Frank J. Fabozzi
Frank J. Jones
Micheal G. Ferri
An asset is any possession that has value in an
Assets can be classified into two categories:
Tangible: whose value depend on particular
Intangible: Legal claim for some future
benefits. Their values bear no relations to the
form physical or otherwise, in which these
claims are recorded.
Debt Instrument: the claim that a holder of a
financial asset has may be either a fixed
amount, or varying, or residual amount.
FOR EXAMPLE: Car loan, US treasury
Bond, GM Corporation Bonds etc.
Equity Instrument: (also called residual
claim) obliges the issuer of Financial Asset to
pay the holder an amount based on earnings, if
any, after holder of debt instrument is paid.
FOR EXAMPLE: Common
Stock, Partnership Share and Preferred Stock.
Price of a FA is equal to the present value of
expected cash flow even if the cash flow is not
known with certainty.
Types of Risks:
1. Purchasing Power Risk or Inflation Risk
2. Credit Risk of Default Risk
3. Exchange Rate Risk
FA and TA share a common characteristic,
both are suppose to bring benefit or their
owner. Both bring future cash flows (CFs) to
FA and TA are linked. FA or debt instrument or
equity instrument are all used to buy tangible
assets for the owner.
FA has two principle economic functions:
1. Transfer funds from those who have surplus
funds to invest in TA.
2. Transfer funds in such a way as to
redistribute the unavoidable risk associated
with Cash Flows generated by the tangible
assets among those seeking and providing the
FM is a market where FA are exchanged (i.e.
traded). Although the existence of financial
markets is not necessary to trade securities in
The market in which financial assets are
traded for immediate delivery is called SPOT
or CASH MARKET.
Primarily there is interaction of buyers and
sellers to determine the price of the traded
asset. (Demand and Supply)
Or, equivalently determine the required rate of
return on the FA. This process is called the
price discovery method.
Secondly, financial markets provide a
mechanism for an investor to sell a FA.
Because of this feature, it is said that FM
offers liquidity, an attractive feature when
circumstances force investor to sell. If there is
no liquidity the investors will be forced to
hold the debt instrument until it matures and
an equity instrument until a company is
voluntarily or involuntarily liquidated.
Third function of the financial market is that it
reduces the transaction costs.
There are two costs associated with the
1. Search Costs: it represent the explicit costs, such as
the money spent to advertise one’s intentions to sell
or purchase a financial asset.
2. Information Costs: it represent implicit costs
associated with the time spent to find the
There are many ways to classify the Financial
Markets. One way is by the type of financial
claim, such as debt markets and equity
markets. Another is by maturity of the claim.
For Example: There is a FM for short term
debt instruments, called the money market
and one for longer maturity FAs called the
A financial market is a market that brings buyers and sellers
together to trade in financial assets such as stocks, bonds,
commodities, derivatives and currencies. The purpose of a
financial market is to set prices for global trade, raise capital
and transfer liquidity and risk. Although there are many
components to a financial market, two of the most commonly
used are money markets and capital markets.
Money markets are used for a short-term basis, usually for
assets up to one year. Conversely,capital markets are used for
long-term assets, which are any asset with maturity greater
than one year. Capital markets include the equity (stock)
market and debt (bond) market. Together the money and
capital markets comprise a large portion of the financial
market and are often used together to manage liquidity and
risks for companies, governments and individuals.
Money Market Instruments consists of Money market
securities consist of negotiable certificates of deposit
(CDs), bankers acceptances, U.S. Treasury bills,
commercial paper, municipal notes, federal funds and
repurchase agreements (repos).
Both the stock and bond markets are parts of the capital
markets. For example, when a company conducts an
IPO, it is tapping the investing public for capital and is
therefore using the capital markets. This is also true
when a country's government issues Treasury bonds in
the bond market to fund its spending initiatives.
FM’s can be categorized as those dealing with
the financial claims that are newly issued,
called the primary market.
And those for exchanging financial claims that
are previously issued, called the secondary
markets or the market for secondary
Explain the difference between tangible and
intangible assets and how they are related?
A US investor who purchases the bonds issued by
the US. Government made the following
statement: “By buying this debt instrument I am
not exposed to default risk or purchasing power
risk.” Explain why you agree or disagree with
What is the basic principle in determining the
price of a financial asset?