Generally speaking, an asset is anything a person owns that has value. Financial assets are the assets that derive their value from a contract or other claim. The majority of financial assets aren’t physical although there may be some physical forms as well. Keep on reading to find out the examples of financial assets, their main types, and how they work.
Definition of Financial Assets
This is a liquid asset that receives its value from an ownership claim or contractual right. A financial asset is a contractual claim to something of value.
There are four main types of financial assets in modern economies: stocks, bonds, bank deposits, and loans. In real life, there are even more kinds of financial assets including calls, derivatives, and puts but knowing about the basic four types is important.
Many people aren’t sure what to know about personal loans or bank deposits but these are the types of financial assets you should learn about to avoid mistakes. Financial assets don’t have inherent physical worth or physical form, unlike property, commodities, or land. Instead, their value reflects factors of demand and supply in the marketplace and the risk they carry.
Types of Financial Assets
Here are the four main types of financial assets and how they work:
Cash and Its Equivalents
It includes certificates of deposit, savings deposits, money market funds, and money market deposit accounts. Such assets are considered strong and safe investments by the federal government.
An agreement should be signed with the financial institution for deposit accounts. You will receive monthly statements mentioning the value in your account. The FDIC usually insures accounts up to $250,000. The type of deposit account is defined by how often money can be withdrawn.
These are ownership claims. If a venture issues stock, the company is exchanging cash for an equal ownership stake in the company. Generally, stocks may also be called equities as they represent equal shares.
This ownership stake entitles the client who owns that stock to a portion of the profit the venture makes, called dividends. Generally, stocks are the riskiest financial assets but they also present the potential for development.
The publication The Basis of Assets issued by the IRS.org states that the basis of stocks and bonds you purchase is typically the purchase price plus any costs of purchase including transfer fees or commissions.
If a consumer buys stocks and bonds other than by purchase, their basis is generally defined by the fair market value (FMV) or the previous owner’s adjusted basis of the stock.
Governments and companies issue bonds to receive cash today in exchange for funding in the future. Bonds don’t give the owner any ownership claim while stocks usually do. A bond is just a lending option and its value to the person who purchases it is based on its maturity and coupon payments.
Maturity is the length of time until a person is paid a fixed sum of cash. This fixed sum is the par value. In other words, this is the type of fixed-income investment where the bond issuer borrows funds from an investor. Bonds work similarly to loans in the way that the lending company promises to repay the bond at an agreed date.
These are near-term business assets where the customer guarantees to pay for the product or service in less than a year and signs a contract. The value of accounts receivable is based on what is owed, unlike other financial assets. This asset is utilized in the balance sheets of many businesses and even universities.
Pros and Cons of Highly Liquid Financial Assets
Cash and cash equivalents like savings accounts, checking accounts, as well as money market accounts are the purest form of financial assets. Liquid accounts can be turned into funds for covering monetary disruptions and paying bills.
Other financial assets may not be as liquid. What is liquidity? This is the ability to change a financial asset into cash fast.
Liquid markets usually have lots of sellers and buyers. In the case of stocks, this is the ability of an investor to sell and buy holdings from a ready market.
As for stocks and bonds, an investor needs to sell and wait for the settlement date to get their funds. It usually takes a couple of business days. If you want to have greater preservation of capital, you should maintain funds in liquid financial assets.
Liquid assets like savings and checking accounts have a limited return on investment (ROI) capability. This is the profit you get from an asset divided by the cost of owning that asset. The savings and checking accounts have minimal ROI. Here are the benefits and downsides of highly liquid financial assets.
- some financial assets have the ability to appreciate in value;
- liquid financial assets convert into cash fast;
- the NCUA and FDIC insured accounts for up to $250,000.
- liquid financial assets might be hard to convert to cash;
- highly liquid assets have little appreciation;
- the value of a financial asset is only as strong as the underlying entity.
Real-World Example of Financial Assets
Individuals and businesses like eWorldtrade hold different financial assets. In the case of asset management or investment company, the financial assets include the funds in the portfolios firm handles for consumers, called assets under management (AUM). For instance, BlackRock Inc. is the major investment manager in the USA and around the globe, judging by its $6.84 trillion in AUM.
As for banking institutions, financial assets include the worth of the outstanding loans they made to clients. The tenth largest bank in the USA is Capital One, It reported $373,191 million in total assets in 2019, of that $240,273 million were from commercial, real estate-secured, and industrial loans.
The Bottom Line
A financial asset is a liquid asset that receives its value from an ownership claim or contractual right. Common examples of financial assets are stocks, bonds, cash, cash equivalents, and bank deposits. While land, commodities, and property are physical assets, financial assets don’t usually have physical form or physical worth.