Financial assets represent claims on future cash flows and typically come in non-physical forms. They include stocks, bonds, rights, certificates, and bank balances, distinguishing them from tangible assets like real property. Essentially, financial assets derive their value from contractual claims, rather than physical form or utility.
Types of Financial Assets
Stocks
Stocks, also known as equities, represent ownership in a corporation. Shareholders are entitled to a portion of the company’s profits and assets. Stocks are typically traded on stock exchanges.
Bonds
Bonds are debt instruments wherein an investor loans money to an entity (corporate or governmental) for a defined period at a variable or fixed interest rate. Bonds are used by companies, municipalities, states, and sovereign governments to finance projects and operations.
Rights and Certificates
Rights allow shareholders to purchase additional shares at a discount, whereas certificates can represent ownership stakes, entitlements, or various forms of financial agreements.
Bank Balances
Bank balances refer to the amounts held in various types of bank accounts. These balances can be instantly liquid and are considered highly secure means of storing value.
Special Considerations
Risk and Return
Financial assets differ widely in terms of risk and return. Stocks might offer higher returns but come with greater volatility, whereas bonds usually provide more predictable but lower returns. The risk-return trade-off must be carefully considered.
Liquidity
The liquidity of financial assets varies. Stocks and bonds are relatively liquid because they can be quickly sold in the markets, whereas some certificates and specific rights might not be as easily convertible to cash.
Examples
Real Property vs. REITs
- Real Property: Tangible asset, represents physical ownership of land or buildings.
- Real Estate Investment Trust (REIT): Financial asset, represents indirect ownership through shares in a trust that owns and manages a portfolio of properties.
Company Bonds
A corporation might issue bonds to raise funds. Investors who purchase these bonds are essentially lending money to the company and will receive interest payments over time, along with the principal amount upon maturity.
Historical Context
Financial assets have evolved substantially over centuries. Originally, such instruments were simple promissory notes or bonds; today, complex derivatives and structured financial products offer various ways of leveraging and hedging financial positions.
Comparisons
Tangible vs. Financial Assets
- Tangible Assets: Physical form, includes real estate, machinery, commodities.
- Financial Assets: Non-physical claims, includes securities like stocks and bonds, and bank balances.
Equity vs. Debt Instruments
- Equity: Represents ownership (e.g., stocks).
- Debt: Represents a loan with an obligation to pay back (e.g., bonds).
Related Terms
- Derivative: Financial securities whose value is derived from an underlying asset like stocks, bonds, or commodities.
- Liquidity: The ease with which an asset can be converted into cash.
- Market Capitalization: The total market value of a company’s outstanding shares, used to measure a company’s size.
FAQs
What are Financial Assets?
How do Financial Assets differ from Tangible Assets?
Are Financial Assets Liquid?
References
- Mankiw, N. Gregory. Principles of Economics. Cengage Learning, 2014.
- Bodie, Zvi, Alex Kane, and Alan J. Marcus. Investments. McGraw-Hill Education, 2014.
- Fabozzi, Frank J. Bond Markets, Analysis, and Strategies. Pearson, 2012.
Summary
Financial assets play a crucial role in the modern economy by allowing individuals, corporations, and governments to manage and allocate capital efficiently. Understanding the different types of financial assets, their risk-return profiles, and how they compare to tangible assets are essential for making informed investment decisions.
