On hearing the word asset, the first thing that pops up in our heads could be a car or a house. But what is a financial asset exactly?
Financial assets are also assets that bring you value over time. The difference between a physical asset (e.g., real estate) and a financial asset lies in its intrinsic value.
Real estate has its intrinsic value in the sense that it is tangible and has physical existence on the face of the earth. Financial assets do not have an intrinsic value. They derive their value from a contractual claim. Let’s take an example of a financial asset- Mr. Paul has invested his money in the debentures of a company. He has provided a long-term loan to the company.
The company in turn promises Mr. Paul that they would provide a fixed dividend regardless of the company’s profitability. This is a contract between Mr. Paul and the company which will be materialized in the form of a debenture holding certificate. The certificate has no intrinsic value, but its value is derived from the contract existing between Mr. Paul and the company.
Some examples of financial assets are shares, bonds, debentures, money market instruments like treasury bills, and bills of exchange. These can be easily traded in financial markets.
It can also be said that whenever someone invests in the financial structure (capital and loan) of a business firm, they earn a financial asset.
What are other characteristics through which we can identify a financial asset?
How quickly and easily can something be converted into cash determines its liquidity. Financial assets are highly liquid. They can be traded in financial markets. Money market instruments can be bought and sold in a day itself.
A person can also pledge their financial assets to financial institutions to get their loans sanctioned. Let’s suppose Mr. Hamza Ahmed pledged his equity investment worth 10 lacs with the Bank of India to get a loan of 7 lacs. Of course, there are other documents checked for loan sanctions like the health of the company in which Mr. Hamza Ahmed has his equity investment and his credit score. In the above case, if Mr. Hamza turns insolvent, then the Bank of India shall become the owner of the pledged asset (equity shares).
Financial assets can either be short, medium, or long-term based on the financial instrument held by them. Treasury bills, being a money market instrument has a maximum maturity period of 364 days. One can hold a debenture for 6 months or invest in government bonds for a tenure of 10 years.
Financial assets can be easily transferred from one person to another without many formalities.