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
benefit or advantage
(either monetary or in the form of some usefulness).
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 need some explanation.
=> In the financial sense,
Assets are investment or savings from which the holder expects normally
a financial return
They can be bought or sold if there is a market, either unorganized
or organized, usually through intermediaries (banks, brokers, agents, insurers...)
=> There is a difference between:
- "Hard" assets, that you can touch physically:
They are not directly financial assets, unless they are transformed into immaterial
contracts (derivatives) that are tradable in markets
- Soft" assets as financial rights:
* Also their "derivatives" (as seen above, in the form of financial contracts such
as futures or options on hard or soft assets).
* Not to forget patents, trademarks...
Categories of financial assets
Innovation has been active in this domain (with some excesses and manipulations
to tell the truth)
To be practical, they might be classified according to the technical skill needed to
use them properly, but also, as a key decision criterion, to a scale
of return / risk. Usually, but it is a simplification :
|high return entails high risk
and low risk entails low return.
This article does not detail
* bank saving accounts and schemes,
* life insurance contracts,
however typical, popular and highly useful they are as saving instruments.
=> 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...).
contracts (thus into soft assets), in order to be traded more easily by investors
Therefore, financial assets (aka financial instruments) include:
- Stocks: those securities are shares of ownership in a business .
They make that company's own capital, also called "equity"
- Bonds, notes, bills: those securities are shares of a loan
(sovereign bonds), municipality...
* bonds are long term instruments (above 5 years),
* notes are medium term (2-5 years)
* and bills short term (1 year or under)
- Derivative contracts on the future price of an asset
This is the case of futures or of option contracts either on securities,
or on currencies, or on various commodities: raw materials, agricultural
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.
What are asset markets and their operations?
(against money) financial assets.
Financial markets and financial institutions can be seen as "shops" where
risks as well as return prospects can be bought or sold.
When stocks (usually those of big corporations) are "listed" in "stock exchanges"
(aka stock markets), they are publicly traded there and 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).
- To agree on future purchases or sales.
- To conclude derivative contracts on the future price of "underlying assets",
- Buying a "call", by paying a "premium" (not refundable),
at a preset price at maturity or before.
- In the same way, buying a "put"
Another type of derivative, that became highly popular is CFD / contract for
The price difference occurring while the CFD is held is paid to the holder a 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.
Such 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 the "official" stock markets
How market prices are reached.
Here is an example on how prices are determined in asset markets, through
a typical comparison process by which supply and demand reach a balance.
Number stocks offered (cumulated)
Number stocks asked (cumulated)
53 and above
45 and under
The quotation is done at that price as it allows that the largest number of stocks
can be exchanged (even if 100 stay unsold).
=> and at a price of 50 only 600
Why to buy stocks?
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.
Stocks are usually more risky than bonds but with a higher expected return in the
long run. This return surplus is called the risk premium (and more specifically the
(*) 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?
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 a similar risk.
But we know that markets obey also investor "sentiments" that can deeply influence
their price (see behavioral finance).
When making a stock valuation, we have therefore to take into account both aspects,
the economic "fundamentals" and the "attitudes" of market players.
Why to use derivatives?
(among them CDS / Credit default swaps), and other derivatives are used
- Either as a hedge (protection)
- Or as a speculation (opportunity) to take advantage of such a variation.
We can 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
produced by using financial engineering. (*)
Those synthetic 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 butwith low potential profitability (such as traditional savings accounts).
Most of them do not deserve that disdain except those built - under pretence
of financial sophistication - on a pyramid (structured assets) 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 finance
complex economic projects, or in asset-liability management for financial
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