Definition
Financial assets, in finance, are assets that are either cash, a contractual right to receive cash or another financial instrument from another entity, or an equity instrument of another entity. They can be categorized into cash & cash equivalents, equity-based financial assets, debt-based financial assets, or derivative financial instruments. They are primarily used as investments which can be sold when they appreciated in value.
Key Takeaways
- Financial Assets are a type of investment that grant their holder a claim on the revenue or income of the issuer. This claim exists in the form of stocks, bonds, or bank deposits.
- Financial assets bring in streams of income or potential profits in the form of dividends, interest, or capital gains. They can often be quickly converted into cash or cash equivalents, making them highly liquid.
- Different types of financial assets, such as bonds, stocks, and cash, react differently to changes in market conditions. This is why diversification, or spreading investments among different types of financial assets, can lower investment risk.
Importance
Financial assets hold significant importance in the finance world because they represent an individual’s, company’s, or country’s economic resources or wealth.
These assets, which include cash, stocks, bonds, mutual funds, or insurance contracts, can be leveraged to generate additional income or capital gains over time.
They serve as an investment tool and act as a cushion for future uncertainties, playing a critical role in financial planning and risk management.
Furthermore, the value and performance of financial assets provide crucial insights into the financial state and stability of the entity that holds them, aiding investment decisions and the assessment of economic trends.
Explanation
Financial assets serve as a critical measure in evaluating the economic health of an individual or a corporation. Their primary purpose is to provide a return on investment (ROI) or income to the owner over time. Essentially, they are investments made with the expectation of generating financial returns.
Financial assets can be used to save or invest money for future needs, form a crucial part of retirement planning, meet unexpected expenses, or generate income through interest, dividends, or capital appreciation. They are income-generating entities that help in wealth accumulation and offer a buffer against financial uncertainties. These assets come in various forms such as cash in hand, funds in bank accounts, stocks, bonds, mutual funds, retirement accounts, and investment properties among others.
Apart from being sources of income or financial growth, they also provide financial security. For corporations, financial assets can be leveraged for business expansion, to manage cash flow effectively, and to mitigate risks. While the nature of financial assets used can differ based on individual or corporate financial goals, their use forms an integral part of effective financial planning and wealth management.
Examples of Financial Assets
Stocks: Stocks are shares in the ownership of a company, representative of a claim on part of the company’s assets and earnings. They are a core component of most investment portfolios. They are also highly liquid assets, meaning they can be quickly bought or sold.
Bonds: Bonds are essentially a loan made by an investor to a borrower, typically corporate or governmental. The borrower promises to pay back the full loan amount by a certain date and makes regular interest payments to the investor until that time.
Bank Deposits: When individuals or businesses open a checking or savings account or make a term deposit such as a certificate of deposit (CD), the money placed into those accounts becomes financial assets because they have the ability to generate income through interest.
FAQs about Financial Assets
What are Financial Assets?
Financial assets are investment assets whose value is derived from a contractual claim, such as bank deposits, bonds, and stocks. They are typically more liquid than other assets, such as commodities or real estate.
What are the types of Financial Assets?
There are various types of financial assets that include but are not limited to, cash equivalents, stocks, bonds, mutual funds, certificates of deposit, and retirement accounts like 401(k) accounts.
How are Financial Assets valued?
Financial assets are typically valued based on how much they could be sold for in the current market, which can fluctuate based on a variety of factors. For example, stocks are valued at their current market price, while the value of a bond might be based on its face value and the interest it earns.
What is the role of Financial Assets in portfolio diversification?
Diversification is a risk management strategy that usually involves mixing a wide variety of investments within a portfolio. Financial assets, due to their nature, play a crucial role in portfolio diversification. Having a mix of different financial assets can help smoothen out unsystematic risk and potentially enhance returns.
How can Financial Assets generate income?
Financial assets can be a source of revenues in several ways. Dividends from stocks, interest from bonds, and profits from the sale of financial assets are all examples of how financial assets might generate income. The specific method of income generation will depend on the type of financial asset.
Related Entrepreneurship Terms
- Equities
- Bonds
- Cash Equivalents
- Mutual Funds
- Derivatives
Sources for More Information
- Investopedia: This is a comprehensive online resource that offers definitions, explanations, and educational content on a wide variety of financial terms including ‘Financial Assets’.
- Corporate Finance Institute (CFI): CFI provides online certification and training courses for financial professionals. They also have a glossary that explains many finance terms including ‘Financial Assets’.
- Accounting Tools: This resource provides a selection of explanations, courses, and books about accounting information, including topics on ‘Financial Assets’.
- Khan Academy: Khan Academy offers a range of free online courses on various topics. In the finance and capital markets section, it covers financial assets and much more.
