Properties Of Financial Assets talks about the properties and the pricing of financial assets which can as well be liken to the mechanism that enhances the funding and the pricing of an assets.
The properties of financial assets are as follows;
- Divisibility and denomination
- Cash flow
- Term to maturity
- Returns predictability
- Tax status
Explanation For properties of financial assets
Moneyness – It means an asset can be called money and used as a medium of exchange or used in settlement of transaction. Money consists of currency and all others that permit us write cheques. Other asset though not money but very close to money such that they can be converted to money within little time and little loss. These are called near money. They include demand deposit, treasury bills etc.
Divisibility And Denomination – Divisibility is the minimum in which a financial asset can be liquidated and exchanged for money. The smaller the size, the more the financial asset such as a deposit is typically infinitely divisibility down to the penny. Other properties of financial assets have varying divisibility depending on their denomination. That means the Dollars amount each unit of asset would pay at maturity e.g many bonds come in $100 denomination. Certificate of deposit = $5000. Divisibility is desirable for investors but not for borrowers.
Reversibility – Implies the coat of investing in a financial asset and getting out of it back into again. Reversing typical assets that are highly reversiblr is like a deposit in a bank. The transaction cost (if any) may be negotiable. That is why reversibility is referred to as turnaround cost or round trip cost. In a formal financial market, we have “market makers” the most relevant part of your round trip cost is the so called bid ask spread. It is in the spread that commissions cost of delivery an asset is embedded.
The spread charge by the market maker varies in line with the financial assets in question. Some properties of financial assets as listed above are more risky than others. The marketable securities are more liquid than others thus turning them to cash is easier. This spread change very reflecting the level of risk the market assumes while making the market.
This market making risk is related to two main forces. They include the following;
- Variability of the price as measured by some measure of dispersion in the price. The greater the variability, the greater the probability that the market maker may lose. In treasure bills, they are very stable in price. It will exhibit sort run. A speculative stock will exhibit much larger short run variations.
- The thickness of the market; by this we refer to the frequency of transactions. A thin market, in essence, one that has few trades on a regular or continuing basis, but the greater the order flows the shorter the time that security will be held in the market maker inventory and hence the smaller the probability of an unfavourable price movement while being held. A thick market is one where frequent transaction is going on. Thickness varies from market to market. A particular market for a given shares may be thin while the other may be thick, for example the Cadbury, treasury bills, shares of small companies will have thinness of the market.
Cash Flow – the return an investor is going to realize by holding a financial assets depends on all the cash distributions which that financial assets is going to pay its owners example given, dividend couple yield payments (for bonds). This is the price we discount. The return also consider the repayment of the principal for a debt security and an expected returns, we must consider such things as non cash payments ( in form of stock dividend yield) and options to purchase additional stock or the distribution of other securities also be accounted for. Owning to inflation, we need to distinguish normal effective returns from real effective returns, the net real return is the amount we get after adjusting the normal against inflation.
Term To Maturity – as one of the properties of financial assets, this entails the length of time taken the instrument to make its final payment or the owner is entitled to demand liquidation. Such instruments we know for which the creditor can ask for repayment at any time is the demand deposit and savings accounts deposit. There other instruments like bond where maturity is an important characteristics which can range from one day to decades. In United states Of America, we have consuls or perpetual bonds, equities are some form of perpetual instruments.
Some financial assets have stated maturity which may terminate before the stated maturity. This is accounted for by some reasons;
- Call provision
It is an important character of a financial asset. It may place within the same class, example given, bond to bond of other times it can be converted into other classes. Firms can have the bonds they issued converted to equity shares.
As properties of financial assets, preferred stock can also be converted into equity shares. The conditions for conversion is usually spelt out in the legal document at the initial investment time.
Currency – Currency is one of the properties of financial assets being that following the globalization of some form of currency like (crypto currency) which is globally used. It is important to know the currency in use. The currency in which a financial asset is bought is important. Some currencies cannot be converted into hard currencies (in essence the currency in which you are to be paid). Dual currency securities may be issued to cushion the effect of the currency. Example given, Euro bond pays interest in one currency and principal in another currency.
Liquidity – liquidity means that certain things cannot be converted to money, even as one of the properties of financial assets. Example given, stock of a small corporation or the bond issued for a small school district. The market for these is very thin. One may have to find the suitable buyers. To sell it off to brokers will cost you a great discount. Another illiquid financial asset is a private pension fund which can only be cashed at retirement. Liquidity also depends on not just the quantities.
A small quantity may be very liquid while a large one will run into illiquidity problems.
The Return Predictability – this is one of the basic properties of financial assets and also a major determinant of investment. The unpredictability to future returns can be measured and how it relates to the level of violability of an asset. Volatility is as a result of happenings in the economy. The cash flow may be a residual payment like the shareholders. In government security treasury bonds, etc these are riskless. Corporate cash flows are riskier than government securities represent a wide range of risks. The inflation factor reduces the degree of returns.
Complexity – the complex financial assets can be obtained by combining two or more simpler assets. To find the time price of that callable assets untie the assets to fund their real value, buying bonds of other countries.
Tax Status – here government regulation comes in, this vary widely if not wildly. Tax rate vary from year to year and from country to country etc. It differs from one financial asset to another depending on the nature of the issuer.
In all, one can simply deduce the importance of these 10 properties of financial assets, they form the heart beat of a financial businesses.