What are Financial Assets?
Financial assets can be defined as an investment asset whose value is derived from a contractual claim of what they represent. These are liquid assets as the economic resources or ownership can be converted into matter, such as cash. These are also referred to as financial instruments or securities. They are widely used to finance real estate and ownership of tangible assets.
Common Types of Financial Assets
According to the commonly cited definition from the International Financial Reporting Standards (IFRS), financial assets include:
- Equity instruments of an entity—for example a share certificate
- A contractual right to receive a financial asset from another entity—known as a receivable
- The contractual right to exchange financial assets or liabilities with another entity under favorable conditions
- A contract that will settle in an entity’s own equity instruments3
In addition to stocks and receivables, the above definition comprises financial derivatives, bonds, money market or other account holdings, and equity stakes. Many of these financial assets do not have a set monetary value until they are converted into cash, especially in the case of stocks where their value and price fluctuate.
Aside from cash, the more common types of financial assets that investors encounter are:
- Stocks are financial assets with no set ending or expiration date. An investor buying stocks becomes part-owner of a company and shares in its profits and losses. Stocks may be held indefinitely or sold to other investors.
- Bonds are one way that companies or governments finance short-term projects. The bondholder is the lender, and the bonds state how much money is owed, the interest rate being paid, and the bond’s maturity date.
- A certificate of deposit (CD) allows an investor to deposit an amount of money at a bank for a specified period with a guaranteed interest rate. A CD pays monthly interest and can typically be held between three months to five years depending on the contract.
Types of Financial Assets
Below is a breakdown of the most common types of financial assets, specifically for investors.
Cash and Cash Equivalents
Cash and cash equivalents include any savings deposits, certificates of deposit (CDs), money market deposit accounts, and money market funds. These assets are considered safe, strong investments by the federal government. A CD, for example, is a type of savings account offered by banks and credit unions that typically earns interest at a fixed rate.
For deposit accounts, you sign an agreement with the financial institution and get monthly statements stating the value in the account. Accounts are generally insured up to $250,000 by the FDIC, and the type of deposit account is determined by how often funds can be withdrawn. For example, checking or demand deposit accounts can be used whenever you want, while CDs lock up your cash for a preset period.
Generally, accounts receivable are short-term business assets where a customer signs a contract, guaranteeing they will pay for the service or product in less than a year. Unlike the other financial assets, the value of receivables is based on what is owed and the probability of payment. This type of asset is used in the balance sheets of many businesses as well as universities, including Cornell University.
Stocks are often considered the riskiest financial assets, but they also offer the greatest potential for growth. Stocks represent ownership in a publicly traded company, which means when you buy a company’s stock, you become part owner of that business.
Bonds are a type of fixed-income investment in which the bond issuer borrows money from an investor. They function similarly to loans in that the borrowing organization promises to pay the bond back at an agreed-upon date. They enable companies to finance short-term projects and tend to offer modest returns.
- Some of these assets, which are highly liquid, can easily be used to pay bills or to cover financial emergencies. Cash and cash equivalents come under this category. On the other hand, one may have to wait for the stock to get money as they have to be sold in exchange first, followed by settlement.
- It gives investors more security when they have more capital parked in liquid assets.
It serves as a major economic function of financing tangible assets. It becomes possible with the transfer of funds from those who have a surplus of it to where it is needed for such financing.
- Financial assets distribute the risk as per the preferences and risk appetite of the parties involved in the intangible asset’s investment.
- It represents legal claims to future cash expected generally at a defined maturity and rate. The counterparties involved in the agreement are the company that will pay the future cash (issuer) and the investors.
- Financial assets (liquid assets) like deposits in savings accounts and checking accounts with banks are greatly limited in their return on investment, as there are no restrictions for their withdrawal.
- Furthermore, these assets like CDs and money market accounts
- may prevent withdrawal for months or years as per the agreement, or they are callable.
- It comes with a maturity date in the contract; attempting to cash out assets before maturity calls for penalties and lower returns.