Updated July 19, 2023
What are Financial Assets?
Financial assets can be defined as an intangible assets whose value is derived from a contractual claim, the assets which are highly liquid and can be converted into cash easily. E.g., Stocks, Bonds, Bank Deposits etc.
Financial Assets are intangible assets that are highly liquid and can be converted into cash immediately when required. These are investment assets whose value is derived from a contractual claim. Financial Assets are also referred as Financial Instruments or securities. These are widely used to generate funds to invest in Tangible assets like Real Estate.
Role of Financial Assets
Role of financial assets are:
- Source of Funds: Financial Assets are often used as a source of Funds. Sometime Organisation or Government raise funds by issuing Corporate Bonds or Govt. Securities. While sometimes an investor can use Loans and Receivable to generate funds.
- Highly Liquid: Credit cards, Saving Accounts are easy sources by which an individual can accumulate money for daily utilities and expenses.
- To generate High Return on Income: Financial assets like Stocks and Derivatives generate high Return on a short span with an applicable market risk.
Types of Financial Assets
The various types are as follows:
- Bonds: Bonds are debt instruments sold by a business entity or government in order to raise funds for short-term projects. A bond contains a a legal document between the borrower and investor that states the amount investor has lent the issuer and how issuer is going to pay the amount back along with the interest rate and maturity date.
- Certificate of Deposit (CD): Certificate of Deposit is an agreement between the investor and bank in which the investor will get the guaranteed rate of interest as per agreed terms in exchange of the amount of money deposited in bank.
- Bank Deposits: Bank Deposits are cash reserves that a customer keep in Banks using saving or checking accounts.
- Stocks: When an investor invest in stocks of a company, he participates in the ownership of the company. Stocks remains with shareholders until they are sold.
- Derivatives: Derivatives are financial instruments whose value is derived from its underlying asset. E.g. Futures, Options.
- Loans & Receivables: Loans and Receivables are the assets that have fixed or variable timely payments.
- Cash or Cash Equivalent: Assets that can be converted in cash easily and immediately comes under cash or cash equivalent.
Financial Assets in the Balance Sheet
Financial Assets are classified on balance sheet as follows:
- Current Assets: Current Assets include those assets which are highly liquid ,i.e., they can be easily converted into cash and are short term in nature. Example – Short-term Investments on balance sheet.
- Non-Current Assets: Non-Current Assets include those assets which will be kept for longer terms. Example – Stocks of a company kept for more than a year.
Measurement of Financial Assets
The value of Financial Assets is mostly derived by demand and supply. If demand for an asset is high, the price will be high and vice-versa. Some Financial Assets are measured at their fair value, while some are measured at their amortised costs.
Following Assets are measured at amortised cost:
- Bonds that are hold till maturity.
- loans and receivables
Following Assets are measured at fair value:
- Stocks and their derivatives
Example of Financial Assets
Following are the example are given below:
1. Bonds
Mark want to purchase a zero-coupon bond with a face value of $10,000, 5 years to maturity with interest rate on the bond as 5% compounded semi-annually. What price will Mark pay for the bond today?
- Mark will pay the present value of all the cash flows. Since there is only one payment that Mark is going to receive and it is 10,000$ after 5 years.
Hence, Present value of Bond will be calculated as discounted value of 10000$ today.
- Price of bond = $10,000 / (1+0.05/2)5*2
- Price of bond = $7811.20
Hence, Mark will $7811.20 today and will receive $10,000 after 5 years.
2. Stocks
Sheen purchased 1000 shares of ABC Inc with a share price of 50$ on 21 April’2019 . ON 16 June’2019, ABC Inc was trading at 60$. Sheena thought of realizing the profit. She sold all 100 shares at 60$. What profit/loss does Sheena realized after selling the stocks.
- On 21 April 2019, Sheena paid = 50*1000 = 50,000$ to buy 1000 shares of ABC Inc.
On 16 June’2019, Sheen sold 1000 shares at 60$, so total sell value = 60*1000 = 60,000$
Net Profit = Selling Value – Buying Value
- Net Profit = 60,000$ – 50,000$
- Net Profit = 10,000$
By the deal , Sheena made a profit of 10,000$.
Financial Assets vs Real Assets
Financial assets are highly liquid assets which are either cash or can be converted into cash quickly. Examples are Stocks, Bonds, Saving Accounts. Real Assets are tangible assets that an entity/owner owns. Real Assets includes Real Estate, commodities, buildings, ships, cars. Real Assets are less liquid as it is quite difficult to get a buyer for a land you owns.
The value of Real Assets is very much dependent on various factors like location, operation costs, while Financial assets are independent of location. The value of Real Assets increases or decreases slowly while the value of Financial Assets like stocks and derivatives can vary gradually.
Real Assets have a positive correlation with inflation as Inflation goes high, asset price also raises. Real assets have high transaction costs on comparing with Financial Assets. Real Assets have higher maintenance costs as compared to Financial Assets. Real Assets does not depend on Financial Market volatility while Financial Assets does.
Advantages
Some of the advantages are:
- Assets that are highly liquid and can easily be converted into cash can be used to pay bills or to cover financial urgencies. An example would be Saving Accounts.
- Some financial assets usually provide Higher interest rate. For an example, stocks can provide high interest rate from 1% to 1000%.
- Corporate Bonds or Govt Securities bonds provide payment at each tenure along with the interest rate. Bonds are usually considered as safe during financial crisis.
- Credit cards are being used as an instrument to directly payoff daily household utilities.
- Savings account does not carry high interest rate but are usually secured.
- Derivatives like Future and Options are best way to get high Return on Income in a very short span.
Disadvantages
Some of the disadvantages are:
- Some Financial assets like Saving Account provide very low interest rate that can’t even beat inflation.
- Some Financial Assets like Stocks and Derivatives provide high Return on Income but are so risky that even an investor can go bankrupt.
- Its like Certificate of Deposits have a lock in period due to which investor can not withdraw funds before maturity and on doing so will be charged with penalty.
- Some Corporate bonds are even callable in which Issuer can reborrow the bond at beneficial price if market rate moves lower.
- The value of most of the Financial Assets is based on demand and supply.
Conclusion
Financial assets are intangible assets that are highly liquid and can be converted to cash easily. They are used to generate funds to finance Real Estate. Some of these assets like Stocks carries high return on income, but also carries high risk as well.
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