Financial assets and stock market

Types of financial investments

An asset is a property that normally gives to its owner an income
or other benefits, and which has a monetary value.

Assets are used as investments, for income  and/or capital gain
Some are physical and others are just financial rights.

Assets can be bought or sold, if there is a market.
Markets can be unorganized, or like the stock exchange, organized.

Their prices are quoted and exchanged under a supply and demand
process.

What are assets,
and among them, financial assets?

Return-producing belongings, of the invisible and soft kind

=>
In the common meaning,

An asset is what gives its holder / owner (a person or an
organization) a boite benefit or advantage (either
monetary or in the form of some usefulness) but entails
also some risk (of loss or absence of return).

Within this vast area, related to
capital and to money this article
limits itself to a specialized aspect: ownership of "soft" or "financial"
assets.
Obviously, this needs some explanation.

=> In the financial sense,

Assets are investment or savings from which the holder expects
normally a
financial return produced by revenues and / or capital
gains
Those financial goodies can be buysell bought or sold if there is
market, either organized or unorganized, accessible usually
through intermediaries (banks, brokers, agents, insurers...)

=>
There is a difference between:
  • "Hard" assets, that you can touch physically: 
Real estate, equipment, commodities, precious metals and gems,
collectibles...

They are not directly financial assets, but some of them might back
immaterial contracts
(derivatives, see below) that are tradable
in markets.

  • "Soft" assets as financial rights:
* Credit balances, currencies, securities, directly held and quoted,
* Also their "derivatives" (mentioned above, in the form of financial
   
contracts, such as futures or options based on the price of hard or
    soft assets).

* Not to forget patents, trademarks...

sous  Financial assets are therefore typical soft assets

Categories of financial assets

There are various types of financial assets.
Innovation has been active in this domain (with some excesses and
deceptive practices to tell the truth) 

To be practical, they might be sorted :
 
* according to the technical skill needed to use them properly,
* but also, as a key
decision decision criterion, to a scale of 
luck return /
 risk risk.
  
On this aspect we can say that, usually, but it is a simplification :

high return entails high risk
and low risk entails low return.

This article does not detail, however typical, popular and highly useful
they are as
saving saving instruments :

 * bank saving accounts and schemes,
 * life insurance contracts
,


=>
It focuses on tradable financial assets (via organized market
       or over the counter with a financial institution).

They are either securities (stocks, bonds) or financial contracts
(derivatives...).

As mentioned above, even some hard assets can be converted
into
financial contracts (thus into soft
assets), in order to be
traded more easily.

There
fore, financial assets (aka financial instruments) include:
  • Stocks: those securities are shares of ownership in a business .
with a legal statute of corporation.
They make that company's own capital, also called "equity"

  • Bonds, notes, bills: those securities are shares of a loan
to a company (corporate bonds) or to another institution:
state
(sovereign bonds), municipality...
Typically,
 * bonds are long term instruments (above 5 years),
 * notes / certificates are medium term
(2-5 years)
 * and bills short term (1 year or under)

  • Derivative contracts on the future price of an asset
(called "underlying asset": see below).
This is the case of futures or of option contracts on securities,
currencies or commodities:
raw materials, agricultural products,
energy....

As explained below, derivatives are not only trading tools but
also hedging tools
that give a guarantee
on the future value
of an asset, a commodity, a commercial contract...
On the other hand they can also be
highly leveraged
speculation instruments used by traders.

Some very customized derivatives are still dealt "over the counter"
but most are now traded in organised markets so as to correct
transparency problems
(they played a highly noxious part in the
last financial crisis).

What are asset markets and their operations?

Financial markets are organized markets on which we can exchange
 (against money) financial assets.
Financial markets and financial institutions can be seen as (physical or
immaterial) "shops" where risks as well as return prospects
can be bought or sold.
A common example is the stock market.
Some stocks (typically of big and also medium-size innovative corporations)
are "listed" in "stock exchanges" (aka stock markets). They are publicly
traded there, which means they can be bought or sold freely by everybody
(via a broker or bank usually).

To be more precise, in an organized market (but also "over the counter" for
some assets directly marketed by some financial institutions), it is possible:
  • To buy or sell cash (in the "spot market") some assets (see above).
The delivery and payment are immediate.
  • To agree on future purchases or sales.
  • To conclude derivative contracts
on the future price of "underlying assets",
This is done notably via financial options.
For example:
    • Buying a "call", by paying a "premium" (not refundable), 
This contract gives the right to buy the asset at a preset price
at maturity or before.
    • In the same way, buying a "put
It gives the right to sell an asset at a preset price.

Another type of derivative, that became highly popular is
CFD / contract
for difference
.
The price difference occurring while the CFD is held is paid to the holder if
it is positive or paid by him if it is negative.

Also are often cited the CDS / Credit default swap), are used to hedge
against high credit risks (as happened in the case of the subprimes, or are
is seen now in the case of
sovereign debt risk).

As markets do not deal with every kind of assets, some of the operations
mentioned here are made "over the counter" (OTC) and the counterpart
is directly a banking or financial institution.
OTC transactions can offer less transparency than market transactions.

Not to complicate things, we will not talk here about "dark pools", which are
parallel (but perfectly legal) market that exchange stocks outside "official"
stock markets

How market prices are reached.

The mystery of market quotes revealed!

Here is an example on how prices are determined in asset markets, via
a matching process by which
buysell supply and demand  reach a   equil balance.

Number of stocks offered (cumulated)

Proposed price

Number of stocks asked (cumulated)

****************************

2800

53 and above

100

*

****************

1800

52

200

**

*************

1300

51

200

***

**********

1000

50

600

******

*******

800

49

900

********

*****

500

48

1100

***********

*

100

47

1500

***************

*

100

46

1600

****************


0

45 and under

2500

*************************

=> 800 stocks are exchanged at 49 (euros or dollars or whatever).

The quotation is done at that price as it allows that the largest number
of stocks
can be exchanged (even if 100 stay unsold).

=> At a price of 48 only 500 stocks would have been exchanged
=> and at a price of 50 only 600

Why to buy stocks?

A business normally creates riches for its customers, employees, owners.
What belongs to the owners (the stockholders), are the profits
(earnings)
.

The company generally keeps a portion of its earnings
(reserves) for its
safety and to invest for its development.
It distributes another piece to its stockholders, as a cash payment for
every stock, which is called a dividend
.

Therefore investors buy stocks (*) in order to get:
  • Incomes (dividends)
  • And / or capital gains when they resell them.
Here they accept a risk (of losing money) if things don't turn out as
expected

Stocks are usually more risky than bonds but with a higher expected long
term return. This return surplus is called the
risk premium (and more
specifically the equity premium)


(*) directly or under the form of shares in "investment funds" that hold
      and manage
a diversified portfolio of stocks and often other financial
      assets.

What are the criteria to select and buy stocks?

Here are the main "objective" criteria of financial valuation
applied to stocks:
  • The expected profitability of the firm,

  • The risk (of the business, of the financial market),

  • The stock price (compared to the stock prospects)

  • Comparison of the expected return with other investments
  • with similar risks.
    Those are the "rational" criteria.
    But we know that markets obey also to investor "sentiments" that
    influence their prices (see
    behavioral finance).

    When making a stock valuation, we have therefore to take into account
    both aspects, economic "fundamentals" and market players' "attitudes" .
    Find more details in the related article about
    stock valuation.
    It can be also useful to look at
    the
    precautions for investors article

    Why to use derivatives?

    Future, selling options (puts), buying options (calls), contracts for difference
    (CFD), swaps (among them CDS / Credit default swaps), and other derivative 
    operations are used
    • Either as a hedge (protection)
    as a kind of insurance  against a strong variation of an underlying
    asset price or value
    to take advantage of such a variation. 
    In such a case the gains can be high but the risk is high also.

    Let us also mention that some of those operations that we will not detail
    here (short selling, buying "puts" or selling "calls") make that a price fall
    brings a trading gain and a price rise brings a trading loss.

    Complex savings and investment instruments

    Financial institutions propose complex complex savings and investment
    instruments
    produced by using financial engineering. (*)

    Those synthetic / structured products are backed by a mix of various
    financial assets and tools in
    order to be adapted closely to specific
    investor needs
    (liquidity, profitability, safety, time horizon, legal
    and tax aspects...).


    For example an investor who tries to find a better return can choose
    • riskier and less liquid contracts, but with a higher gain potential
      (in a word, more "speculative")
    • than financial assets that offer a nearly full liquidity and safety but
      but with low potential return (such as traditional savings accounts).
    Those products are sometimes demonized.
    Most of them do not deserve that disdain
    except those built - under
    pretence of financial sophistication - on a pyramid of mysterious exotic
    instruments with the intention to hide behind an obscure technicality the
    low value of the underlying assets.

    We have then a
    financial fraud like the one that led to the subprime crisis.

    (*) financial engineering is used also for other purposes, for example to fund 
          complex economic projects, or in asset-liability management for financial
          institutions.


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    M.a.j. / updated : 09 Aug. 2015
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