Financial Assets: Characteristics, types and other factors.

Introduction

Tangibility and intangibility of financial assets have been answered differently. There are instruments like gold and silver which always puts confusion. However, in modern day finance most of the financial instruments are intangible because they do not depend on metals like gold or silver for business purposes. At the same time, modern Financial Market are based on intangible instruments where people’s interest matters more than its tangible or intangible nature. This writing is intended to elaborate two major types of financial assets associated with its types. The discussed ones are intangible in nature, and pays an important role in production purposes.

Financial Assets

In simple words, the assets represent claim for future benefit or cash. These assets are formed by establishing contracts between participants. These assets are used for collection of huge amounts of money for business purposes. When an entity agrees for future benefit or payment, in this case, become an issuer of such assets. A person who shows an interest and holds such asset become investor. Broadly financial instruments are designed to support businesses and economies. Mostly, those individuals or entities invest capital who have surplus of funds, and used for raising of funds. There are multiple types of financial assets, but our concern, with respect to financial markets, lies on the following categories:

• Debt instruments
• Equity instruments

Debt Securities

Also known as fixed-income debt securities or instruments. The type of assets is formed by establishing contracts between investor and issuer of the asset. The type of asset is formed for raising huge amount of capital by governments and corporations, and represents borrowing. Issuer, under the contractual obligations, is obliged to pay the fixed income (interest) and the original payment to the investor when the contract matures.

Equity Securities:

General perception of investment is potential profit either in the form of periodic or fixed term interest, or in the form of dividends. However, in financial world, investment in equity securities confers ownership rights to asset holder. Huge amount of capital is raised by companies. Holder of such securities are residual owner. Their claims are fulfilled only when company pay all their debts and obligation made to others. There are no fixed maturity dates in such securities, and asset’s value is determined by company’s performance. There are two major types of equity securities: common stock and preferred stock.

The Liquidity and Illiquidity of Financial Assets

Liquidity

Liquidity refers to the ease with which an asset can be converted into cash or quickly sold without significantly impacting its price. Highly liquid assets are favored because it can be easily bought and sold without causing major price fluctuations. Cash, government bonds, and stocks of large, actively traded companies are examples of highly liquid financial assets.

• Advantages of Liquidity: These assets are flexible and accessible and can be quickly converted into cash. This helps to meet short-term financial needs or take advantage of investment opportunities. Financial assets carry risk but highly liquid assets minify risk and provide opportunity to close position if market situation become unfavorable.
• Disadvantages of Too Much Liquidity: Holding too much liquidity can lead to missed investment opportunities and lower returns. Cash and highly liquid assets often have lower yields compared to riskier investments, such as stocks or real estate. Therefore, maintaining a balance between liquidity and investment returns is crucial for optimizing financial resources.

Illiquidity

Illiquidity refers to the difficulty or inability to sell an asset quickly without significantly impacting its price. Illiquid assets often have limited market demand or require a longer time to find a buyer. Examples of illiquid assets include certain types of real estate, private equity investments, and some types of bonds.

• Challenges of Illiquidity: Illiquid assets can pose challenges, especially when immediate cash is needed. Selling illiquid assets quickly may result in selling at a discount or below the asset’s intrinsic value. This lack of liquidity can also restrict investment choices and limit portfolio diversification.
• Potential Benefits of Illiquid Investments: Despite the challenges, some investors seek illiquid investments for potential long-term benefits. Illiquid assets, such as private equity or real estate, may offer higher returns compared to liquid assets over time. Additionally, they can provide portfolio diversification and a hedge against market volatility.

Why to invest or acquire Financial Assets?

Investing or acquiring financial assets can offer several benefits and opportunities for individuals and businesses. Here are some key reasons why investing in financial assets can be advantageous:

1. Wealth Accumulation: Investing in financial assets provides an opportunity to grow wealth over time. Assets like stocks, bonds, mutual funds, and real estate have the potential to generate returns through capital appreciation, dividends, interest payments, or rental income.
2. Diversification: Holding a diversified portfolio of financial assets can help spread risk across different asset classes, industries, and regions. Diversification can reduce the impact of adverse events on a single investment and improve overall portfolio stability.
3. Income Generation: Many financial assets, such as dividend-paying stocks, bonds, and rental properties, can generate regular income streams. This income can supplement other sources of revenue and contribute to financial stability and cash flow.
4. Inflation Hedge: Certain financial assets, such as real estate and commodities, can serve as a hedge against inflation. As the prices of goods and services rise over time, the value of these assets may also appreciate, preserving purchasing power.
5. Capital Appreciation: Financial assets like stocks and equity investments offer the potential for capital appreciation, where the value of the asset increases over time. This capital growth can lead to significant wealth accumulation, especially in long-term investment strategies.
6. Portfolio Flexibility: Investing in financial assets provides flexibility to adjust portfolio allocations based on changing market conditions, economic trends, and personal financial goals. Investors can rebalance their portfolios, add or reduce exposure to specific assets, and optimize risk-return profiles.
7. Liquidity and Accessibility: Many financial assets, such as publicly traded stocks and bonds, offer high liquidity, allowing investors to buy or sell them easily in financial markets. This liquidity provides access to cash when needed and supports portfolio management strategies.
8. Tax Benefits: Certain financial assets, such as retirement accounts (e.g., 401(k), IRA), offer tax advantages such as tax-deferred growth or tax-free withdrawals under specific conditions. Tax-efficient investing strategies can help minimize tax liabilities and maximize after-tax returns.
9. Long-Term Financial Goals: Investing in financial assets aligns with long-term financial goals, such as retirement planning, education funding, wealth preservation, and legacy building. By starting early and maintaining a disciplined investment approach, individuals can work towards achieving their financial aspirations.
10. Economic Growth and Development: Investments in financial assets contribute to capital formation, support businesses, stimulate economic activity, and drive innovation. This capital flow fuels economic growth, job creation, and overall prosperity in the economy.

Risk associated with financial Assets

Financial assets come with various risks that investors should consider when making investment decisions. Here are some of the key risks associated with financial assets:

1. Market Risk: Market risk, also known as systematic risk, refers to the risk of losses due to factors affecting the overall market, such as economic conditions, interest rate changes, geopolitical events, or market sentiment. Market risk can impact the value of financial assets across various asset classes, including stocks, bonds, and commodities.
2. Volatility Risk: Volatility risk pertains to the potential for rapid and unpredictable price fluctuations in financial assets. Assets with higher volatility may experience significant price swings over short periods, leading to potential gains or losses for investors.
3. Credit Risk: Credit risk, also called default risk, is the risk that the issuer of a financial asset, such as a bond or loan, may fail to meet its financial obligations, resulting in a loss of principal or missed interest payments. Credit risk varies based on the creditworthiness of the issuer and the terms of the asset.
4. Liquidity Risk: Liquidity risk refers to the risk of not being able to buy or sell a financial asset quickly and at a reasonable price. Illiquid assets may have limited market demand or require longer timeframes to find buyers, potentially leading to challenges in executing trades or realizing cash when needed.

Conclusion

Investing or acquiring financial assets can be a strategic approach for individuals and businesses looking to build wealth, generate income, and achieve long-term financial goals. By diversifying portfolios, taking advantage of income-generating opportunities, and leveraging the potential for capital appreciation, investors can optimize risk-return profiles and enhance financial stability. Moreover, financial assets offer liquidity, flexibility, and tax advantages, making them versatile tools for wealth management and economic growth. Whether aiming for wealth accumulation, retirement planning, or funding future endeavors, investing in financial assets aligns with prudent financial planning and can pave the way for a secure and prosperous financial future.