In the previous chapter we went over the process by which investors form portfolios, how to measure the risk and return of a given portfolio, and how an optimal portfolio can be chosen from a riskless asset and a set of risky assets. We saw that the optimal portfolio consists of holding some portion of one’s money in the riskless asset and some portion in the tangency portfolio consisting of the optimal combination of risky assets (OCRA). In this chapter we introduce the capital asset pricing model (CAPM), which specifies exactly what the OCRA should be. The CAPM predicts, under a set of assumptions, that the OCRA consists of holding all assets in the market in proportion to their value. Thus, all investors should hold some combination of the market portfolio and the riskless asset because it is most efficient.

In Chapter 13 we saw that the general choice of financing—debt or equity—affected overall firm value only due to frictions such as agency problems or asymmetric information. Debt and equity financing can come from many different sources in the financial system, and the institutional details of these sources can introduce important considerations for the firms seeking financing. In this chapter we explore the different sources of financing that may be available and/or feasible for firms to use at various stages of their lives: from new startup firms to mature and stable publicly traded corporations. Broadly speaking, the global financial system successfully meets the financial needs of the many different types of firms that operate in the economy. However, firms are constantly in flux, and as a result so are their financial needs. While the financial sources we discuss in this chapter continue to be important to the financial system, in response to the evolving nature of firms, new financial innovations and different ways of financing are always being introduced.

This chapter reviews changes to cognition with age. This includes sections on attention, executive function, motor control, and language. After reviewing cognitive aging and these basic cognitive functions, the chapter considers the burgeoning literature on training cognitive ability with age. This section includes review of intervention programs focused on physical activity, mediation and mediation, cognitive activities, working memory training, and long-term memory training.

In the previous chapter we explored how to determine the interest rates (rates of return) for risk-fee assets (i.e., investments with no default risk); however, individuals and investment professionals invest their wealth in not only risk-free assets, but also risky assets. There are a great number of risky assets, such as individual stocks, that individuals can potentially invest in, and thus individuals can form a portfolio of different assets. In addition to choosing which assets to invest in, individuals must also choose how much to invest in each asset. The process through which people choose assets to invest their wealth in is called portfolio selection.

In previous chapters, we introduced the fundamental principles behind understanding the value of financial investments, such as stocks, bonds, and options. However, many of these investments (such as shares of stock or bonds issued by a company or call options that allow the holder to purchase shares of a company’s stock) are based on specific companies. To fully understand such investments, it is necessary to better understand the companies that they are based on. In Chapter 8 we examined company financial statements as a first step toward analyzing companies in more detail. We now expand upon this and explore how the information from financial statements can be used to estimate the economic value of a company.

In this chapter we focus on further developing and applying our valuation tools to better understand company value. We begin by taking the perspective of an observer examining a company from the “outside,” that is, someone who cannot influence the way a company is run. In other words, given how a company is being managed by its current managers, what should its value be? Starting in the next chapter, we will consider the perspective of a manager from within a company, and determine how the actions of those running a company can affect its value.

This chapter reviews research on social cognition and age. This covers self-focused processes, including self-referencing and memory as well as own-age bias and stereotype threat and stigma. Processes focused on other people are also reviewed, including moral judgment, empathy, theory of mind, social interactions and impression formation, memory for impressions, and trust.

In this chapter we review an important source of information about companies: financial statements. Financial statements are reports published by businesses and other organizations that provide investors and other stakeholders with information about a firm’s assets, liabilities, existing and potential cash flows, and so on. The core financial statements, which are usually published quarterly and annually, are the balance sheet, the income statement, and the statement of cash flows. Financial statements provide information about a firm’s current and past financial state, information that is key in figuring out a firm’s current economic value and the outlook on how the firm may perform in the future.

In the previous chapter we focused on decisions within companies, and discussed decision rules that managers can follow to choose investment projects. A key takeaway is that managers should make project decisions that increase the value of the company. In this chapter, we explore how organization structure can support decision making that increases value. We also consider how in some circumstances it can cause poor decisions to be made that disadvantage the firm.

Many firms separate ownership and control—the people who run companies and make decisions (referred to as agents) are not always the same people who own the companies (known as principals). This separation offers many benefits, helping to guide companies toward optimal investment and operating decisions. However, it can also result in bad decisions being made. For example, managers and other stakeholders may have their own interests and take actions that benefit themselves but not the company.

In this chapter we explore the global financial system, which encompasses the institutions that carry out the financial decisions of households, firms, and governments. Up to this point in the book, we have presented principles, concepts, models, and analytical tools that are valid no matter what the institutional structure. In most cases the exact details of the institutions did not matter—for example, whether a company borrowed money from a small regional bank or a large international bank. However, in practice, the institutional structure does matter and you need to understand why and how in order to know what tools are best for financial decision making. There is a wide variety of different financial institutions across the globe that make up the financial system, and the nature and details of these institutions vary across different countries and also change over time. How can we understand why there are so many different financial institutions and the roles they play, when they are constantly changing?

This chapter opens with a list of scenarios that are all examples of financial decisions. It introduces a scientific approach to analyzing and making such decisions. We first look at what finance is and at the various contributions a study of finance can make to individuals, firms, and societies. Next, we look at a general overview of the financial system and the roles that various actors play within it. We then explore ten unifying principles from which all the tools and techniques of modern finance can be derived.