Financial Assets and Financial Transactions

1.1. What is the financial asset?
Claim against the income or wealth of an economic unit (business firm, household, and unit of government), i.e., Money, equities, debt securities.

1.2. Types of Financial Assets
Money
Equities
Debt securities

A. Money
Generally accepted in payment for purchasing of goods and services.
Checking account, currency, and coins.
Perfectly liquid asset

B. Equities (Preferred stocks and Common Stocks)
Ownership shares in a business firm, claims against the firm’s profits, and claims against proceeds from the sales of its assets.
Common Stocks: entitles shareholders to voting rights
Preferred Stocks: No voting rights, but priority in claim of earnings. They have features of both debt (must-be-paid-dividends) and equity (investment).

C. Debt Securities
Bonds, notes, accounts payable, saving deposits- IOU entitle their holders to a priority claim (interest payments) over the stock holders
Claim against EBIT (Earnings Before Interest and Tax)
Negotiable: can be transferred to another party - Treasury bonds, corporate bonds
Nonnegotiable: cannot legally be transferred - US savings bonds

1.3. Sources of Financing
Internal Financing: from accumulated savings
External Financing: from outside sources of fund

A. Internal Financing
Households: Disposable income less expenditure
Firms: Retained earnings
Gov’t: Tax revenue

B. External Financing
Households: consumer loans
Firms: Issuing stocks, bond, notes, commercial loans, & other debt instruments
Gov’t: Printing money, and Issuing bonds, notes, & bills
1.4. Money

The Function of Money
Standard of Value (or Unit of account)
Medium of Exchange
Store of Value the Only perfectly liquid asset

A. Unit of Account
The price of a good can be expressed in terms of the monetary base, $, £, €, etc.
Without money, the price of a good would have to be expressed in terms of exchange rates with all other goods.

B. Medium of Exchange
Without money, trading would have to be based on barter system, which requires an exact coincidence of wants in terms of quality, quantity, time, and location

C. Store of Value
Reservation of purchasing power
The value of money suffers from inflation
This implies that holding money yields a negative return due to inflation
The (opportunity) cost of holding money is the forgone income from more profitable investments

D. Perfect Liquid Asset
Money is the only perfectly liquid asset with no cost involved in conversion process (i.e., no fee)
Characteristics of a liquid asset
Price stability
Ready marketability
Reversibility

1.5. Financial Instruments
Money Market Instruments
Capital Market Instruments
Derivative Securities
International Financial Instruments

A. Money Market Instruments
Maturity of less than or up to one year
The most liquid, short-term debt obligations
Commercial Papers, CDs, T-bills, Repurchase Agreement, Eurodollars, Banker’s Acceptances, Federal Funds.

B. Capital Market Instruments
Maturity of more than one year
Corporate Stock, Corporate Bonds, Mortgages, Gov’t Securities, Consumer & Commercial Loans, and Municipal Bonds.

C. Derivative Securities
Stock options
Convertibles
Warrants
Futures contracts

D. International Financial Instruments
Eurodollar deposits, Eurodollar CD’s, Eurobonds

2. Money Market (Short-term) Instruments

Treasury Bills (T-bills)
Short-term (1, 3, 6,& 12 Month) debt instruments issued by the federal Gov’t do not pay interest payments, but instead are sold at a discount – You must remember how to get the T-bill discounted bid/ask price and rate.
Due to secondary market sales, it is highly liquid
Almost NO RISK is involved
Face value: $ 10,000

Negotiable Bank Certificates of Deposit (CDs)
Debt instruments sold by banks and other depository institutions
CDs pay interest plus the purchase price at maturity: A $1000, one-year CD with 5% interest rate would pay $1050 at the end of one year
Substantial penalty for early withdrawal
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