What Does Financial Assets Include?

Financial assets are non-physical assets that derive their value from a contractual claim or ownership right. They include cash, bank deposits, stocks, bonds, derivatives, and other securities. Financial assets are usually more liquid than tangible assets, such as property or machinery, meaning they can be easily converted into cash or exchanged for other assets. Financial assets are also subject to market fluctuations, which can affect their value and performance.

The main purpose of investing in financial assets is to generate income, capital appreciation, or both. Financial assets can provide various benefits to investors, such as:

• Diversification: Financial assets can help investors reduce their overall risk by spreading their portfolio across different asset classes, sectors, regions, or strategies.
• Higher Returns: Financial assets can offer higher returns than traditional savings accounts or fixed deposits, which can help investors achieve their financial goals faster.
• Security: Financial assets can provide a degree of security to investors, as they are backed by contractual claims or ownership rights. Some financial assets, such as bank deposits or government bonds, are also insured or guaranteed by the government or other entities.
• Flexibility: Financial assets can provide flexibility to investors, as they can be easily bought or sold in the market or transferred to other parties. Investors can also adjust their portfolio according to their changing needs, preferences, or market conditions.

However, investing in financial assets also involves some risks, such as:

• Market Risk: Financial assets are exposed to market risk, which is the risk of losing value due to changes in market prices, interest rates, exchange rates, or other factors. Market risk can be influenced by various economic, political, social, or environmental events or trends.
• Credit Risk: Financial assets are exposed to credit risk, which is the risk of not receiving the contractual payments or returns from the issuer or counterparty of the asset. Credit risk can be influenced by the financial condition, performance, or reputation of the issuer or counterparty.
• Liquidity Risk: Financial assets are exposed to liquidity risk, which is the risk of not being able to sell or buy the asset quickly or at a fair price. Liquidity risk can be influenced by the supply and demand of the asset, the trading volume, the market depth, or the transaction costs.

Therefore, investors need to understand the characteristics, advantages, disadvantages, and risks of different types of financial assets before investing in them.

Types of Financial Assets

There are many types of financial assets that investors can choose from. However, for simplicity, we can classify them into four main categories: cash and cash equivalents, equity instruments, debt instruments, and derivatives.

Cash and Cash Equivalents

Cash and cash equivalents are the most liquid type of financial assets. They include money in hand, bank deposits, money market fundsMoney Market FundsMoney market funds refer to a type of mutual fund that invests in high-quality short-term debt securities with low credit risk such as treasury bills (T-bills), commercial paper (CP), repurchase agreements (repos), etc.read more, certificates of depositCertificates Of DepositA certificate of deposit (CD) refers to a savings certificate issued by a bank that pays a fixed interest rate on a specified amount for a specified period.read more, and treasury billsTreasury BillsTreasury Bills (T-Bills) are investment vehicles that allow investors to lend money to the government.read more. They have a maturity periodMaturity PeriodMaturity period refers to the time period for which an investment is made or the time period at which the investment contract expires. It is also the time period at which the bond issuer will return the principal amount to the bondholder.read more of less than one year and are usually measured at their face value or amortized costAmortized CostAmortized cost is the amount at which a financial asset or liability is measured at the time of its initial recognition and includes the transaction costs and the principal repayments and interest payments.read more.

Some examples of cash and cash equivalents are:

• Cash in hand: This is the physical money that an investor has in their possession, such as coins, notes, or cheques. Cash in hand is the most liquid and accessible form of financial asset, but it also has the lowest return and the highest risk of theft or loss.
• Bank deposits: These are the amounts of money that an investor has in their bank account, such as savings account, current account, or fixed deposit account. Bank deposits are also very liquid and accessible, as they can be withdrawn or transferred at any time. They also have a low risk, as they are insured by the government up to a certain limit. However, they also have a low return, as they usually pay a low or zero interest rate.
• Money market funds: These are mutual funds that invest in short-term debt securities with high credit quality and low interest rate risk, such as treasury bills, commercial paper, or repurchase agreements. Money market funds are relatively liquid and safe, as they aim to maintain a stable net asset value (NAV) of $1 per share. They also offer a higher return than bank deposits, as they pay a variable interest rate based on the market conditions. However, they also have some fees and expenses that can reduce their net return.
• Certificates of deposit: These are debt instruments issued by banks or other financial institutions that pay a fixed interest rate for a fixed period of time, usually ranging from one month to five years. Certificates of deposit are less liquid than bank deposits or money market funds, as they have a penalty for early withdrawal. They also have a higher risk than bank deposits, as they are not insured by the government beyond a certain limit. However, they also offer a higher return than bank deposits or money market funds, as they pay a higher interest rate for longer maturity periods.
• Treasury bills: These are short-term debt securities issued by the government that pay no interest but are sold at a discount to their face value. Treasury bills have a maturity period of less than one year, usually ranging from four weeks to 52 weeks. Treasury bills are very liquid and safe, as they can be easily bought or sold in the market or redeemed by the government at maturity. They also have a low risk, as they are backed by the full faith and credit of the government. However, they also have a low return, as they pay no interest but only reflect the difference between their purchase price and their face value.

The advantages of cash and cash equivalents are:

• They provide liquidity and accessibility to investors, as they can be easily converted into cash or used for transactions.
• They provide security and stability to investors, as they have a low risk of default or loss of value.
• They provide flexibility and convenience to investors, as they can be easily adjusted according to their needs or preferences.

The disadvantages of cash and cash equivalents are:

• They provide low returns to investors, as they pay low or zero interest rates or reflect minimal capital appreciation.
• They provide low diversification to investors, as they are highly correlated with each other and with the market conditions.
• They provide low protection to investors, as they are vulnerable to inflationInflationInflation is an economic concept that refers to increases in the price level of goods over a set period of time. The rise in the price level signifies that the currency in a given economy loses purchasing power (i.e., less can be bought with the same amount of money).read more or currency depreciationCurrency DepreciationCurrency depreciation refers to when one country’s currency loses its value relative to another currency due to economic factors such as inflation rates, interest rates, trade deficits etc.read more that can erode their real value.

Equity Instruments

Equity instruments are financial assets that represent ownership rights in an entity. They include common stocksCommon StocksCommon stock is an equity component that represents ownership in an entity.read more, preferred stocksPreferred StocksPreferred stock (also called preferred shares) is a hybrid security that has characteristics of both debt and equity. It represents ownership in a company but does not entitle holders to voting rights.read more, stock optionsStock OptionsStock options refer to contracts that give holders (buyers) the right but not obligation to buy/sell an underlying security at an agreed-upon price on/before an agreed-upon date.read more, warrantsWarrantsWarrants refer to financial instruments issued by companies that give holders (buyers) rights but not obligations to buy/sell underlying securities at an agreed-up.