Lesson Summary: Financial assets
|financial system||the set of institutions that connect savers with borrowers|
|financial intermediary||an institution that transforms the savings from individuals into financial assets (for the saver) and liabilities (for the borrower); the financial intermediary that people have the most experience with is a bank, which converts the savings and other deposits of many depositors into loans for borrowers.|
|asset||some item of value that is expected to provide the holder some future benefit; factories are an asset because they can be used to produce goods that provide income to a firm in the future, and a bond is an asset to a bondholder because it will provide income in the future.|
|liabilities||requirements to pay money in the future; a loan is a liability for the person who takes out a loan, but an asset to the person who loaned money out.|
|real asset||(sometimes called a physical asset) a claim on a tangible object that gives the owner the right to use it as they wish. A house is a real asset that its owner can sell or rent out, and a factory is a real asset that a business can use to earn profits.|
|financial asset||a contractual claim to something of value; modern economies have four main types of financial assets: bank deposits, stocks, bonds, and loans. In reality, there are many more types of financial assets (like derivatives, calls, puts, and so on), but you only need to know the basics of these four types for this course.|
|financial risk||when there is any uncertainty about the future value of an asset; for example, if you don't know how many lime smoothies you can buy with the money in your savings account next week, the value of your savings account has risk, because inflation can reduce its value.|
|bank deposits||(also called demand deposits) money kept in a bank, like checking accounts; we call these "demand deposits" because banks are usually required to provide access to the money in those accounts immediately on request (in other words, on demand).|
|liquidity||how easily an asset converts to cash without loss of purchasing power; a house might be a store of value, but it's not a very liquid asset because you can't immediately buy a bowl of ice cream with it very easily. Cash is the most liquid asset because you can use it immediately.|
|return||the profit made on an asset, usually expressed as a percentage; for example, a stock that is purchased for and sold for has a return of .|
|bonds||bonds are a form of an IOUs (a promise to pay back some amount in the future); bonds have three key features: the bond’s par, the bond’s maturity, and the bond’s coupon payments.|
|stock||a slice of ownership in a company; if you own one share of a company that has a total of 100 shares, you own of that company. Stocks derive their value from their ability to appreciate and the payment of dividends.|
Cash and demand deposits are the most liquid forms of money
There are many kinds of financial assets
When interest rates increase, bond prices decrease
The interest rate is the opportunity cost of money
The Savings-Investment spending identity
- A lot of people think of loans only as a liability, not an asset, because having a loan means you owe something. Butut to the person who is owed that money, the loan is an asset. Banks count loans as assets because they are a store of value for them. If a bank has made a loan for , that is it knows will be paid back. In fact, banks frequently sell loans to other banks.
- Similarly, people tend to only think of their bank accounts as assets. That’s true, but to the bank that has to pay the account holder that money when they want to withdraw it, that deposit is a liability.
- Money is not just pieces of paper or coins with historical faces it. Money is anything that can serve the three functions of money. That means that anything we believe is performing those functions is money, including printed currency, electronic records, or even the giant stone money on the island of Yap.
- Some people believe that "financial risk" is when you don't know if the value of something is going to go down or not. In reality, financial risk means uncertainty in any direction, not just down.
- A common mistake is to mix up the relationship between bond prices and interest rates. Think of bonds and other financial assets (such as savings accounts) as substitute goods. Like other substitutes, when the price of one goes up, the demand for its substitute goes down. When interest increases (which is basically the “price” you are paid for the money in your savings account), the demand for bonds will decrease. As a result, the price of bonds will decrease.
- Use the format below to create a table describing the four financial assets that includes
|Asset||source of risk||source of return|