What are Financial Assets
Financial assets are claims on real assets or claims on the income generated by real assets. Real assets are assets used to produce goods and services, such as property, plant, and equipment. Examples of financial assets include stocks and bonds. Financial assets are no more than pieces of paper and a means where individuals hold their claims on real assets.
To understand what financial assets are, we must first distinguish among three types: debt, equity, and derivatives. Debt securities, also known as fixed-income, promise either a fixed stream of income or a stream of income determined by a specific formula, unless the borrower is declared bankrupt. The performance of debt securities is closely related to the financial condition of the issuer.
Debt securities come in a variety of maturities. Money market instruments are debt securities that are short term and generally less risky. Money market securities include U.S. Treasury bills, bank certificates of deposit (CDs), and commercial paper. On the other hand, the fixed-income capital market includes long-term securities, which range from low risk bonds to risky, high yield or junk bonds. Examples of capital market instruments include Treasury bonds (relatively risky), municipal bonds, and corporate bonds.
Unlike debt securities, equity, or common stock, in a firm represents an ownership share in the corporation. Stockholders have a residual claim, meaning they have a claim on anything after everyone else has been paid. In fact, they are not promised any particular payment. However, they may receive dividends if a company has decided to issue them. If the company is successful, the firm's equity will increase. If the company does poorly, the firm's equity will decrease. Thus, the performance of our equity investments is tied to the success of the firm and its real assets. Due to this reason, equities tend to be riskier investments than debt securities.
Lastly, derivative securities are determined by the prices of other assets, such as the prices of bonds or stocks. Examples of derivatives include options, futures, and swap contracts. Derivatives are simply bets, where their value is derived from the prices of other assets. For example, the value of an IBM call option will depend on the price of IBM's stock. The primary use of derivatives is to hedge risks or transfer them to other parties. Derivatives are also used to take highly speculative positions.