Financial Assets

What is a Financial Asset? 

An asset is anything of value owned by a person or a firm. A financial asset is a financial claim, an intangible asset that derives value because of a contractual claim. It simply means a claim on someone else to pay you money. Financial Assets include cash and bank accounts plus securities and investment accounts that can be readily converted into cash. 

For example your saving bank account with the bank is a financial asset because it represents a claim you have against a bank to pay you an amount of money equal to the monetary value of your account. Financial assets can be divided into securities that are tradable in a financial market and other financial assets. Financial markets are places or channels for buying and selling stocks, bonds, and other securities, such as the New York Stock Exchange or National Stock Exchange (NSE India). 

Other examples include bank deposits, bonds, and stocks. Financial assets are usually more liquid than tangible assets, such as land or real estate, and are traded on financial markets. 

Types of Financial Assets: 

Given below are different types of financial assets: 

  • Money: Cash or cash equivalent;
  • Stocks: Equity instruments of another entity;
  • Contractual right to receive cash or another financial asset from another entity;
  • Bonds
  • Foreign exchange
  • Securitized loans 

We now briefly discuss these key financial assets. 

1. Money:

Money is a medium of exchange, an agreed-upon system for measuring the value of goods and services. Anything with an agreed-upon value might be a medium of exchange. Today, many forms of money are used. Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given socio-economic context or country. 

Money is anything that people are willing to accept in payment for goods and services or to pay off debts. The money supply is the total quantity of money in the economy. 

Anything with an agreed-upon value might be a medium of exchange. Today, many forms of money are used. Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given socio-economic context or country. 

2. Stocks: 

Also known as equities, stocks or equity investments generally refers to the buying and holding of shares of stock on a stock market by individuals and firms in anticipation of income from dividends and capital gains, as the value of the stock rises. These financial securities represent partial ownership of a corporation. When you buy share of any large company like Facebook, you become a shareholder of that company, and you own part of that Company’s equity, although only a tiny part because the company might have issued millions of shares of stock. 

As an owner of a share of stock in a corporation, you have a legal claim to a share of the corporation’s assets and to a share of its profits, if there are any. Firms keep some of their profits as retained earnings and pay the remainder to shareholders in the form of dividends, which are payments corporations typically make every quarter. 

3. Bonds: 

In finance, a bond is an instrument of indebtedness of the bond issuer to the holders. When you buy a bond issued by a corporation or a government, you are lending the corporation or the government a fixed amount of money. It is a debt security, under which the issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay them interest (the coupon) and/or to repay the principal at a later date, termed the maturity. 

The interest rate is the cost of borrowing funds (or the payment for lending funds), usually expressed as a percentage of the amount borrowed. Interest is usually payable at fixed intervals (semiannual, annual, sometimes monthly). Very often the bond is negotiable, i.e. the ownership of the instrument can be transferred in the secondary market. 

Bonds and stocks are both securities, but the major difference between the two is that stockholders have an equity stake in the company (i.e. they are owners), whereas bondholders have a creditor stake in the company (i.e. they are lenders). Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding indefinitely. 

When a bond matures, the seller of the bond repays the principal. A bond that matures in one year or less is a short-term bond. A bond that matures in more than one year is a long-term bond. Bonds can be bought and sold in financial markets, so, like stocks, bonds are securities. 

4. Foreign Exchange: 

People may need to exchange currencies in a number of situations. For example, people intending to travel to another country may buy foreign currency in a bank in their home country, where they may buy foreign currency cash, traveller's cheques or a travel-card. Similarly, many goods and services purchased in a country are produced outside that country. Also, many investors buy financial assets issued by foreign governments and firms. To buy foreign goods and services or foreign assets, a domestic business or a domestic investor must first exchange domestic currency for foreign currency. 

Foreign exchange refers to units of foreign currency. The foreign exchange market (forex, FX, or currency market) is a form of exchange for the global decentralized trading of international currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends. The most important buyers and sellers of foreign exchange are large banks. Banks engage in foreign currency transactions on behalf of investors who want to buy foreign financial assets. Banks also engage in foreign currency transactions on behalf of firms that want to import or export goods and services or to invest in physical assets, such as factories, in foreign countries. 

5. Securitized Loans: 

We all know that people borrows money from banks in the form of loans. Banks make these loans with the intention of making profits by collecting interest payments on a loan until the loan was paid off. Now it is also possible to sell most loans in financial markets, and hence loans also become securities from just being financial assets. Loans that banks could sell on financial markets became securities, so the process of converting loans into securities is known as securitization. Securitization is the process of pooling various types of debt; mortgages, car loans, or credit card debt, for example; and packaging that debt as bonds, pass-through securities, or collateralized mortgage obligations (CMOs), which are sold to investors. 

The principal and interest on the debt underlying the security is paid to the investors on a regular basis, though the method varies based on the type of security. Debts backed by mortgages are known as mortgage-backed securities, while those backed by other types of loans are known as asset-backed securities. 

For example, a bank might grant a mortgage, which is a loan a borrower uses to buy a home, and sell it to a government-sponsored enterprise or a financial firm that will bundle the mortgage together with similar mortgages granted by other banks. This bundle of mortgages will form the basis of a new security called a mortgage-backed security that will function like a bond. The banks that grants, or originates, the original mortgages will still collect the interest paid by the borrowers and send those interest payments on to the government agency or financial firm to distribute to the investors who have bought the mortgage-backed security. The bank will receive fees for originating the loan and for collecting the loan payments from borrowers and distributing them to lenders.

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Created On: Tuesday, 09 April 2013 Posted in BFSI Domain - Finance Domain

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