What are Financial Assets?
Financial assets can be defined as investment assets whose value is derived from a contractual claim of what they represent. These are liquid assets as the economic resources or ownership can be converted into matter, such as cash. These are also referred to as financial instruments or securities. They are widely used to finance real estate and ownership of tangible assetsTangible AssetsTangible assets are assets with significant value and are available in physical form. It means any asset that can be touched and felt could be labeled a tangible one with a long-term valuation..
These are legal claims, and these legal contracts are subject to future cash at a predefined maturity valueMaturity ValueMaturity value is the amount to be received on the due date or on the maturity of instrument/security that the investor holds over time. It is calculated by multiplying the principal amount to the compounding interest, further calculated by one plus rate of interest to the period's power. and predetermined time frame. These are a crucial part of any organization. It always needs to have a good record of its financial assets list to be put to use whenever needed, like in financial emergencies.
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Financial Assets Explained
Financial assets are a crucial component of an individual’s or organization’s wealth and investment portfolio. These assets are a broad category that encompasses a variety of instruments designed to generate economic value over time. They can be easily converted into cash and traded in the financial markets. Understanding financial assets is essential for making informed investment decisions.
Financial assets typically fall into several key categories, including equities (stocks), fixed-income securities (bonds), cash and cash equivalents, and alternative investments like real estate investment trusts (REITs) and commodities. Each of these asset classes carries its own level of risk and potential return.
Equities represent ownership in a company and are traded on stock exchanges. Investing in stocks can provide the opportunity for capital appreciation and potential dividends.
Fixed-income securities, such as bonds, represent loans made by investors to corporations or governments. They pay periodic interest and return the principal amount at maturity.
Cash and cash equivalents include liquid assets like bank deposits, money market funds, and short-term government securities. They provide safety and liquidity.
Investors allocate their resources among these asset classes based on their financial goals, risk tolerance, and time horizon. The goal is to create a diversified portfolio that maximizes returns while managing risk.
Hence, financial asset management is the building blocks of wealth and investment, and understanding them is fundamental to achieving one’s financial goals. Balancing the various asset classes in a portfolio is a strategic approach to secure financial well-being.
Let us understand the different types of assets in the financial assets list through the detailed explanation below.
#1 – Certificate of Deposit (CD)
This financial asset is an agreement between an investor (here, a company) and a bank institution. The customer (Company) keeps a set amount of money deposited in the bank for the agreed term in exchange for a guaranteed interest rate.
#2 – Bonds
This financial asset is usually a debt instrumentDebt InstrumentDebt instruments provide finance for the company's growth, investments, and future planning and agree to repay the same within the stipulated time. Long-term instruments include debentures, bonds, GDRs from foreign investors. Short-term instruments include working capital loans, short-term loans. sold by companies or the government to raise funds for short-term projects.A bond is a legal documentA Bond Is A Legal DocumentBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period. that states the money the investor has lent the borrower, the amount it needs to be paid back (plus interest), and the bond’s maturity date.
#3 – Stocks
Stocks do not have any maturity date. Investing in stocks of a company means participating in the company’s ownership and sharing its profits and losses. Stocks belong to shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares. until and unless they sell them.
#4 – Cash or Cash Equivalent
This type of financial assetType Of Financial AssetFinancial assets are investment assets that derive their value from a contractual claim of what they represent. Cash and cash equivalents, accounts receivable, fixed deposits, equity shares, debentures/bonds, preference shares, mutual funds, interests in subsidiaries, associates, and joint ventures, insurance contracts, rights and obligations under leases, Share-Based Payments, Derivatives, and Employee Benefit Plans are all examples of financial assets. is the cash or equivalentCash Or EquivalentCash and Cash Equivalents are assets that are short-term and highly liquid investments that can be readily converted into cash and have a low risk of price fluctuation. Cash and paper money, US Treasury bills, undeposited receipts, and Money Market funds are its examples. They are normally found as a line item on the top of the balance sheet asset. reserved with the organization.
#5 – Bank Deposits
These are the cash reserve of the organization with Banks in saving and checking accountsChecking AccountsA checking account is a bank account that allows multiple deposits and withdrawals. Additionally, it provides superior liquidity..
#6 – Loans & Receivables
Loans and Receivables are those assets with fixed or determinable payments. For banks, loans are such assets as they sell them to other parties as their business.
#7 – Derivatives
DerivativesDerivativesDerivatives in finance are financial instruments that derive their value from the value of the underlying asset. The underlying asset can be bonds, stocks, currency, commodities, etc. The four types of derivatives are - Option contracts, Future derivatives contracts, Swaps, Forward derivative contracts. are financial assets whose value is derived from other underlying assets. These are contracts.
All the above assets are liquid assetsLiquid AssetsLiquid Assets are the business assets that can be converted into cash within a short period, such as cash, marketable securities, and money market instruments. They are recorded on the asset side of the company's balance sheet. as they can be converted into their respective values as per the contractual claims of what they represent. They do not necessarily have inherent physical worth like land, property, commodities, etc.
There is no single measurement classification technique suitable for all these assets. However, they can be classified as Current AssetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc. or Non-Current AssetsNon-Current AssetsNon-current assets are long-term assets bought to use in the business, and their benefits are likely to accrue for many years. These Assets reveal information about the company's investing activities and can be tangible or intangible. Examples include property, plant, equipment, land & building, bonds and stocks, patents, trademark. on a company’s balance sheet.
#1 – Current Assets
It contains those investment assets which are short-term in nature and are liquid investments.
#2 – Non-Current Assets
Non-Current assets like shares of other companies or debt instruments held in the portfolio for more than a year.
Now that we understand the basics, types, and classification of financial assets management, let us apply the theoretical knowledge to practical application through the examples below.
Elton, a software engineer had saved $10,000 and already had a significant exposure in the stock market. To diversify his overall portfolio and ensure efficient risk management, he decided to invest in government bonds.
However, he planned to move to a bigger house in two years. Hence, he chose the bond with a similar time frame. Since his goal was fixed and in the short term, investing in the stock market or any other commodity might have been too much risk.
Therefore, he went with the bond with a fixed interest that would be paid at maturity.
According to a national-level cross-sectional study called the Indian Human Development Survey in 2011-12. This survey studied the role of the availability of bank branches in influencing their customers’ investment in risky financial assets.
It was found that out of 1000 households, at least two would invest in risk assets if there was a bank branch present within a 5 Km radius of their home. This study not only examines the availability of a bank but also the availability of information and support.
Let us understand the advantages of financial assets list through the points below.
- Some of these assets, which are highly liquid, can easily be used to pay bills or to cover financial emergencies. Cash and cash equivalents come under this category. On the other hand, one may have to wait for the stock to get money as they have to be sold in exchange first, followed by settlement.
- It gives investors more security when they have more capital parked in liquid assets.
- It serves as a major economic function of financing tangible assets. It becomes possible with the transfer of funds from those who have a surplus of it to where it is needed for such financing.
- Financial assets distribute the risk as per the preferences and risk appetite of the parties involved in the intangible asset’sIntangible Asset'sIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. investment. It represents legal claims to future cash expected generally at a defined maturity and rate. The counterparties involved in the agreement are the company that will pay the future cash (issuer) and the investors.
Despite the various advantages mentioned above, there are a few factors from the other end of the spectrum that prove to be a disadvantage. Let us understand them through the points below.
- Financial assets (liquid assets) like deposits in savings accounts and checking accounts with banks are greatly limited in their return on investment, as there are no restrictions for their withdrawal.
- Furthermore, these assets like CDs and money market accountsMoney Market AccountsMoney Market Account is the account which receives all the interests from the instruments in the money market according to the agreed-upon terms. This account is separate from that of securities account, it only accounts for the proceeds. may prevent withdrawal for months or years as per the agreement, or they are callable.
- It comes with a maturity date in the contract; attempting to cash out assets before maturity calls for penalties and lower returns.
Financial Assets Vs Real Assets
Let us understand the differences between financial assets and real assets through the comparison below.
- Financial assets refer to intangible assets with monetary value, typically represented by legal ownership or a contractual claim. These assets can include stocks, bonds, cash and cash equivalents, and alternative investments.
- Financial assets are highly liquid, meaning they can be readily converted into cash. They are actively traded on financial markets, making it easy for investors to buy and sell them.
- Different types of financial assets come with varying levels of risk and potential return. For example, stocks offer the potential for capital appreciation and dividends, while bonds provide fixed interest payments.
- Market conditions, interest rates, and economic factors influence financial assets. They can be subject to price fluctuations due to changes in supply and demand.
- Investors often diversify their portfolios by allocating resources among different financial asset classes. This strategy helps spread risk and optimize returns.
- Real assets encompass physical properties like real estate, infrastructure, natural resources, and tangible items such as collectibles and art.
- Real assets derive their value from their utility, scarcity, and demand in the real economy. They often serve practical purposes or have inherent worth.
- They tend to be less liquid compared to financial assets. Selling real assets may take time and involve a more extended investment horizon.
- Real assets can act as a hedge against inflation. They may retain or increase in value as the general price level of goods and services rises.
- They are not as directly influenced by financial market conditions, making them less susceptible to market volatility.
This article has guide to what are Financial Assets. Here we explain its types, examples, advantages & disadvantages, and compare it with real assets. You may also learn more about the following articles –