Financial industry as you know exists because on the one side of dice are people who are in need of money and on the other are a set of people who have money to offer. The financial industry acts as a pipeline connecting the two sides. People need money to grow their business, purchase house, car and provide education to their children. People offer money because they have a surplus. There are savers and then there are spenders. The role of the financial industry is to match the perfect spender with a suitable kind of saver.
Let’s take an example. Sanjay is a young entrepreneur who just started an organic juice corner. He needs money to buy machinery and hire people. There is another person named, Rajni who has a lot of capital but is looking for attracting investment options to spend. Organic juice to Rajni sounds like an interesting idea as the growing number of people is going crazy over healthy diets. Rajni thinks if successful, this business can offer her huge returns on her invested capital. She, therefore, lends Sanjay a fraction of her savings.
People usually invest money (mind you I said invest and not spend), to accumulate assets. What are assets? Assets are things that have value. They could be real assets or financial assets.
Real assets: Something like land, machinery and gold is called a real asset which you can later sell for a price typically higher than what you purchased it for.
Financial assets: They vary in type but they are usually paper assets. Let’s say you own a share of a company. That means you own a part of the company’s assets and earnings. This kind of an asset is called a financial asset.
Why would somebody consider some business to be a financial asset? Most of the times people invest in companies they expect will thrive and therefore multiply their money in terms of a share in the increasing profits of the company over the period of time. The above example answers that.
Some financial assets can be traded. These assets are called as Securities. The place where these assets are traded is called financial markets. Trading can be done directly or through means of an intermediary.
Securities are broadly categorized as:
Bonds: This is where the saver lends the spender a loan. They are therefore also known as debt securities. In return, the saver wants the spender to pay some interest on the lend money which earns a consistent profit to the saver. Since the interest is fixed, the return for such kind of securities is fixed. They are therefore called fixed income securities
Equity: They are the share that you own in a company. Let’s say I am confident that Nestle will do wonders in the coming years and therefore I invested a fraction of my money in Nestle. High side, there is no bar to the profits I can make as long as the company continue to excel and make huge profits, Downside, nobody is responsible for my money and if the company closes the next day of my investment, all my hard earned money is gone.
Interesting? Isn’t it!
So the next question is, are you accumulating assets with your hobby every day? Each coin or banknote that I own is worth a good sum of money today and as the time pass, this asset value is only going to shoot up. So yes, my hobby is accumulating my assets.
A question to all my numismatic friends here; is your asset a real or a financial asset? Looking forward to the answer in your comments below!
Next time we will see why we have financial intermediaries in the system.