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) 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"
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
Those financial goodies can be bought or sold if there is
a 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:
They are not directly financial assets, but some of them might back
immaterial contracts (derivatives, see below) that are tradable
- "Soft" assets as financial rights:
* Also their "derivatives" (mentioned above, in the form of financial
contracts, such as futures or options based on the price of hard or
* Not to forget patents, trademarks...
Categories 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 criterion, to a scale of
return / 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 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
into financial contracts (thus into soft assets), in order to be
traded more easily.
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
state (sovereign bonds), municipality...
* 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
This is the case of futures or of option contracts on securities,
currencies or commodities: raw materials, agricultural products,
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?
(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.
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).
- To agree on future purchases or sales.
- To conclude derivative contracts
This is done notably via financial options.
- Buying a "call", by paying a "premium" (not refundable),
at maturity or before.
- In the same way, buying a "put"
Another type of derivative, that became highly popular is CFD / contract
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"
How market prices are reached.
Here is an example on how prices are determined in asset markets, via
a matching process by which supply and demand reach a balance.
Number of stocks offered (cumulated)
Number of 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
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 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
What are the criteria to select and buy stocks?
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)
with similar risks.
Comparison of the expected return with other investments
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" .
Why to use derivatives?
(CFD), swaps (among them CDS / Credit default swaps), and other derivative
operations are used
- Either as a hedge (protection)
asset price or value
- Or as a speculation (opportunity)
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
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 butbut with low potential return (such as traditional savings accounts).
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
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