Financial assets and the markets they inhabit

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker 2020!
    Free Trading Education!
    Free Demo Account!
    Perfect for Beginners!

  • Binomo
    Binomo

    2 place in the ranking!

Financial Assets

What are Financial Assets?

The financial assets can be defined as an investment asset whose value is derived from a contractual claim of what they represent. These are liquid assets as the economic resources or ownership can be converted into something of value such as cash. These are also referred to as financial instruments or securities. They are widely used to finance real estate and ownership of tangible assets.

These are basically legal claims and these legal contracts are subject to future cash at a predefined maturity value and predetermined time frame.

Types of Financial Assets

These all can be classified in different categories according to the features of the cash flow associated with them.

#1 – Certificate of Deposit (CD)

This type of financial asset is an agreement between an investor (here, company) and a bank institution in which the customer (Company) keep a set amount of money deposited in the bank for the agreed term in exchange for a guaranteed rate of interest.

#2 – Bonds

This type of financial asset is usually a debt instrument sold by companies or government in order to raise fund for short-term projects. A bond is a legal document that states money the investor has lent the borrower and the amount when it needs to be paid back (plus interest) and the bond’s maturity date.

#3 – Stocks

Stocks do not have any maturity date. Investing in stocks of a company means participating in the ownership of the company and sharing its profits and losses. Stocks belong to shareholders until and unless they sell them.

#4 – Cash or Cash Equivalent

This type of financial assets is the cash or equivalent reserved with the organization.

#5 – Bank Deposits

#6 – Loans & Receivables

Loans and Receivables are those assets with fixed or determinable payments. For banks, loans are such assets as they sell them to other parties as their business.

#7 – Derivatives

Derivatives are financial assets whose value is derived from other underlying assets. These are basically contracts.

All the above assets are liquid assets as they can be converted into their respective values as per the contractual claims of what they represent. They do not necessarily have inherent physical worth like land, property, commodities, etc.

Financial Assets Classification

There is no single measurement classification technique that is suitable for all these assets. It can be classified as Current Assets or Non-Current Assets on a company’s balance sheet.

#1 – Current Assets

This contains those investment assets which are short term in nature and are liquid investments.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker 2020!
    Free Trading Education!
    Free Demo Account!
    Perfect for Beginners!

  • Binomo
    Binomo

    2 place in the ranking!

#2 – Non-Current Assets

Non-Current assets like shares of other company or debt instruments held in portfolio for more than a year.

Advantages

  • Some of these assets which are highly liquid can easily be used to pay bills or to cover financial emergencies. Cash and cash equivalents come under this category. On the other hand, one may have to wait for the stock to get money as they have to be sold in exchange first followed by settlement.
  • For investors, it gives them more security when they have more capital parked in liquid assets.
  • It serves as a major economic function of financing tangible assets. This becomes possible with the transfer of funds from those who have a surplus of it to where it is needed for such financing.
  • It distributes the risk as per preferences and risk appetite of the parties involved in the investment in tangible assets. It represents legal claims to future cash expected generally at a defined maturity and defined rate. The counterparties involved in the agreement are the company that will pay the future cash (issuer) and the investors.

Disadvantages and Limitations

  • Financial assets (liquid assets) like deposits in savings accounts and checking accounts with banks are greatly limited when it comes to its return on investment, as there are no restrictions for their withdrawal.
  • Furthermore, these assets like CDs and money market accounts may prevent withdrawal for months or years as per the agreement or they are callable.
  • This majorly come with a maturity date in the contract, attempting to cash out assets before maturity calls for penalties and lower returns.

Important Points

  • The value of this asset is determined by the demand and supply of such asset in the market.
  • These assets are valued as per the cash required to convert them which again is decided based on certain parameters. The value of people’s financial assets can change significantly, especially in the case they have invested majorly in stocks.
  • The measurement of financial assets cannot be done using a single measurement method. Suppose we are measuring stocks when investments are small in quantum, the market price can be considered to measure the value of the stock at that time. However, if a company owns a large number of shares of other companies, the market price of the share is not relevant because the investor holding majority shares may not sell them.
  • Every financial asset has different risks and returns for its purchaser. For instance, a car company usually has no idea of the sale of its cars, so, the value of stocks of the company may increase or decrease. A bond can default as issuers may fail to pay back the par value of a bond. Even cash and savings accounts have risks associated as inflation may put an impact on purchasing power.

Conclusion

These are a crucial part of any organization. It always needs to have a good record of its financial assets so that is can be put to use whenever needed like in financial emergencies. It is helpful to keep a check on the availability of such assets.

Each and every financial asset has a different but particular goal for the holder, each has a different amount of risk associated with it and thus returns are also different based on risk for the purchaser of such asset. Since each type of asset has some reward & risk associated with it, it’s always advisable to keep a mix of different asset types to have an optimal portfolio. This helps in the proper functioning of the organization without any dearth of assets.

This has been a guide to what are Financial Assets and its definition. Here we discuss the types of Financial Assets and its classification along with examples, advantages, and disadvantages. You may also learn more about the following articles –

Financial Asset

What Is a Financial Asset?

A financial asset is a liquid asset that gets its value from a contractual right or ownership claim. Cash, stocks, bonds, mutual funds, and bank deposits are all are examples of financial assets. Unlike land, property, commodities, or other tangible physical assets, financial assets do not necessarily have inherent physical worth or even a physical form. Rather, their value reflects factors of supply and demand in the marketplace in which they trade, as well as the degree of risk they carry.

Financial Asset

Understanding a Financial Asset

Most assets are categorized as either real, financial, or intangible. Real assets are physical assets that draw their value from substances or properties, such as precious metals, land, real estate, and commodities like soybeans, wheat, oil, and iron.

Intangible assets are the valuable property that is not physical in nature. They include patents, trademarks, and intellectual property.

Financial assets are in-between the other two assets. Financial assets may seem intangible—non-physical—with only the stated value on a piece of paper such as a dollar bill or a listing on a computer screen. What that paper or listing represents, though, is a claim of ownership of an entity, like a public company, or contractual rights to payments—say, the interest income from a bond. Financial assets derive their value from a contractual claim on an underlying asset.

This underlying asset may be either real or intangible. Commodities, for example, are the real, underlying assets that are pinned to such financial assets as commodity futures, contracts, or some exchange-traded funds (ETFs). Likewise, real estate is the real asset associated with shares of real estate investment trusts (REITs). REITs are financial assets and are publicly traded entities that own a portfolio of properties.

The Internal Revenue Service (IRS) requires businesses to report financial and real assets together as tangible assets for tax purposes. The grouping of tangible assets is separate from intangible assets.

key takeaways

  • A financial asset is a liquid asset that represents—and derives value from—a claim of ownership of an entity or contractual rights to future payments from an entity.
  • A financial asset’s worth may be based on an underlying tangible or real asset, but market supply and demand influence its value as well.
  • Stocks, bonds, cash, CDs, and bank deposits are examples of financial assets.

Common Types of Financial Assets

According to the commonly cited definition from the International Financial Reporting Standards (IFRS), financial assets include:

  • Cash
  • Equity instruments of an entity—for example a share certificate
  • A contractual right to receive a financial asset from another entity—known as a receivable
  • The contractual right to exchange financial assets or liabilities with another entity under favorable conditions
  • A contract that will settle in an entity’s own equity instruments

In addition to stocks and receivables, the above definition comprises financial derivatives, bonds, money market or other account holdings, and equity stakes. Many of these financial assets do not have a set monetary value until they are converted into cash, especially in the case of stocks where their value and price fluctuate.

Aside from cash, the more common types of financial assets that investors encounter are:

  • Stocks are financial assets with no set ending or expiration date. An investor buying stocks becomes part-owner of a company and shares in its profits and losses. Stocks may be held indefinitely or sold to other investors.
  • Bonds are one way that companies or governments finance short-term projects. The bondholder is the lender, and the bonds state how much money is owed, the interest rate being paid, and the bond’s maturity date.
  • A certificate of deposit (CD) allows an investor to deposit an amount of money at a bank for a specified period with a guaranteed interest rate. A CD pays monthly interest and can typically be held between three months to five years depending on the contract.

Pros and Cons of Highly Liquid Financial Assets

The purest form of financial assets is cash and cash equivalents—checking accounts, savings accounts, and money market accounts. Liquid accounts are easily turned into funds for paying bills and covering financial emergencies or pressing demands.

Other varieties of financial assets might not be as liquid. Liquidity is the ability to change a financial asset into cash quickly. For stocks, it is the ability of an investor to buy or sell holdings from a ready market. Liquid markets are those where there are plenty of buyers and plenty of sellers and no extended lag-time in trying to execute a trade.

In the case of equities like stocks and bonds, an investor has to sell and wait for the settlement date to receive their money—usually two business days. Other financial assets have varying lengths of settlement.

Maintaining funds in liquid financial assets can result in greater preservation of capital. Money in bank checking, savings, and CD accounts are insured against loss of up to $250,000 by the Federal Deposit Insurance Corporation (FDIC)—the National Credit Union Administration (NCUA) for credit union accounts. If for some reason the bank fails, your account has dollar-for-dollar coverage up to $250,000. However, since FDIC covers each financial institution individually, an investor with brokered CDs totaling over $250,000 in one bank faces losses if the bank becomes insolvent.

Liquid assets like checking and savings accounts have a limited return on investment (ROI) capability. ROI is the profit you receive from an asset less than the cost of owning that asset. In checking and savings accounts the ROI is minimal. They may provide modest interest income but, unlike equities, they offer little appreciation. Also, CDs and money market accounts restrict withdrawals for months or years. When interest rates fall, callable CDs are often called, and investors end up moving their money to potentially lower-income investments.

Liquid financial assets convert into cash easily.

Some financial assets have the ability to appreciate in value.

The FDIC and NCUA insure accounts up to $250,000.

Highly liquid financial assets have little appreciation

Illiquid financial assets may be hard to convert to cash.

The value of a financial asset is only as strong as the underlying entity.

Illiquid Assets Pros and Cons

The opposite of a liquid asset is an illiquid asset. Real estate and fine antiques are examples of illiquid financial assets. These items have value but cannot convert into cash quickly.

Another example of an illiquid financial asset are stocks that do not have a high volume of trading on the markets. Often these are investments like penny stocks or high-yield, speculative investments where there may not be a ready buyer when you are ready to sell.

Keeping too much money tied up in illiquid investments has drawbacks—even in ordinary situations. Doing so may result in an individual using a high-interest credit card to cover bills, increasing debt and negatively affecting retirement and other investment goals.

An Introduction to the Financial Markets

Make Financial Markets Work for You

What are the financial markets? It can be confusing because they go by many terms. They include capital markets, Wall Street, and even simply “the markets.” Whatever you call them, financial markets are where traders buy and sell assets. These include stocks, bonds, derivatives, foreign exchange, and commodities. The markets are where businesses go to raise cash to grow. It’s where companies reduce risks and investors make money.

  • Financial markets create liquidity that allows businesses to grow and entrepreneurs to raise money for their ventures.
  • They reduce risk by having information publicly available to investors and traders.
  • These markets calm the economy by instilling confidence in investors.
  • Investor confidence stabilizes the economy.

Types of Financial Markets

Most people think about the stock market when talking about financial markets. They don’t realize there are many kinds that accomplish different goals. Markets exchange a variety of products to help raise liquidity. Each market relies on each other to create confidence in investors. The interconnectedness of these markets means when one suffers, other markets will react accordingly.

The Stock Market

This market is a series of exchanges where successful corporations go to raise large amounts of cash to expand. Stocks are shares of ownership of a public corporation that are sold to investors through broker-dealers. The investors profit when companies increase their earnings. This keeps the U.S. economy growing. It’s easy to buy stocks, but it takes a lot of knowledge to buy stocks in the right company.

To a lot of people, the Dow is the stock market. The Dow is the nickname for the Dow Jones Industrial Average. The DJIA is just one way of tracking the performance of a group of stocks. There is also the Dow Jones Transportation Average and the Dow Jones Utilities Average. Many investors ignore the Dow and instead focus on the Standard & Poor’s 500 index or other indices to track the progress of the stock market. The stocks that make up these averages are traded on the world’s stock exchanges, two of which include the New York Stock Exchange (NYSE) and the Nasdaq.

The market depends on the perceptions, actions, and decisions of both buyers and sellers concerning the profitabilities of the companies being traded.

Mutual funds give you the ability to buy a lot of stocks at once. In a way, this makes them an easier tool to invest in than individual stocks. By reducing stock market volatility, they have also had a calming effect on the U.S. economy. Despite their benefits, you still need to learn how to select a good mutual fund.

The Bond Market

When organizations need to obtain very large loans, they go to the bond market. When stock prices go up, bond prices go down. There are many different types of bonds, including Treasury Bonds, corporate bonds, and municipal bonds. Bonds also provide some of the liquidity that keeps the U.S. economy functioning smoothly.  

It’s important to understand the relationship between Treasury bonds and Treasury bond yields. When Treasury bond values go down, the yields go up to compensate. When Treasury yields rise, so do mortgage interest rates. Even worse, when Treasury values decline, so does the value of the dollar. This makes import prices rise, which can trigger inflation.  

Treasury yields can also predict the future. For example, an inverted yield curve heralds a recession.

The Commodities Market

A commodity market is where companies offset their futures risks when buying or selling natural resources. Since the prices of things like oil, corn, and gold are so volatile, companies can lock in a known price today.   Since these exchanges are public, many investors also trade in commodities for profit only. For example, most investors have no intention of taking shipment of large quantities of pork bellies.

Oil is the most important commodity in the U.S. economy. It is used for transportation, industrial products, plastics, heating, and electricity generation. When oil prices rise, you’ll see the effect in gas prices about a week later. If oil and gas prices stay high, you’ll see the impact on food prices in about six weeks.   The commodities futures market determines the price of oil.

Futures are a way to pay for something today that is delivered tomorrow. They increase a trader’s leverage by allowing him or her to borrow the money to purchase the commodity.

The futures market removes some of the volatility in the U.S. economy. It allows businesses to control the future costs of the critical commodities they use every day.

Leverage can create outsize gains if traders guess right. It also magnifies the losses if traders guess wrong. If enough traders guess wrong, it can have a huge impact on the U.S. economy, actually increasing overall volatility.

Another important commodity is gold. It’s bought as a hedge against inflation. Gold prices also go up when there is a lot of economic uncertainty in the world. In the past, every dollar could be traded in for its value in gold. When the U.S. went off the gold standard, it lost this relationship to money. Still, many people look at gold as a safer alternative to cash or currency.

Derivatives

Derivatives are complicated financial products that base their value on underlying assets.   Sophisticated investors and hedge funds use them to magnify their potential gains. In 2007, hedge funds increased in popularity due to their supposed higher returns for high-end investors. Since hedge funds invest heavily in futures, some argued they decreased the volatility of the stock market and, therefore, the U.S. economy. The hedge fund investments in subprime mortgages and other derivatives caused the 2008 global financial crisis.

Even before this, hedge funds had demonstrated their risky nature. In 1997, the world’s largest hedge fund at the time, Long Term Capital Management, practically brought down the U.S. economy.

Forex Trading

Forex trading is a decentralized global market in which currencies are bought and sold. About $6.6 trillion were traded per day in April 2020, and 88% involved the U.S. dollar. Almost one-fourth of the trades are done by banks for their customers to reduce the volatility of doing business overseas. Hedge funds are responsible for another 11%, and some of it is speculative.  

This market affects exchange rates and, thus, the value of the dollar and other currencies. Exchange rates work on the basis of demand and supply of a nation’s currency, as well as of that nation’s economic and financial stability.

Functions of Financial Markets

Financial markets create an open and regulated system for companies to acquire large amounts of capital.   This is done through the stock and bond markets. Markets also allow these businesses to offset risk. They do this with commodities, foreign exchange futures contracts, and other derivatives.

Since the markets are public, they provide an open and transparent way to set prices on everything traded. They reflect all available knowledge about everything traded. This reduces the cost of obtaining information because it’s already incorporated into the price.

The sheer size of the financial markets provides liquidity. In other words, sellers can unload assets whenever they need to raise cash. The size also reduces the cost of doing business. Companies don’t have to go far to find a buyer or someone willing to sell.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker 2020!
    Free Trading Education!
    Free Demo Account!
    Perfect for Beginners!

  • Binomo
    Binomo

    2 place in the ranking!

Like this post? Please share to your friends:
Binary Options Online Trading
Leave a Reply

;-) :| :x :twisted: :smile: :shock: :sad: :roll: :razz: :oops: :o :mrgreen: :lol: :idea: :grin: :evil: :cry: :cool: :arrow: :???: :?: :!: