45.b: Classification of Assets and Markets
Financial assets comprise securities (debt and equity), currencies, and derivative contracts. Real assets include real estate, commodities (gold, silver etc), and other physical assets.
Securities traded on public markets like exchanges or through dealers are called publically traded securities. They are usually liquid and their trading is subject to scrutiny by regulators (for e.g. U.S. Securities and Exchange Commission).
Private securities, on the other hand, are not traded publically and are generally illiquid. Investors purchase such securities directly from the issuer or through an investment vehicle (like Private Equity, Venture Capital fund). Private securities are subject to minimal regulatory scrutiny.
Derivative Contracts are contracts deriving their value from an underlying asset. Depending on the underlying asset, Derivative Contracts can be classified as financial (equity, fixed income) or physical (wheat, metal etc) contracts.
Delivery based classification: Markets, where contracts are traded for immediate delivery, are called spot markets while markets with delivery in future are called futures or forward markets.
Primary and secondary markets: When a security is first issued to investors, it is called primary market sale (for e.g. initial public offerings or IPOs). These investors can then sell the securities to others in secondary markets (for e.g. stock exchanges).
Duration based classification: Markets with debt instruments of less than one-year maturity (short-term deposits, government bills etc) are called Money markets. Capital markets on the other hand trade longer duration securities (equities, bonds etc).
Traditional vs. Alternative investments: Traditional markets refer to equity and fixed income instruments. Alternative investments include private equity, venture capital, hedge fund, gems and jewelry, paintings, collectibles, real estate etc. Alternative investments are usually hard to value and have low liquidity.
Check your concepts:
(45.5) Which of the statements most accurately describe publicly traded securities?
(a) Publically traded securities are more liquid and are subject to lesser regulatory requirements than private securities
(b) Publically traded securities are less liquid and are subject to lesser regulatory requirements than private securities
(c) Publically traded securities are more liquid and are subject to more regulatory requirements than private securities
(45.6) Which of the following is least likely to be classified as a financial asset and more likely to be classified as a real asset?
(a) Currencies
(b) Silver
(c) Derivatives Contracts
(45.7) An investor buys a stock for $12.50 and plans to sell it after 6 months. The stock price of $12.50 and the stock is most likely to be classified as:
(a) Spot price and money market security
(b) Futures price and money market security
(c) Spot price and capital market security
Solutions:
(45.5) Correct Answer is C: The publically traded securities are more liquid and are subject to stringent regulatory requirements.
(45.6) Correct Answer is B: Stocks, bonds, currencies, and derivatives contracts are classified as financial assets. Commodities like gold, silver, metals, Real estate, and other physical assets are classified as real assets.
(45.7) Correct Answer is C: $12.50 is the current price of the stock. It is called as the spot price. Even though the investor is expecting to sell the stock after 6 months, the stock would be classified as a capital market security. The classification of the securities does not depend on the holding period of the investor but on the maturity of the security.
