Financial economics is a branch of economics that analyzes the use and distribution of resources in markets. Financial decisions must often take into account future events, whether those be related to individual stocks, portfolios, or the market as a whole.

Making financial decisions is not always a straightforward process. Time, risk, opportunity costs, and information can create incentives and disincentives. Financial economics employs economic theory to evaluate how certain things impact decision-making, providing investors with the instruments to make the right calls.

Financial economics usually involves the creation of sophisticated models to test the variables affecting a particular decision. Often, these models assume that individuals or institutions making decisions act rationally, though this is not necessarily the case. The irrational behavior of parties has to be taken into account in financial economics as a potential risk factor.

This branch of economics builds heavily on microeconomics and basic accounting concepts. It is a quantitative discipline that uses econometrics as well as other mathematical tools.

Financial economics necessitates familiarity with basic probability and statistics since these are the standard tools used to measure and evaluate risk. 

Financial economics studies fair value, risk and returns, and the financing of securities and assets. Numerous monetary factors are taken into account, including interest rates and inflation.

Traditional economics focuses on exchanges in which money is one—but only one—of the items traded. In contrast, financial economics concentrates on exchanges in which money of one type or another is likely to appear on both sides of a trade. 

The financial economist can be distinguished from traditional economists by their focus on monetary activities in which time, uncertainty, options, and information play roles. 

There are many angles to the concept of financial economics. Two of the most prominent are:

Decision-making over time recognizes the fact that the value of $1 in 10 years' time is less than the value of $1 now. Therefore, the $1 at 10 years must be discounted to allow for risk, inflation, and the simple fact that it is in the future. Failure to discount appropriately can lead to problems, such as underfunded pension schemes.

Advertisements for stock market-based financial products must remind potential buyers that the value of investments may fall as well as rise.

Financial institutions are always looking for ways of insuring, or hedging, this risk. It is sometimes possible to hold two highly risky assets but for the overall risk to be low: if share A only performs badly when share B performs well (and vice versa) then the two shares perform a perfect hedge.

An important part of finance is working out the total risk of a portfolio of risky assets, since the total risk may be less than the risk of the individual components.

Financial economists analyze economic and monetary trends, particularly as they relate to policy. This work involves tracking and collecting data, forecasting trends, assessing the impact of fiscal and monetary policy, and articulating business strategies to hedge against potential risks.

Financial economics as a field plays a key role in estimating the potential impacts of events and policy, be they fiscal or monetary. Consider if a central bank increased interest rates, or if Congress passed legislation to issue stimulus payments to the general public. Financial economics would assess how such policies might affect the market.

Economics and finance are closely intertwined disciplines, but there are key distinctions. Finance is centered primarily on the management of money, and involves assessing different components of financial systems, such as banking, credit, and investments. Economics is a broader and more theoretical realm of study, one that focuses on the production and distribution of resources throughout a society.

Financial economics is a branch of economics that analyzes the use and distribution of resources in markets. Financial economists evaluate how variables like time, risk, and information should weigh in decision-making. The field considers critical factors including fiscal and monetary policy when calculating potential returns on investments and evaluating whether to invest in certain securities and assets.