The Penguin Guide to Finance [Paperback]

Sir Marcus Mushkin had just died. The eponymous founder of Mushkin Multimedia has left behind a media conglomerate spanning five continents. Its interest in movies, music, television and the internet put it on a par with Disney, Tie Warner or News Corporation. And its newspapers are so powerful that they make or break governments.

Into the breach steps Atalandi, Sir Marcus' feisty 31-year-old daughter. She has inherited not only her father's shares but also his dynamism. She spends most of her time whizzing around the world in her gulf stream private jet, trying to keep the far-flung empire together.

But Atalandi has also inherited a few problems. Outside shareholders, who own most of the company are unhappy with the dynastic succession. They are also angry about Sir Marcus' last acquisition - of Rock & Pop, a big music label. They think he overpaid and his daughter is not up to the job of running such a vast business. Sir Marcus used to run the company as if it was his own private family fiefdom. SO as long as the share price rose, investors tolerated that. But the share price is now falling and investors are calling for action.

Atalandi turns to Lex Buzzard for advice on how to win shareholders back. The senior partner of Buzzard Brothers, the investment bank, Lex is also an old friend of the Mushkin family. He has to explain the principles of finance and why the market is unhappy. As Lex spells out some home truths, Atalandi initially resists. But eventually she begins to see the sense of his proposals. Finally he recommends a step which would have appalled her father.

Meanwhile, Sophia Butcher ha just been elected prime minister of Fouliland. The large mid-Atlantic island has been badly managed for many years. Inflation is high, the public finances are in a mess and unions have been running riot. The country has been considered a basket case in financial markets.

Sophia has come in proposing to sweep away all the old bad practices, and investors love it. She herself, is rather bemused at the speed with which the markets have reacted. So she too calls on Lex.

The Penguin Guide to Finance is not a novel but a book about finance. Nevertheless, I have used fictional characters in the hope that it will make the subject accessible to a broad audience. Although most of the book is in conventional prose, Lex, Atalandi and Sophia keep popping p in dialogues. When there is an especially tricky issue, Atalandi or Sophie contacts Lex and demands an explanation. Sometimes he sets an exercise to see if they really understand. Although these are the main characters, there are several walk-on parts: Ajit, a Calcutta fruit trader; Edward Bluebottle, the governor of the Bank of Fouliland; and Multigear, a company obsessed with financial engineering.

Finance is a hard topic, but an important one. How money flows around the system helps dictate the pattern of economic activity. This was always so. But, if anything, finance is becoming increasingly important as barriers to the free flow of capital around the world are dismantled. I the past, governments could print their own money and get away with it - at least for a time. Companies, too, could often rely on handouts from the state or loans from the banks with whom they had long-term relationships. This often meant they were able to ignore their shareholders.

But in he modern capital markets, money is footloose and fancy-free. Investors show little loyalty to the institutions they invest in. What they want is the best balance between high returns and low risks - and they will sell an institution's bonds or shares if their interests are not being catered to.

This puts those who need to raise money under a harsh discipline. Countries like Fouliland find they are losing the ability to pursue irresponsible economic policies. Instead they are forced to fight inflation. Similarly, companies like Mushkin are less able to engage in grandiose empire-building. The pursuit of shareholder value is increasingly their guiding light.

All this is achieved through a system of carrot and sticks. Those who do the bidding of the financial markets get rewarded. Money flows their way, capital is cheap and they can expand rapidly. But those who ignore investors' needs get punished. Capital is expensive, they can get cut off from finance and may have to shrink. In the extreme, there is crisis and bankruptcy.

The survival of the fittest and Adam Smith's invisible hand. These are not new ideas. They even go back to the New Testament parable of the ten talents in Matthew, Chapter 25: 'For unto every one that hath shall be given, and he shall have in abundance: but from him that hath not shall be taken away even that which he hath.' What is new is how modern financial markets - where asset prices change continuously - have dramatically speeded up the allocation of resources.

But investors are not always entirely rational. Like manic-depressives, their irrational exuberance sometimes gives way to irrational despondency. The result is bubbles followed by crashes. The rewards and punishments delivered by the market are not always fair - or at least not always proportionate o the merit or crime.

This book's root lies in the seminars I gave to journalists while I was head of Lex at the Financial Timesand to non-specialists elsewhere. These seminars were not intended to turn journalists into corporate financiers but rather to explain to them the assumptions that the financiers rely on - and so equip journalists to ask difficult, probing questions. The book is also a culmination of my own attempts to piece together an intellectual framework for making sense of what at first seemed a bewildering subject. I have tried to write the book I wish existed before I plunged into the deep end of financial journalism.

It is intended for a broad range of readers. At one end of the spectrum will be those who just want to satisfy their intellectual curiosity. At the other are the financial professionals - bankers, brokers, professional investors and finance directors. Though they will know much o hat is ion this book, I hope there will be nuggets that appeal t them too. In between are readers who are not professional financiers but have to deal with the world of finance in their daily lives: ordinary investors, business executives, students, journalists, civil servants, perhaps even politicians.

As such, I have tried to show how financial theories are applied in the real world. I explain the tools of analysis used in the City of London and on Wall Street as well as the accepted wisdom of the business schools and economics faculties. Often the academics throw up their hands in horror at the impurity of these techniques. But professional financiers do grapple with the messy real world, day in day out.

I have also included some tricks of my own. These are mainly short cuts I use n order to simplify analysis - for example to asses the merits of a takeover or to work out how long it will take to double your money. I am keen n calculations that can be done by scribbling a few figures o the back of an envelope, even if this involves sacrificing some of the accuracy comes from using an elaborate computer model.

Another small innovation is that the book covers both corporate finance and financial markets. Most texts concentrate on one or the other, but microfinance and macrofinance are really two parts of the same story. The wealth of companies determines the wealth of nations; equally, the overall mood of financial markets influences the terms on which companies can raise funds.

I could not think how to write a guide to finance without a few equations. But on the Stephen Hawking principle - when writing A Brief History of Timehe was told every equation would half his sales - they have been excluded from the man text. Instead I have made liberal use of tables and flow charts. I have also created an appendix, Formula Hell, where the equations he been sent. No reader needs to visit Formula Hell. But it is there for enthusiasts.