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Subject COMMERCE

Paper No and Title 14. SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT

Module No and Title 4. FINANCIAL ASSETS

Module Tag COM_P14_M4

COMMERCE Paper No. 14. SECURITY ANALYSIS AND PORTFOLIO

MANAGEMENT
MODULE No. 4. FINANCIAL ASSETS
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TABLE OF CONTENTS

1. Learning Outcomes
2. Introduction
3. Classification of Financial Assets
4. Summary

COMMERCE Paper No. 14. SECURITY ANALYSIS AND PORTFOLIO

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MODULE No. 4. FINANCIAL ASSETS
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1. LEARNING OUTCOMES

After the study of this lesson, the you should be able to



COMMERCE Paper No. 14. SECURITY ANALYSIS AND PORTFOLIO

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MODULE No. 4. FINANCIAL ASSETS
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2. INTRODUCTION

Financial assets are intangible assets that consist of financial claims arising out of
predetermined relationships amongst two institutional units. When one organized
unit be responsible for funds to another unit, financial claims arise and the asset
owners obtain claims on economic means of other institutional unit. Therefore,
financial assets are also termed as economic assets.

Financial assets includes bank deposits, bonds, stocks, gold bullion etc. and are
more liquid than tangible assets such as commodities, real estate etc. Financial
assets can also be traded in financial markets.

Financial assets are contracts that do not involve any contingency and are a part of
financial instruments.

3. Classification of Financial Assets

As per International Financial Reporting Standards (IFRS), financial assets can be

classified into following categories:

 Cash or cash equivalent,

 Equity instruments of additional entity,
 Contractual right to receive cash or another financial asset from another entity
 Contract that will or may be stable in the entity's own equity mechanisms and is
either a non-derivative for which the entity is or may be pleased to receive a
variable number of the entity's own equity instruments, or a derivative that will or
may be established other than by interchange of a fixed amount of cash or another
financial asset for a fixed number of the entity's own equity instruments.

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MODULE No. 4. FINANCIAL ASSETS
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Financial assets can also be classified on the basis

of their two principal characteristics i.e.
 Liquidity of the asset which includes other characteristics such as
negotiability, transferability, marketability or convertibility; and
 Legal characteristics

According to these two characteristics, financial assets can be classified as:

Classification of Financial Assets
Monetary Gold and SDRs
Currency and Deposits
Debt Securities
Loans
Borrowings
Equity and investment fund shares
Financial derivatives
Other accounts receivable/payable

3.1 Monetary Gold and SDRs

Monetary Gold and Special Drawing Rights (SDRs) are allotted by International
Monetary Fund (IMF). These financial assets are generally held only by monetary
authorities and are the only financial assets for which there are no conforming
financial liabilities.
Monetary Gold can be a financial asset only for the Central Bank or the
Government as standard bullions of gold are held by Central Bank or Government
as part of official reserves. Purchase and sale of gold transactions are carried out
between the central banks or between central banks and international financial
organizations. All monetary gold is involved in reserve assets or is held by
international financial organizations. However, gold bullion holdings that are not
portion of reserve assets are classified as nonfinancial assets.

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MODULE No. 4. FINANCIAL ASSETS
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Special Drawing Rights (SDRs) are

“international reserve assets created by IMF and allocated to member countries to
supplement existing official reserves”. SDRs are held only by Central Bank or
Government and few international financial institutions that are authorized
holders. SDR holdings determine each holder’s assured rights to obtain foreign
exchange or other reserve assets from other IMF members. SDRs are financial
assets with corresponding liabilities. However, these financial assets represent
claims on the participants (member countries of IMF and certain international
agencies) collectively and not on IMF. A participant can sell some or all of its
SDR holdings to another participant and get in return other reserve asset.

3.2 Currency and Deposits

Currency and deposits are the most liquid assets and comprises of notes, coins and
deposits – both in national and foreign currency.
Currency comprises of notes and coins in circulation that are usually of fixed
nominal value and have no dates of repayment. Currency can be held as an asset
by all sectors of economy and non-residents but it is issued by central banks or
governments only. Currency is classified into domestic and foreign currency
(claims on nonresident central banks or governments).
Deposits comprises of entitlements on the central bank, other depository
corporations, and government units. Deposits can be classified as:
Transferable deposits: Transferable deposits can be held and operated by all
subdivisions of economy and nonresidents (rest of the world). These deposits
contain all deposits that are (i) exchangeable for banknotes and coins on demand
at par and without any restriction; and (ii) directly usable for making third-party
payments by cheque, draft, direct debit/credit etc.
Other nontransferable deposits: All types of deposits other than transferable
deposits are included in other deposits. These deposits are financial
intermediaries’ deposits or liabilities which cannot be used for making payments.
These deposits are not exchangeable with cash or transferable deposit. All

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segments of economy and nonresidents can open

and operate such accounts. Other deposits include time deposits, nontransferable
payments denominated in foreign currency and repurchase agreements.
3.3 Debt Securities
Securities can be debt or equity securities. Debt securities are negotiable
appliances and include bonds, notes, certificates of deposit, commercial paper,
debentures, and similar instruments usually traded in financial markets. Some
common types of debt securities issued and traded in international markets are:
 Short term securities sold on a zero coupon (discount) basis
 Long-term securities sold on a fixed-rate coupon basis
 Debentures
 Debt securities with embedded financial derivatives

3.4 Loans
Loans are financial assets that arise when a creditor lends funds to a debtor and
are evidenced by non-negotiable instruments. Loans include all types of advances
(except accounts receivable/payable) provided by financial corporations,
government to various sectors of the economy and includes overdrafts,
installment loans, hire-purchase credit and loans to finance trade credit.
Repurchase agreements, gold swaps and financing through a financial lease are
also part of loans. Loans can be categorized as:
 Short-term loans – have a maturity of less than or equal to one year. Loans
that matures on request are also classified as short-term loans even if these
are not expected to be repaid within one year
 Medium-term loans – have a maturity ranging between 1 to 5 years.
 Long-term loans – have a maturity that exceeds those of short-term and
medium-term loans.

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3.5 Borrowings
Usually, borrowings are not considered as a separate financial instrument.
Borrowing is done through other financial measures such as loans, deposits etc.
However, it is treated as a separate financial instrument in Armenian law.
According to this law, the lender gives the money to the borrower under an
agreement and the borrower agrees to return the specified money to the lender as
per the terms of the agreement. If the maturity date is not specified then the
amount of loan has to be returned within 30 days upon the request of the lender,
unless otherwise mentioned in the agreement.
Borrowings are less liquid as compared to time deposits. In a borrowing
transaction, the lender earns interest against the amount provided to the borrower.
3.6 Equity and investment fund shares
Equity consists of all instruments and records having entitlements on the residual
value of an establishment after the claims of all creditors have been met. Equity is
considered as a liability of the corporation. Ownership of equity in an entity is
evidenced by stock, shares, participations, depository receipts or similar
instruments. Equities can be sub-divided into listed shares, unlisted shares and
other equity. Listed and unlisted shares are accessible and are therefore termed as
equity securities.
Investment fund shares or units comprises of shares or units of all kinds of
investment funds. Exchange Traded Fund (ETF) is also a part of investment fund
shares.

3.7 Financial Derivatives

Financial derivatives are instruments that are linked to other specific financial
instruments. The value of a financial derivative is derived from the price of
underlying asset. Financial derivatives are primarily used for risk management,
hedging, arbitrage between markets and speculation. Financial derivative

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contracts are settled through net payments of cash

rather than the actual delivery of underlying items. Financial derivatives can be
sub-classified into:
 Forward –In a forward contract, both the parties agree to interchange a
specified quantity of the underlying asset on a stated date at an agreed
contract price. A forward contract needs to be executed mandatorily but
only when the period specified in the contract is expired.
 Option- In an option contract, the buyer has a right but no obligation to
sell or purchase a specific asset at an agreed price in a specified period.
For this, the buyer has to pay a price to the seller of the option. The buyer
of the option contract can also sell the option i.e. his right to exercise the
option.
 Swap – A swap signifies a spot purchase or sale of the underlying asset
with a condition of forward sale or purchase. Swap is a type of forward
contract in which two parties agree to exchange different currencies i.e.
buy (or sell) any money for another in spot market and at the same time
enter into a repurchase agreement on sale (or purchase) of these currencies
in forward market at prices already determined.

3.8 Other accounts receivable/payable

Other Accounts receivable/payable comprises of:
 Trade credits and advances: Trade credit and advances are claims that
arise as a result of sale or purchase of goods and services for which
payment has not yet become due. Trade credit is extended directly by
suppliers to buyers of goods and services. Advances are payments made
in advance by customers for goods and services not yet provided or for
work that is in progress or yet to be undertaken. Trade credits do not
include loans taken to finance trade credit.

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 Other receivables/payables: includes

accrued taxes and accrued expenses such as rent, wages and salaries. It
also includes items such as deferred income and provisions for loan losses.

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MODULE No. 4. FINANCIAL ASSETS
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4. SUMMARY

Financial assets are intangible assets that consist of financial claims arising out of
predetermined relationships amongst two institutional units.
Monetary Gold can be a financial asset only for the Central Bank or the Government as
standard bullions of gold are held by Central Bank or Government as part of official
reserves.
Special Drawing Rights (SDRs) are “international reserve assets created by IMF and
allocated to member countries to supplement existing official reserves”. SDRs are held
only by Central Bank or Government and few international financial institutions that are
authorized holders.
Currency comprises of notes and coins in circulation that are usually of fixed nominal
value and have no dates of repayment. Currency can be held as an asset by all sectors of
economy and non-residents but it is issued by central banks or governments only.
Financial derivatives are instruments that are linked to other specific financial
instruments. The value of a financial derivative is derived from the price of underlying
asset.

COMMERCE Paper No. 14. SECURITY ANALYSIS AND PORTFOLIO

MANAGEMENT
MODULE No. 4. FINANCIAL ASSETS