeds their expenditure can lend or invest the excess income. On the other hand, an entity whose income is less than its expenditure can raise capital by borrowing or selling equity claims, decreasing its expenses, or increasing its income. The lender can find a borrower, a financial intermediary such as a bank, or buy notes or bonds in the bond market. The lender receives interest, the borrower pays a higher interest than the lender receives, and the financial intermediary pockets the difference.

A bank aggregates the activities of many borrowers and lenders. A bank accepts deposits from lenders, on which it pays interest. The bank then lends these deposits to borrowers. Banks allow borrowers and lenders, of different sizes, to coordinate their activity. Banks are thus compensators of money flows in space.

A specific example of corporate finance is the sale of stock by a company to institutional investors like investment banks, who may sell it on to private investors, or other financial institutions such as pension funds. The stock give part ownership in that company in proportion to shares owned.

In return for the stock, the company receives cash, which it may use expand its business; ("equity financing"), to reduce its debt[5]. Equity financing mixed with the sale of bonds (or any other debt financing) is called the company's capital structure.

Finance is used by individuals (personal finance), by governments (public finance), by businesses (corporate finance), as well as by a wide variety of organizations including schools and non-profit organizations. In general, the goals of each of the above activities are achieved through the use of appropriate financial instruments and methodologies, with consideration to their institutional setting.

Finance is one of the most important aspects of business management. Without proper financial planning a new enterprise is unlikely to be successful. Managing money (a liquid asset) is essential to ensure a secure future, both for the individual and an organization.

Personal finance

Questions in personal finance revolve around

  • How much money will be needed by an individual (or by a family), and when?
  • Where will this money come from, and how?
  • How can people protect themselves against unforeseen personal events, as well as those in the external economy?
  • How can family assets best be transferred across generations (bequests and inheritance)?
  • How does tax policy (tax subsidies or penalties) affect personal financial decisions?
  • How does credit affect an individual's financial standing?
  • How can one plan for a secure financial future in an environment of economic instability?

Personal financial decisions may involve paying for education, financing durable goods such as real estate and cars, buying insurance, e.g. health and property insurance, investing and saving for retirement.

Personal financial decisions may also involve paying for a loan, or debt obligations.

Corporate finance

Managerial or corporate finance is the task of providing the funds for a corporation's activities. For small business, this is referred to as SME finance (Small and Medium Enterprises). It generally involves balancing risk and profitability, while attempting to maximize an entity's wealth and the value of its stock.

Long term funds are provided by ownership equity and long-term credit, often in the form of bonds. The balance between these forms the company's capital structure. Short-term funding or working capital is mostly provided by banks extending a line of credit.

Another business decision concerning finance is investment, or fund management. An investment is an acquisition of an asset in the hope that it will maintain or increase its value. In investment management – in choosing a portfolio – one has to decide what, how much and when to invest. To do this, a company must:

  • Identify relevant objectives and constraints: institution or individual goals, time horizon, risk aversion and tax considerations;
  • Identify the appropriate strategy: active v. passive – hedging strategy
  • Measure the portfolio performance

Financial management is duplicate with the financial function of the Accounting profession. However, financial accounting is more concerned with the reporting of historical financial information, while the financial decision is directed toward the future of the firm.

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Capital

Capital, in the financial sense, is the money that gives the business the power to buy goods to be used in the production of other goods or the offering of a service.

The desirability of budgeting

Budget is a document which documents the plan of the business. This may include the objective of business, targets set, and results in financial terms, e.g., the target set for sale, resulting cost, growth, required investment to achieve the planned sales, and financing source for the investment. Also budget may be long term or short term. Long term budgets have a time horizon of 5–10 years giving a vision to the company; short term is an annual budget which is drawn to control and operate in that particular year.

Capital budget

This concerns proposed fixed asset requirements and how these expenditures will be financed. Capital budgets are often adjusted annually and should be part of a longer-term Capital Improvements Plan.

Cash budget

Working capital requirements of a business should be monitored at all times to ensure that there are sufficient funds available to meet short-term expenses.

The cash budget is basically a detailed plan that shows all expected sources and uses of cash. The cash budget has the following six main sections:

  1. Beginning Cash Balance - contains the last period's closing cash balance.
  2. Cash collections - includes all expected cash receipts (all sources of cash for the period considered, mainly sales)
  3. Cash disbursements - lists all planned cash outflows for the period, excluding interest payments on short-term loans, which appear in the financing section. All expenses that do not affect cash flow are excluded from this list (e.g. depreciation, amortization, etc)
  4. Cash excess or deficiency - a function of the cash needs and cash available. Cash needs are determined by the total cash disbursements plus the minimum cash balance required by company policy. If total cash available is less than cash needs, a deficiency exists.
  5. Financing - discloses the planned borrowings and repayments, including interest.
  6. Ending Cash balance - simply reveals the planned ending cash balance.

Management of current assets

Credit policy

Credit gives the consumer the opportunity to buy, purchase or acquire goods and services, and pay for them at a later date. This has its advantages and disadvantages as follows:

Advantages of credit trade
  • Usually results in more customers than cash trade.
  • Can charge more for goods to cover the risk of bad debt.
  • Gain goodwill and loyalty of customers.
  • People can buy goods and pay for them at a later date.
  • Farmers can buy seeds and implements, and pay for them only after the harvest.
  • Stimulates agricultural and industrial production and commerce.
  • Can be used as a promotional tool.
  • Increase the sales.
  • Modest rates to be filled.
Disadvantages of credit trade
  • Risk of bad debt.
  • High administration expenses.
  • People can buy more than they can afford.
  • More working capital needed.
  • Risk of Bankruptcy.
  • May lose peace of mind.
Forms of credit
  • Suppliers credit:
  • Credit on ordinary open account
  • Installment sales
  • Bills of exchange
  • Credit cards
  • Contractor's credit
  • Factoring of debtors
  • Cash credit
  • Cpf credits
  • Exchange of product
Factors which influence credit conditions
  • Nature of the business's activities
  • Financial position
  • Product durability
  • Length of production process
  • Competition and competitors' credit conditions
  • Country's economic position
  • Conditions at financial institutions
  • Discount for early payment
  • Debtor's type of business and financial positions
Credit collection
Overdue accounts
  • Attach a notice of overdue account to statement.
  • Send a letter asking for settlement of debt.
  • Send a second or third letter if first is ineffectual.
  • Threaten legal action.
Effective credit control
  • Increases sales
  • Reduces bad debts
  • Increases profits
  • Builds customer loyalty
  • Builds confidence of financial industry
  • Increase company capitalisation
  • Increase the customer relationship
Sources of information on creditworthiness
  • Business references
  • Bank references
  • Credit agencies
  • Chambers of commerce
  • Employers
  • Credit application forms
Duties of the credit department
  • Legal action
  • Taking necessary steps to ensure settlement of account
  • Knowing the credit policy and procedures for credit control
  • Setting credit limits
  • Ensuring that statements of account are sent out
  • Ensuring that thorough checks are carried out on credit customers
  • Keeping records of all amounts owing
  • Ensuring that debts are settled promptly
  • Timely reporting to the upper level of management for better management.

Stock

Purpose of stock control
  • Ensures that enough stock is on hand to satisfy demand.
  • Protects and monitors theft.
  • Safeguards against having to stockpile.
  • Allows for control over selling and cost price.
Stockpiling

This refers to the purchase of stock at the right time, at the right price and in the right quantities.

There are several advantages to the stockpiling, the following are some of the examples:

  • Losses due to price fluctuations and stock loss kept to a minimum
  • Ensures that goods reach customers timeously; better service
  • Saves space and storage cost
  • Investment of working capital kept to minimum
  • No loss in production due to delays

There are several disadvantages to the stockpiling, the following are some of the examples:

  • Obsolescence
  • Danger of fire and theft
  • Initial working capital investment is very large
  • Losses due to price fluctuation
Rate of stock turnover

This refers to the number of times per year that the average level of stock is sold. It may be worked out by dividing the cost price of goods sold by the cost price of the average stock level.

Determining optimum stock levels
  • Maximum stock level refers to the maximum stock level that may be maintained to ensure cost effectiveness.
  • Minimum stock level refers to the point below which the stock level may not go.
  • Standard order refers to the amount of stock generally ordered.
  • Order level refers to the stock level which calls for an order to be made.

Cash

Reasons for keeping cash
  • Cash is usually referred to as the "king" in finance, as it is the most liquid asset.
  • The transaction motive refers to the money kept available to pay expenses.
  • The precautionary motive refers to the money kept aside for unforeseen expenses.
  • The speculative motive refers to the money kept aside to take advantage of suddenly arising opportunities.
Advantages of sufficient cash
  • Current liabilities may be catered for meeting the current obligations of the company
  • Cash discounts are given for cash payments.
  • Production is kept moving
  • Surplus cash may be invested on a short-term basis.
  • The business is able to pay its accounts in a timely manner, allowing for easily-obtained credit.
  • Liquidity

Management of fixed assets

Depreciation

Depreciation is the allocation of the cost of an asset over its useful life as determined at the time of purchase. It is calculated yearly to enforce the matching principle.

Insurance

Insurance is the undertaking of one party to indemnify another, in exchange for a premium, against a certain eventuality.

Uninsured risks
  • Bad debt
  • Changes in fashion
  • Time lapses between ordering and delivery
  • New machinery or technology
  • Different prices at different places
Requirements of an insurance contract
  • Insurable interest
    • The insured must derive a real financial gain from that which he is insuring, or stand to lose if it is destroyed or lost.
    • The item must belong to the insured.
    • One person may take out insurance on the life of another if the second party owes the first money.
    • Must be some person or item which can, legally, be insured.
    • The insured must have a legal claim to that which he is insuring.
  • Good faith
    • Uberrimae fidei refers to absolute honesty and must characterise the dealings of both the insurer and the insured.

Shared Services

There is currently a move towards converging and consolidating Finance provisions into shared services within an organization. Rather than an organization having a number of separate Finance departments performing the same tasks from different locations a more centralized version can be created.

Finance of states

Country, state, county, city or municipality finance is called public finance. It is concerned with

  • Identification of required expenditure of a public sector entity
  • Source(s) of that entity's revenue
  • The budgeting process
  • Debt issuance (municipal bonds) for public works projects

Financial economics

Financial economics is the branch of economics studying the interrelation of financial variables, such as prices, interest rates and shares, as opposed to those concerning the real economy. Financial economics concentrates on influences of real economic variables on financial ones, in contrast to pure finance.

It studies:

  • Valuation - Determination of the fair value of an asset
    • How risky is the asset? (identification of the asset-appropriate discount rate)
    • What cash flows will it produce? (discounting of relevant cash flows)
    • How does the market price compare to similar assets? (relative valuation)
    • Are the cash flows dependent on some other asset or event? (derivatives, contingent claim valuation)

Financial Econometrics is the branch of Financial Economics that uses econometric techniques to parameterise the relationships.

Financial mathematics

Financial mathematics is a main branch of applied mathematics concerned with the financial markets. Financial mathematics is the study of financial data with the tools of mathematics, mainly statistics. Such data can be movements of securities—stocks and bonds etc.—and their relations. Another large subfield is insurance mathematics. This is also known as quantitative finance, practitioners as Quantitative Analysts.

Experimental finance

Experimental finance aims to establish different market settings and environments to observe experimentally and provide a lens through which science can analyze agents' behavior and the resulting characteristics of trading flows, information diffusion and aggregation, price setting mechanisms, and returns processes. Researchers in experimental finance can study to what extent existing financial economics theory makes valid predictions, and attempt to discover new principles on which such theory can be extended. Research may proceed by conducting trading simulations or by establishing and studying the behaviour of people in artificial competitive market-like settings.

Behavioral finance

Behavioral Finance studies how the psychology of investors or managers affects financial decisions and markets. Behavioral finance has grown over the last few decades to become central to finance.

Behavioral finance includes such topics as:

  1. Empirical studies that demonstrate significant deviations from classical theories.
  2. Models of how psychology affects trading and prices
  3. Forecasting based on these methods.
  4. Studies of experimental asset markets and use of models to forecast experiments.

A strand of behavioral finance has been dubbed Quantitative Behavioral Finance, which uses mathematical and statistical methodology to understand behavioral biases in conjunction with valuation. Some of this endeavor has been led by Gunduz Caginalp (Professor of Mathematics and Editor of Journal of Behavioral Finance during 2001-2004) and collaborators including Vernon Smith (2002 Nobel Laureate in Economics), David Porter, Don Balenovich, Vladimira Ilieva, Ahmet Duran). Studies by Jeff Madura, Ray Sturm and others have demonstrated significant behavioral effects in stocks and exchange traded funds. Among other topics, quantitative behavioral finance studies behavioral effects together with the non-classical assumption of the finiteness of assets.

Intangible Asset Finance

Intangible asset finance is the area of finance that deals with intangible assets such as patents, trademarks, goodwill, reputation, etc.

Related professional qualifications

There are several related professional qualifications in finance, that can lead to the field:

See also


References

  1. ^ Gove, P. et al. 1961. Finance. Webster's Third New International Dictionary of the English Language Unabridged. Springfield, Massachusetts: G. & C. Merriam Company.
  2. ^ finance. (2009). In Encyclopædia Britannica. Retrieved June 23, 2009, from Encyclopædia Britannica Online: http://www.britannica.com/EBchecked/topic/207147/finance
  3. ^ http://www.charitytimes.com/pages/ct_news/news%20archive/July_06_news/030706_wellcome_trust_charity_bond.htm
  4. ^ Board of Governors of Federal Reserve System of the United States. Mission of the Federal Reserve System. URL:http://www.federalreserve.gov/aboutthefed/mission.htm. Accessed: 2010-01-16. (Archived by WebCite at http://www.webcitation.org/5mpS52OAl)
  5. ^ http://business.timesonline.co.uk/tol/business/industry_sectors/natural_resources/article5602963.ece

External links


1911 encyclopedia

Up to date as of January 14, 2010

From LoveToKnow 1911

FINANCE. The term " finance," which comes into English through French, in its original meaning denoted a payment (finatio). In the later middle ages, especially in Germany, it acquired the sense of usurious or oppressive dealing with money and capital. The specialized use of the word as equivalent to the management of the public expenditure and receipts first became prominent in France during the 16th century and quickly spread to other countries. The plural form (Les Finances) was particularly reserved for this application, while the singular came to denote business activity in respect to monetary dealings (as in the expression la haute finance). For the Germans the phrase " science of finance " (Finanzwissenschaft) refers exclusively to the economy of the state. English and American writers are less definite in their employment of the term, which varies with the convenience of the author.

A work on " finance " may deal with the Money Market or the Stock Exchange; it may treat of banking and credit organization, or it may be devoted to state revenue and expenditure, which is on the whole the prevailing sense. The expressions " science of finance " and " public finance " have been suggested as suitable to delimit the last mentioned application. At all events, the broad sense is quite intelligible. " Financial " means what is concerned with business, and the idea of a balance between effort and return is also prominent. In the present article attention will be directed to " public finance "; for the other aspects of the subject reference may be made (inter alia) to the following: - B Anks And Banking; Company; Exchange; Market; STOCK Exchange. See also English Finance, and the sections on finance under headings of countries.

Finance, regarded as state house-keeping, or " political economy " (see Economics) in the older sense of the term, deals with (I) the expenditure of the state; (2) state revenues; (3) the balance between expenditure and receipts; (4) the organization which collects and applies the public funds. Each of these large divisions presents a series of problems of which the practical treatment is illustrated in the financial history of the great nations of the world. Thus the amount and character of public ex penditure necessarily depends on the functions that the state undertakes to perform - national defence, the maintenance of internal' order, and the efficient equipment of the state organization; such are the tasks that all governments have to discharge, and for their cost due provision has to be made. The widening sphere of state activity, so marked a characteristic of modern civilization, involves outlay for what may be best described as " developmental " services. Education, relief of distress, regulation of labour and trade, are duties now in great part performed by public agencies, and their increasing prominence involves augmented expense. The first problem on this side of expenditure is the due balancing of outlay by income. The financier has to " cover " his outlay. There is, further, the duty of establishing a proper proportion between the several forms of expenditure. Not only has there to be a strict control over the total national expense; supervision has to be carried into each department of the state. No one branch of public activity is entitled to make unlimited calls on the state's revenue. The claims of the " expert " require to be carefully scrutinized. The great financiers have made their reputation quite as much by rigorous control over extravagance in expenditure as by dexterity in devising new forms of revenue. Unfortunately they have not been able to reduce their methods to rule. As yet no more definite principle has been discovered than the somewhat obvious one of measuring the proposed items of outlay (I) against each other, (2) against the sacrifice that additional taxation involves. Of almost equal importance is the rule that the utmost return is to be obtained for the given outlay. The canon of economy is as fundamental in regard to public expenditure as it will appear, later, to be in respect to revenue. Just application of the outlay of the state, so that no class receives undue advantage, and the use of public funds for " reproductive," in preference to " unproductive " objects, are evident general principles whose difficulty lies in their application to the circumstances of each particular case.

Far greater progress has been made in the formulation of general canons as to the nature, growth and treatment of the public revenues. Historically, there is, first, the tendency towards increase in state income to balance the advance in outlay. A second general feature is the relative decline of the receipts from state property and industries in contrast to the expansion of taxation. Regarded as an organized system, the body of receipts has to be made conformable to certain general conditions. Thus there should be revenue sufficient to meet the public requirements. Otherwise the financial organization has failed in one of its essential purposes. In order continuously to attain this end, the revenue must be flexible, or, as is often said, elastic enough to vary in response to pressure. Frequently recurring deficits are, in themselves, a condemnation of the methods under which they are found. Again, the rule of " economy" in raising revenue, or, in other words, taking as little as possible from the contributors over and above what the state receives, holds good for the whole and for each part of public revenue. In like manner the principle of formal justice has the same claim in respect to revenue as to expenditure. No class of person should bear more than his or its proper share. In fact the special maxims usually placed under the head of taxation have really a wider scope as governing the whole financial system. The recognition of even the most elementary rules has been a very slow process, as the course of financial history abundantly proves. Until the 18th century no scientific treatment of financial problems was attained, though there had been great advances on the administrative side.

A brief description of the historical evolution of the earlier financial forms will be the most effective illustration of this statement. The theory of well-organized public finance is also discussed under Taxation and National Debt.

The earliest forms of public revenue are those obtained from the property of the chief or ruler. Land, cattle and slaves are the principal kinds of wealth, and they are all constituents of the king's revenue; enforced work contributed by members of the community, and the furnishing commodities on requisition, further aid in the maintenance of the primitive state. Financial organization makes its earliest appearance in the great Eastern monarchies, in which tribute was regularly collected and the oldest and most general form of taxation - that levied on the produce of land - was established. In its normal shape this impost consisted in a given proportion of the yield, or of certain portions of the yield, of the soil; one-fourth as in India, onefifth as in Egypt, or two separate levies of a tenth as in Palestine, are examples of what may from the last instance be called the " tithe " system. Dues of various kinds were gradually added to the land revenue, until, as in the later Egyptian monarchy, the forms of revenue reached a bewildering complexity. But no Eastern state advanced beyond the condition generally characterized as the " patrimonial," - i.e. an organization on the model of the household. The part played by money economy was small, and it is noticeable that the revenues were collected by the monarch's servants, the farming out of taxes being completely unknown. Tribute, however, was paid by subject communities as a whole, and was collected by them for transmission to the conquerors.

A much higher stage was reached in the financial methods of the Greek states, or more correctly speaking of Athens, the best-known specimen of the class. Instead of the comparatively simple expedients of the barbarian monarchies, as indicated above, the Athenian city state by degrees developed a rather complex revenue system. Some of the older forms are retained. The city owned public land which was let on lease and the rents were farmed out by auction. A specially valuable property of Athens was the possession of the silver mines at Laurium, which were worked on lease by slave labour. The produce, at first distributed amongst the citizens, was later a part of the state income, and forms the subject of some of the suggestions respecting the revenue in the treatise formerly ascribed to Xenophon. The reverence that attached to the precious metals caused undue exaltation of the services rendered by this property.

One of the characteristics of the ancient state was its extensive control over the persons and property of its citizens. In respect to finance this authority was strikingly manifested in the burdens imposed on wealthy citizens by the requirements of the " liturgies " (Xarovpyiat), which consisted in the provision of a chorus for theatrical performances, or defraying the expenses of the public games, or, finally, the equipment of a ship, " the trierarchy," which was economically and politically the most important. Athenian statesmanship in the time of Demosthenes was gravely exercised to make this form of contribution more effective. The grouping into classes and the privilege of exchanging property, granted to the contributor against any one whom he believed entitled to take his place, are marks of the defective economic and financial organization of the age.

Amongst taxes strictly so called were the market dues or tolls, which in some cases approximated to excise duties, though in their actual mode of levy they were closely similar to the octrois of modern times. Of greater importance were the customs duties on imports and exports. These at the great period of Athenian history were only 2%. The prohibition of export of corn was an economic rather than a financial provision. In the treatment of her subject allies Athens was more rigorous, general import and export duties of 5% being imposed on their trade. The high cost of carriage, and the need of encouraging commerce in a community relying on external sources for its food supply, help to explain the comparatively low rates adopted. Neither as financial nor as protective expedients were the custom duties of classical societies of much importance.

Direct taxation received much greater expansion. A special levy on the class of resident aliens (µEToiKtov), probably paralleled by a duty on slaves, was in force. A far more important source of revenue was the general tax on property (E1r40pa), which according to one view existed as early as the time of Solon, who made it a part of his constitutional system. Modern inquiry, however, tends towards the conclusion that it was under the stress of the Peloponnesian War that this impost was intro duced (428 B.C.). At first it was only levied at irregular intervals; afterwards, in 378 B.C., it became a permanent tax based on elaborate valuation under which the richer members paid on a larger quota of their capital; in the case of the wealthiest class the taxable quota was taken as one-fifth, smaller fractions being adopted for those belonging to the other divisions. The assessment (Ti nmµa) included all the property of the contributor, whose accuracy in making full returns was safeguarded by the right given to other citizens to proceed against him for fraudulent under-valuation. A further support was provided in the reform of 378 B.C. by the establishment of the symmories, or groups of tax-paying citizens; the wealthier members of each group being responsible for the tax payments of all the members.

The scanty and obscure references to finance, and to economic matters generally, in classical literature do not elucidate all the details of the system; but the analogies of other countries, e.g. the mode of levying the taille in 18th century France and the " tenth and fifteenth " in medieval England, make it tolerably plain that in the 4th century B.C. the Athenian state had developed a mode of taxation on property which raised those questions of just distribution and effective valuation that present themselves in the latest tax systems of the modern world. Taken together with the liturgies, the " eisphora " placed a very heavy burden on the wealthier citizens, and this financial pressure accounts in great part for the hostility of the rich towards the democratic constitution that facilitated the imposition of graduated taxation and super-taxes - to use modern terms - on the larger incomes. The normal yield of the property tax is reported as 60 talents (14,400); but on special occasions it reached 200 talents (48,000), or about one-sixth of the total receipts.

On the administrative side also remarkable advances were made by the entrusting of military expenditure to the " generals," and in the 4th century B.C. by the appointment of an administrator whose duty it was to distribute the revenue of the state under the directions of the assembly. The absence of settled public law and the influence of direct democracy made a complete ministry of finance impossible.

The Athenian " hegemony " in its earlier and later phases had an important financial side. The confederacy of Delos made provision for the collection of a revenue (46pos) from the members of the league, which was employed at first for defence against Persian aggression, but afterwards was at the disposal of Athens as the ruling state. The annual collection of 460 talents (I 10,400) shows sufficiently the magnitude of the league.

Too little is known of the financial methods of the other Greek states and of the Macedonian kingdoms to allow of any definite account of their position. In the latter, particularly in Egypt, the methods of the earlier rulers probably survived. Their finance, like their social life generally, exhibited a blending of Hellenic and barbarian elements. The older land-taxes were probably accompanied by import dues and taxes on property.

In the infancy of the Roman republic its revenues were of the kind usual in such communities. The public land yielded receipts which may indifferently be regarded as rents or taxes; the citizens contributed their services or commodities, and dues were raised on certain articles coming to market. With the progress of the Roman dominion the financial organization grew in extent. In order to meet the cost of the early wars a special contribution from property (tributum ex censu) was levied at times of emergency, though it was in some cases regarded as an advance to be repaid when the occasion of expense was over. Owing to the great military successes, and the consequent increase of the other sources of revenue, it became feasible to suspend the tributum in 167 B.C., and it was not again levied till after the death of Julius Caesar. From this date the expenses of the Roman state " were undisguisedly supported by the taxation of the provinces." Neither the state monopolies nor the public land in Italy afforded any appreciable revenue. The other charges that affected Italy were the 5% duty on manumissions, and customs dues on seaborne imports. But with the acquisition of the important provinces of Sicily, Spain and Africa, the formation of a tax system based on the tributes of the dependencies became possible. To a great extent the pre-existing forms of revenue were retained, but were gradually systematized. In legal theory the land of conquered communities passed into the ownership of the Roman state; in practice a revenue was obtained through land taxes in the form of either tithes (decumae) or money payments (stipendia). To the latter were adjoined capitation and trade taxes (the tributum capitis). For pasture land a special rent was paid. In some provinces (e.g. Sicily) payment in produce was preferred, as affording the supply needed for the free distribution of corn at Rome.

The great form of indirect taxation consisted in the customs dues (portoria), which were collected at the provincial boundaries and varied in amount, though the maximum did not exceed 5 Under the same head were included the town dues (or octrois). Further, the local administration was charged on the district concerned, and requisitions for the public service were frequently made on the provincial communities. Supplies of grain, ships and timber for military use were often demanded.

The methods of levy may be regarded as an additional tax. " Vexation," as Adam Smith remarks, " though not strictly speaking expense, is certainly equivalent to the expense at which every man would be willing to redeem himself from it "; and the Roman system was extraordinarily vexatious. From an early date the collection of the taxes had been farmed out to companies of contractors (societates vectigales), who became a by-word for rapacity. Being bound to pay a stated sum to the public authorities these publicani naturally aimed at extracting the largest possible amount from the unfortunate provincials, and, as they belonged to the Roman capitalist class, they were able to influence the provincial governors. Undue claims on the part of the tax collectors were aggravated by the extortion of the public officials. The defects of the financial organization were a serious influence in the complex of causes that brought about the fall of the Republic.

One of the reasons that induced the subject populations to accept with pleasure the establishment of the Empire was the improvement in financial treatment that it secured. The corrupt and uneconomical method of farming out the collection of the revenue was, to a great extent, replaced by collection through the officials of the imperial household. The earlier Roman treasury (aerarium) was formally retained for the receipt of revenue from the senatorial provinces, but the officials were appointed by the Princeps and became gradually mere municipal officers. The real centre of finance was the Fiscus or imperial treasury, which was under the exclusive control of the ruler (` ` res fiscales," says Ulpian, " quasi propriae et privatae principis sunt "), and was administered by officials of his household. Under the Republic the Senate had been the financial authority, with the Censors as finance ministers and the Quaestors as secretaries of the treasury. Never very precise, this system in the 1st century B.C. fell into extreme decay. By means of his freedmen the emperor introduced the more rigorous economy of the Roman household into public finance. The census as a method of valuation was revived; the important and productive land taxes were placed on a more definite footing; while, above all, the substitution of direct collection by state officials for the letting out by auction of the tax-collection to the companies of publicani was made general. Thus some of the most valuable lessons as to the normal evolution of a system of finance are to be learned in this connexion. Of equal, or even greater moment is the failure of the administrative reforms of the Empire to secure lasting improvement, a result due to the absence of constitutional guarantees. The close relation between finance and general policy is most impressively illustrated in this failure of benevolent autocracy.

Viewed broadly, the financial resources of the earlier Empire were obtained from (1) the public land alike of the state and the Princeps; (2) the monopolies, principally of minerals; (3) the land tax; (4) the customs; (5) the taxes on inheritances, on sales and on the purchase of slaves (vectigalia). One result of the establishment of the Principate was the consolidation of the public domain. The old " public land " in Italy had nearly disappeared; but the royal possessions in the conquered provinces and the private properties of the emperor became ultimately a part of the property of the Fiscus. Such land was let either on five-year leases or in perpetuity to colon. Mines were also taken over for public use and worked by slaves or, in later times, by convict labour. The tendency towards state monopoly became more marked in the closing days of the Empire, the 4th and 5th centuries A.D. Perhaps the most comprehensive of the fiscal reforms of the Empire was the reconstruction of the land tax, based on a census or (to use the French term) cadastre, in which the area, the modes of cultivation and the estimated productiveness of each holding were stated, the average of ten preceding years being taken as the standard. After the reconstruction under Diocletian at the end of the 3rd century A.D., fifteen years (the indictio) - though probably used as early as the time of Hadrian - was recognized as the period for revaluation. With the growing needs of the state this taxation became more rigorous and was one of the great grievances of the population, especially of the sections that were declining in status and passing into the condition of villenage. The portoria, or customs, received a better organization, though the varying rates for different provinces continued. By degrees the older maximum of 5% was exceeded, until in the 4th century 121% was in some cases levied. Even at this higher rate the facilities for trade were greater than in medieval or (until the revolution in transport) modern times. In spite of certain prejudices against the import of luxuries and the export of gold, there is little indication of the influence of mercantilist or protectionist ideas. The nearest approach to excise was the duty of r % on all sales, a tax that in Gibbon's words " has ever been the occasion of clamour and discontent." The higher charge of 4% on the purchase of slaves, and the still heavier 5% on successions after death, were likewise established at the beginning of the Empire and specially applied to the full citizens. Escheats and lapsed legacies (caduca) were further miscellaneous sources of gain to the state.

Taken as a whole, the financial system of Imperial Rome shows a very high elaboration in form. The patrimonium, the tributa and the vectigalia are divisions parallel to the domaine, the contributions directes and the contributions indirectes of modern French administration; or the English " non-tax " revenue, inland revenue and " customs and excise." The careful regulations given in the Codes and the Digest show the observance of technical conditions as to assessment and accounting. In substance and spirit, however, Roman finance was essentially backward. Without altogether accepting Merivale's judgment that " their principles of finance were to the last rude and unphilosophical," it may be granted that Roman statesmen never seriously faced the questions of just distribution and maximum productiveness in the tax system. Still less did they perceive the connexion between these two aspects of finance. Mechanical uniformity and minute regulation are inadequate substitutes for observance of the canons of equality, certainty and economy in the operation of the tax system. Whether (as has been suggested) an Adam Smith in power could have saved the Empire is doubtful; but he would certainly have remodelled its finance. The most glaring fault was plainly the undue and increasing pressure on the productive classes. Each century saw heavier burdens imposed on the actual workers and on their employers, while expenditure was chiefly devoted to unproductive purposes. The distribution was also unfair as between the different territorial divisions. The capital and certain provincial towns were favoured at the expense of the provinces and the country districts. Again, the cost of collection, though less than under the farming-out system, was far too great. Some alleviation was indeed obtained by the apportionment of contributions amongst the districts 'liable, leaving to the community to decide as it thought best between its members. The allotment of the land-tax to units (juga) of equal value whatever might be the area, was a contrivance similar in character.

The gradual way in which the several provinces were brought under the general tax system, and the equally gradual extension of Roman citizenship, account further for the irregularity and increased weight of the taxes; as the absence of publicity and the growth of autocracy explain the sense of oppression and the hopelessness of resistance so vividly indicated in the literature of the later Empire. Exemptions at first granted to the citizens were removed, while the cost of local government which continually increased was placed on the middle-class of the towns as represented by the decuriones, or members of the municipalities.

The fact that no ingenuity of modern research has been able to construct a real budget of expenditure and receipt for any part of the long centuries of the Empire is significant as to the secrecy that surrounded the finances, especially in the later period. For at the beginning of the principate Augustus seems to have aimed at a complete estimate of the financial situation, though this may be regarded as due to the influence of the freer republican traditions which the reverence that soon attached to the emperor's dignity completely extinguished.

In addition to its value as illustrating the difficulties and defects that beset the development of a complex financial organization from the simpler forms of the city and the province, Roman finance is of special importance in consequence of its place as supplying a model or rather a guide for the administration of the states that arose on its ruins. The barbarian invaders, though they were accustomed to contributions to their chiefs and to the payment of commodities as tributes or as penalties, had no acquaintance with the working of a regular system of taxation. The more astute rulers utilized the machinery that they inherited from the Roman government. Under the Franks the land tax and the provincial customs continued as forms of revenue, while beside them the gifts and court fees of Teutonic origin took their place. Similar conditions appear in Theodoric's administration of Italy. The maintenance of Roman forms and terms is prominent in fiscal administration. But institutions that have lost their life and animating spirit can hardly be preserved for any length of time. All over western Europe the elaborate devices of the census and the stations for the collection of customs crumbled away; taxation as such disappeared, through the hostility of the clergy and the exemptions accorded to powerful subjects. This process of disintegration spread out over centuries. The efforts made from time to time by vigorous rulers to enforce the charges that remained legally due, proved quite ineffectual to restore the older fiscal system. The final result was a complete transformation of the ingredients of revenue. The character of the change may be best indicated as a substitution of private claims for public rights. Thus, the land-tax disappears in the 7th century and only comes into notice in the 9th century in the shape of private customary dues. The customs duties become the tolls and transit charges levied by local potentates on the diminishing trade of the earlier middle ages. This revolution is in accordance with - indeed it is one side of - the movement towards feudalism which was the great feature of this period. Finance is essentially a part of public law and administration. It could, therefore, hold no prominent place in a condition of society which hardly recognized the state, as distinct from the members of the community, united by feudal ties. The same conception may be expressed in another way, viz. by the statement that the kingdoms which succeeded the Roman Empire were organized on the patrimonial basis (i.e. the revenues passed into the hands of the king or, rather, his domestic officials), and thus in fact returned to the condition of preclassical times. Notwithstanding the differing features in the several countries, retrogression is the common characteristic of European history from the 5th to the 10th century, and it was from the ruder state that this decline created that the rebuilding of social and political organization had to be accomplished. On the financial side the work, as already suggested, was aided by the ideas and institutions inherited from the Roman Empire. This influence was common to all the continental states an,l indirectly was felt even in England. Each of the great realms has, however, worked out its financial system on lines suitable to its own particular conditions, which are best considered in connexion with the separate national histories.

Running through the different national systems there are some common elements the result not of inheritance merely but still more of necessity, or at the lowest of similarity in environment. Over and above the details of financial development there is a thread of connexion which requires treatment under Finance taken as a whole. As the great aim of this side of public activity is to secure funds for the maintenance of the state's life and working, the administration which operates for this end is the true nucleus of all national finance. The first sign of revival from the catastrophe of the invasions is the reorganization of the Imperial household under Charlemagne with the intention of establishing a more exact collection of revenue. The later German empire of Otto and the Frederics; the French Capetian monarchy and, in a somewhat different sphere, the medieval Italian and German cities show the same movement. The treasury is the centre towards which the special receipts of the ruler or rulers should be brought, and from it the public wants should be supplied. Feudalism, as the antithesis of this orderly treatment, had to be overthrown before national finance could become established. The development can be traced in the financial history of England, France and the German states; but the advance in the French financial organization of the r 5th and 16th centuries affords the best illustration. The gradual unification operates on all the branches of finance, - expenditure, revenue, debt and methods of control. In respect to the first head there is a well-marked " integration " of the modes for meeting the cost of the public services. What were semi-private duties become public tasks, which, with the growing importance of " money-economy," have to be defrayed by state payments. Thus, the creation of the standing army in France by Charles VII. marks a financial change of the first order. The English navy, though more gradually developed, is an equally good illustration of the movement. All outlay by the state is brought into due co-ordination, and it becomes possible for constitutional government to supervise and direct it. This improvement, due to English initiative, has been adopted amongst the essential forms of financial administration on the continent. The immense importance of this view of public expenditure as representing the consumption of the state in its unified condition is obvious; it has affected, for the most part unconsciously, the conception of all modern peoples as to the functions of the state and the right of the people to direct them.

On the side of receipts a similar unifying process has been accomplished. The almost universal separation between " ordinary " and " extraordinary " receipts, taxation being put under the latter head, has completely ceased. It was, however, the fundamental division for the early French writers on finance, and it survives for England as late as Blackstone's Commentaries. The idea that the ruler possessed a normal income in certain rents and dues of a quasi-private character, which on emergency he might supplement by calls on the revenues of his subjects, was a bequest of feudalism which gave way before the increasing power of the state. In order to meet the unified public wants, an equally unified public fund was requisite. The great economic changes which depreciated the value of the king's domain contributed towards the result. Only by welladjusted taxation was it possible to meet the public necessities. In respect to taxation also there has been a like course of readjustment. Separate charges, assigned for distinct purposes, have been taken into the national exchequer and come to form a part of the general revenue. There has been - taking long periods - a steady absorption of special taxes into more general categories. The replacement of the four direct taxes by the income tax in France, as proposed in 1909, is a very recent example. Equally important is the growth of " direct " taxation. As tax contributions have taken the places of the revenue from land and fees, so, it would seem, are the taxes on commodities likely to be replaced or at least exceeded by the imposts levied on income as such, in the shape either of income taxes proper or of charges on accumulated wealth. The recent history of the several financial systems of the world is decisive on this point. A clearer perception of the conditions under which the effective attainment of revenue is possible is another outcome of financial development. Security, and in particular the absence of arbitrary impositions, combined with convenient modes of collection, have come to be recognized as indispensable auxiliaries in financial administration which further aims at the selection of really productive forms of charge. Unproductiveness is, according to modern standard, the cardinal fault of any particular tax. How great has been the progress in these aspects is best illustrated in the case of English finance, but both French and German fiscal history can supply many instructive examples.

In a third direction the co-ordination of finance has been just as remarkable. Financial adjustment implies the conception of a balance, and this should be found in the relation of outlay and income. Under the pressure of war and other emergencies it has been found impossible to maintain this desirable equilibrium. But the use of the system of credit, and the general establishment of constitutional government, have enabled the difficulty to be surmounted by the creation on a vast scale of national debts. Apart from the special problems that this system of borrowing raises, there is the general one of its aid in making national finance continuous and orderly. Deficits can be transferred to the capital account, and the country's resources employed most usefully by repaying liabilities contracted in times of extreme need. The growth of this department, parallel with the general progress of finance, is significant of its function.

Finally, in all countries though with diversities due to national peculiarities, the modes of account and control have been brought into a more effective condition. Previous legislative sanction for both expenditure and receipts in all their particular forms is absolutely necessary; so is thorough scrutiny of the actual application of the funds provided. Either by administrative survey or by judicial examination care is taken to see that there has been no improper diversion from the designed purposes. It is only when the varied systems of financial organization are studied in their general bearing, and with regard to what may be called their frame-work, that their essential resemblance is thoroughly realized. Such a real underlying unity is the reason and justification for regarding " public finance " as a distinct subject of study and as an independent division of political science.

Local Finance

One of the most remarkable features of modern financial development has been the growth of the complementary system of local finance, which in extent and complication bids to rival that of the central authority. Under the constraining power of the Roman Empire the older city states were reduced to the position of municipalities, and their financial administration became dependent on the control of the Emperor - as is abundantly illustrated in the correspondence of Pliny and Trajan. After the fall of the Western Empire, a partial revival of city life, particularly in Italy and Germany, gave some scope for a return to the type of finance presented by the Athenian state. Florence affords an instructive specimen; but the passage from feudalism to the national state under the authority of monarchy made the cities and country districts parts of a larger whole. It is in this condition of subordination that the finance of localities has been framed and effectively organized. Though each great state has adopted its own methods, influenced by historical circumstances and by ideas of policy, there are general resemblances that furnish material for scientific treatment and allow of important generalizations being made.

Amongst these the first to be noticed is the essential subordination of local finance. Alike in expenditure, in forms of receipt, and in methods of administration the central government has the right of directing and supervising the work of municipal and provincial agencies. The modes employed are various, but they all rest on the sovereignty of the state, whether exercised by the central officials or by the courts. A second characteristic is the predominance of the economic element in the several tasks that local administrations have to perform, and the consequent tendency to treat the charges of local finance as payments for services rendered, or, in the usual phrase, to apply the " benefits " principle, in contrast to that of " ability," which rightly prevails in national finance. Over a great part of municipal administration - particularly that engaged in supplying the needs of the individual citizens - the finance may be assimilated to that of the joint-stock company, with of course the necessary differences, viz. that the association is compulsory; and that dividends are paid, not in money, but in social advantage. The great expansion in recent years of what is known as Municipal Trading has brought this aspect of local finance into prominence. Water supply, transport and lighting have become public services, requiring careful financial management, and still retaining traces of their earlier private character.

Corresponding to the mainly economic nature of local expenditure there is the further limitation imposed on the side of revenue. Unlike the state in this, localities are limited in respect to the amount and form of their taxation. Several distinct influences combine to produce this result. The needs of the central government lead to its retention of the more profitable modes of procuring revenue. No modern country can surrender the chief direct and indirect taxes to the local administrations. Another limiting condition is found in the practical impossibility of levying by local agencies such imposts as the customs and the income-tax in their modern forms. The elaborate machinery that is requisite for covering the national area and securing the revenue against loss can only be provided by an authority that can deal with the whole territory. Hence the very general limitation of local revenues to certain typical forms. Though in some cases municipal taxation is imposed on commodities in the form of octrois or entry duties - as is notably the case in France yet the prevailing tendency is towards the levy of direct charges on immovable property, which cannot escape by removal outside the tax jurisdiction. In addition to these " land " and " house " taxes, the employment of licence duties on trades, particularly those that are in special need of supervision, is a favourite method. Closely akin are the payments demanded for privileges to industrial undertakings given as " franchises," very often in connexion with monopolies, e.g. gas-works and tramways. Over and above the peculiar revenues of local bodies there is the further resource - which emphasizes the subordinate position of local finance - of obtaining supplemental revenue from the central treasury, either by taxes additional to the charges of the state, and collected at the same time; or by donations from its funds, in the shape of grants for special services, or assignments of certain parts of the state's receipts. Great Britain, France and Prussia furnish good examples of these different modes of preserving local administration from financial collapse.

The broad resemblance between the two parts of the entire system of public finance is seen in another direction. To national debts there has been added a great mass of municipal and local indebtedness, which seems likely to equal, or even exceed in magnitude the liabilities of the central governments. But here also the essential limitations of the newer form are easily perceptible. The sovereignty of the state enables it to deal as it thinks best with the public creditor. In its methods of borrowing, in its plans for repayment, or, in extremity, in its power of repudiation it is independent of external control. Local debt on the other hand can only be contracted under the sanction of the appropriate administrative organ of the state. The creditor has the right of claiming the aid of the law against the defaulting municipality; and the amounts, the terms, and the time of duration of local debt are supervised in order to prevent injustice to particular persons or improvidence with regard to the revenue and property of the local units. The chief reason for contracting local debt being the establishment of works that are, directly or indirectly, reproductive, the governing conditions are evidently to be found in the character and probable yield of those businesses. The principles of company investments are fully applicable: the creation of sinking-funds, the fixing the term of each loan to the time at which the return from its employment ceases, and the avoidance of the formation of fictitious capital, become guiding rules from this part of finance, and indicate the connexion with what the commercial world calls " financial operations." Finally, there is the same set of problems in respect to accounting and control in local as in central finance. Though the materials are simpler, the need for a well-prepared budget is existent in the case of the city, county or department, if there is to be clear and accurate financial management. Perhaps the greatest weakness of local finance lies in this direction. The public opinion that affects the national budget is unfortunately too often lacking in the most important towns, not excluding those in which political life is highly developed.

BIBLIOGRAPHY

The English literature on finance is rather unsatisfactory; for public finance the available text-books are: Adams, Science of Finance (New York, 1898); Bastable, Public Finance (London, 1892; 3rd ed., 1903); Daniels, Public Finance (New York, 1899), and Plehn, Public Finance (3rd ed., New York, 1909). In French, Leroy-Beaulieu, Traite de la science des finances (1877; 3rd ed., 1908), is the standard work. The German literature is abundant. Roscher, 5th ed. (edited by Gerlach), 1901; Wagner (4 vols.), incomplete; Cohn (1889) and Eheberg (9th ed., 1908) have published works entitled Finanzwissenschaft, dealing with all the aspects of state finance. For Greek financial history Boekh, Staatshaushaltung der Athenen (ed. Frankel, 1887), is still a standard work. For Rome, Marquardt, Rdmische Staatsverwaltung, vol. ii., and Humbert, Les Finances et la comptabilite publique chez les Romains, are valuable. Clamageran, Histoire de l'imp& en France (1876), gives the earlier development of French finance. R. H. Patterson, Science of Finance (London, 1868), C. S. Meade, Trust Finance (1903), and E. Carroll, Principles and Practice of Finance, deal with finance in the wider sense of business transactions. (C. F. B.)


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WikiBooks Presents:
Principles of Finance

Authored by: Venkatesh Sridhar, Patrick Felton

Table of Contents

Introduction

What is Finance
History
Branches of Finance
Prerequisites
How to use this book?

Section 1 Introductory Concepts

Chapter 1 The Basics

An Overview on Money
Principle of Relative Valuation
Role of a CFO and Finance Managers
Is Accounting and Finance one and the same?

Chapter 2 The Time Value of Money

Introduction to Time Value of Money
The concept of returns
The Present Value of Money, Net Present Value and Discounting
The Opportunity Cost of Capital
The effect of compounding and Future Value
Summary

Chapter 3 Applications of Time Value of Money

How to make Investment Decisions?
All about Perpetuities
Annuity
Summary

Section 2 Investments and Returns

Chapter 4 Bonds

Rate of Returns: Varying and Annualized
The Yield Curve
Valuing Bonds
The Yield to Market Curve
Advanced Concepts of Bonds
Summary

Chapter 5 Risk and Return

What is Risk?
Types of Risk
Summary

Chapter 6 Corporate Finance

Weighted Average Cost of Capital
Beta and its Uses
Return on Equity
Modigliani & Miller
Project Valuation
Growth Opportunity

Chapter 7 Portfolio Theory

Correlation Among Securities
Optimal Market Portfolio
Summary

Section 3 Market Theory


Simple English

Finance is how people study and figure out how people, businesses and groups make and use money. It can mean:

  • Thinking about money
  • Thinking about how to control money to make profit
  • Studying how to take chances in projects that make money
  • As a verb, "to finance" is to make money for business.

Contents

Some simple finance ideas

The process of finance is learning how people and groups act in managing their money, and most of all how they manage making money, and making a profit, with spending money, and making a loss.

A group that makes more money than it spends can lend or invest the excess profit. On the other hand, a group that makes less money than it spends can raise money by getting a loan or selling stock, or spending less, or making more money.

A bank is where many people borrowing money meet people lending money. A bank gets money from lenders, and pays interest. The bank then lends this money to borrowers. Banks allow borrowers and lenders of different sizes to meet.

Corporate finance is about things like the sale of stock by a company to the public. Stock is ownership in a company, broken up into pieces. The stock gives whoever owns it part ownership in that company. If someone buys one share of XYZ Inc, and the company has 100 shares available, the buyer is 1/100th owner of that company and owns 1/100th (1%) of the profit.

Finance is used by people, by governments, by businesses, etc., as well as by all kinds of groups.

Personal finance

This is finance for people. It is about:

  • How much money will be needed by a person, now and when they get old.
  • Where will this money come from (e.g. savings or borrowing)?
  • How can people protect themselves against problems with money in their lives?
  • How can family money be given to children and grandchildren?
  • How do taxes affect money choices?

Business finance

Business finance is about finding money for a company's activities. It studies trying to make more profit than loss, and taking good risks for the chance to make more money. LFC

Financial economics

Financial economics is the study of economics which is important to financial things like changes in price and supply of goods.

It studies how much risk some actions that a company may take will cause, and how the company should spend its money.

Financial maths

Financial maths is the study of maths for financial markets. Financial maths studies mathematics, mainly statistics.

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