A week or so ago I said I would post about the different types of financial assets. This is it. Types of Assets: Investment Asset: The study of investments is about selecting investment assets. An investment asset is any asset that an investor buys with the goal of increasing his or her wealth. Financial Assets vs Real Assets: Investment assets may be divided into two broad categories. -Financial assets are claims to income streams produced by other assets. Typically financial assets are defined as stocks and bonds. -Real assets are tangible assets with a physical presence. A landlord who owns rental properties have real assets. Financial assets and real assets can both be placed in finer classes. Types of Financial Assets: There are three broad categories of financial assets: equity, debt, and derivatives. -Equity: Equity represents an ownership claim. Common equity, like securities that are traded on the stock market, represents ownership in a corporation. Common equity has a claim to the residual income of a corporation, that is, the income that is left over after all other claims are paid. These claims by common equity to a corporation’s net income are issued in the form dividends, as declared by the board of directors. Another form of equity is preferred equity. Owners of preferred equity are paid a stated dividend amount and will experience little capital appreciation. -Debt: Debt instruments are IOUs issued by governments, corporations and other entities. Debt instruments may be divided into money-market instruments and long-term debt. Money-market instruments are generally defined as debt issues with an original maturity date of less than one year. Generally, money-market instruments do not pay interest. Instead, money-market debt is issued and bought by investors at a discount from face value and receives a return as the money-market debt increases to face value at its maturity date. Long-term debt may take several forms but generally long-term debt is issued with a maturity date and a coupon rate. The face value of this type of debt will be paid at maturity. Equal periodic interest payments are made in accordance with the coupon rate and face value. We will study debt more in later lectures. -Derivatives: The term, derivatives, is used because the value of this financial asset is derived from the value of an underlying asset. There are two main types of derivatives: options and futures. An investor can buy either a call option or a put option. A call option allows an investor to buy the underlying asset at a certain price over a certain time period. A put option allows an investor to sell the underlying asset at a certain price over a certain period of time. An investor will choose to buy a call or a put depending on whether the investor is bullish or bearish. A bullish investor thinks that the price of an asset will increase, while a bearish investor thinks that the price of an asset will decrease. So, would a bullish investor choose to buy a call or a put? A bullish investor, an investor who thinks the price of a particular asset will increase, would buy a call. So, would a bearish investor choose to buy a call or a put? A bearish investor, an investor who thinks the price of an asset will decrease, would buy a put. The holder of a call or put may or may not choose to exercise their right to buy or sell an underlying asset. That is why this is called an option. The investor has the option to exercise their position. Options are used most frequently with common equity as the underlying asset. Bullish and bearish investors may also purchase futures. A future contract requires the investor buy or sell a certain number of units of a particular asset. Future contracts may deal with common stocks or other financial assets, but future contracts deal primarily with real assets such as agricultural commodities. A futures contract is created by a trade in the future market. In a trade creating a futures contract one side of the trade agrees to make delivery of a commodity at a certain price on a certain date in the future. The other side of the trade agrees to accept delivery of the commodity at that same price and date. Bullish investors will agree to accept delivery of the commodity, thinking that the market price will increase. This way the bullish investor can buy cheap on the futures market and sell high on the current or spot market (eventually). Bearish investors agree to make delivery of the commodity, thinking that the market price will decrease. This way the bearish investor can buy cheap on the spot market, and sell high on the future market. Types of Real Assets: There are a number of different classifications for real assets. They tend to be divided into four broad categories. -Real Estate: Real estate, land and buildings, is the largest category of real assets. Real estate may be divided into categories such as: undeveloped land, single unit housing (rental units), multi-unit housing, and commercial real estate. -Precious Metal & Gems: Precious metals and gems have long served as investment alternatives. The most popular investment asset in the precious metal category tends to be gold. Investors bullish on gold are often referred to as “gold bugs.” Gold prices are regularly reported in the financial press. On July 24th, 2013, gold was selling for $1,328 per troy ounce. Historically, gold has not been a good long-term investment. Other precious metals include silver, platinum, and various other rare metals. There are many different ways one can invest in precious metals. If an investor wants to invest in gold, for instance, an investor can physically buy gold bullion, gold jewelry, or gold coins. The other option for a gold investor is to buy financial assets such as gold mining stocks, options on gold, and gold futures. -Collectibles: “Investors” buy various types of collectibles in hopes that they will increase in value. These include, but are not limited to, fine art, antiques, beanie babies, wine, comic books, baseball cards, etc. There are a couple of notes that need to be added. The first is that it costs money to maintain collectibles, especially true for fine art. The second is that the value of collectibles tend to be subject to fads. The value of a great baseball card collection is much less today than it was 15 years ago, but the market for vintage vinyl and music memorabilia is booming. The last is that collectibles are not considered an investment if the holder of the collectible is not willing to part with it. For instance, if a collector holds the worlds greatest collection of Marvel comic books, but would never dream about selling them, the comic books are not considered an investment (although he will tell his wife it is!). -Commodities: Commodities are assets which are used in production processes and which fluctuate in value. These include, for example, grains, cattle, oil, and common metals such as copper and aluminum. Bullish investors buy the commodity that they think is on an upward trend with the hopes of selling the commodity at more than what they bought it for, or at a profit. As with precious metals, an investor can choose to invest in commodities using financial assets rather than buying its real asset directly. The use of futures contracts allow both bullish and bearish investors to participate in the futures market. Misc. definitions Portfolio and Portfolio Effect: Investors generally do not buy a single investment asset. Instead, investors hold a group of investment assets which is referred to as a portfolio. A portfolio may consists of any combination of real and/or financial assets. As the size of a portfolio increases an important thing occurs; the portfolio effect. The portfolio effect is the idea that the overall risk of a portfolio becomes smaller than the average risk of the securities included in the portfolio. This occurs because of diversification. Not all securities will move in concert with one another. If security A decreases in value, Security B may increase in value, offsetting the negative impact from Security A. The more assets that are in a portfolio, the greater the likelihood that these offsets will occur. And, the less impact anyone one security has on the overall fluctuation of a portfolio. Types of Investors: Investors may be divided into two types: individual investors and institutional investors. -Institutional investors include investment companies which pool money of other investors to purchase a portfolio of assets. Small investors can place money into mutual funds, closed-end funds and private equity funds. -Institutional investors also include firms such as Goldman Sachs and Smith Barney. These firms engage in a wide variety of activities including buying and selling securities and offering investment advice. All of these institutions are to have buy and sell side activities. Employment Opportunities: Investment employment opportunities also have a buy and sell side. -The sell side includes commercial banks, brokerage firms, mutual funds and insurance companies. Despite negative stereotypes about pushy insurance salesman and cold calling, if the sales position provides a financial services this is a tremendous opportunity to help others and achieve good financial rewards. If you enter the sell side you should plan to get your CFP (Certified Financial Planner) certificate. -The buy side involves conducting investment analysis to select securities for a portfolio managed by a mutual fund or other institutional investors. A position on the buy side is much more difficult to land. Investment analysis will want to get the CFA (Chartered Financial Analyst) certificate. Many firms hiring investment analyst require that the analyst has or is working on his/her CFA. --------------------------------------------------------------------------- A lot of this information was extracted from an anonymous post someone made once upon a time. Soon Ill post about RRSPs and TFSAs and how they work because that is a common question I get and pretty useful information to know.
Posted on: Wed, 04 Dec 2013 21:22:46 +0000
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