Her curiosity led her to explore various price charts, but the plethora of trading instruments available with its chart overwhelmed her.She longed to
Eager to satisfy her curiosity, Tara picked up the phone and dialed Dev’s number. With bated breath, she asked if he could spare time to guide her through the vast and seemingly complex universe of trading instruments.
As a seasoned expert, Dev wasn’t surprised by Tara’s problem. He explained that financial markets offer a vast array of instruments that can be traded on exchanges, providing traders and investors with the opportunity to diversify their portfolios, manage risks, and generate returns.
But before exploring these trading instruments, it’s imperative to have an understanding of the underlying asset classes that they are built upon.
“So what exactly are these asset classes?” Tara asked with great excitement.
Dev replied: “Asset classes refer to broad categories of investments that share similar characteristics and behaviour. Some common asset classes you would have heard of are equities (stocks), fixed income (bonds), real estate, and commodities. Each asset class has its unique characteristics. For example, equities are generally more volatile but may offer higher returns over the long-term, while fixed income is less risky and provides a steady stream of income.”
“So, trading instruments that are available for buying and selling on exchanges are not the same as asset classes?” asked Tara in a curious tone.
Dev replied: “Trading instruments are financial products designed to provide exposure to asset classes, such as stocks. It’s important to note that there can be multiple instruments for a single asset class, and they may or may not involve owning the underlying asset. However, for now, we’ll focus on asset classes and reserve the discussion of trading instruments for later.”
Tara recognized the importance of understanding asset classes and their risk profiles for making smart investment choices.
1. Equities
Tara recognized the importance of understanding asset classes and their risk profiles for making smart investment choices.
“Let’s start with the most common asset class – equities, also known as stocks,” Dev began. “When you buy a stock, you’re essentially buying a piece of ownership in a company, giving you a chance to profit from its success.”
“There are two types of stocks – common and preferred,” he continued. “Common stocks offer voting rights and are more commonly issued, while preferred stocks offer fixed dividends without voting rights.”
Dev continued elaborating further: “The stock price can fluctuate based on various factors like financial performance, industry trends, and market conditions. You can even earn dividends if the company performs well! Even if you’re not interested in dividends, you can still benefit from price changes by trading stocks on the exchange or taking exposure through derivatives without owning any underlying stocks.”
Tara’s voice held a note of anticipation as she spoke to Dev on the phone. “Hmm, so what’s next?” she asked, eager to hear more about other asset classes.
2. Bonds
Moving on to bonds, Dev explained, “Bonds are popular low-risk investment options that offer a fixed rate of return. When you invest in a bond, you lend money to the issuer – a company or government entity – and receive regular interest payments. Your principal is repaid when the bond matures. You can buy bonds directly from the issuer or other bondholders in the secondary market, like stocks.”
Tara was intrigued. “But if the interest payments and principal are fixed, why do bond prices fluctuate?” she asked.
“Well, the prices of bonds can fluctuate due to factors such as changes in interest rates and the balance of supply and demand,” Dev replied. “For example, if interest rates increase, existing bonds with lower interest rates become less attractive, causing their prices to fall.”
As Tara’s mind worked through the idea, she voiced her thought. “Wait a minute, wouldn’t there come a point where even a lower interest payment would become appealing if the price of purchasing that bond goes down?” she asked, and Dev acknowledged on the call that her understanding was indeed correct.
“So, how do you analyze the value of a bond?” she asked further.
“The yield and maturity are two important factors to consider,” Dev explained.
“Yield is the amount of income the bond generates as a percentage of its price, and maturity is the length of time until the bond’s principal is repaid to the investor. By plotting yields of different bonds against their maturity, we can create a yield curve that provides valuable information about the bond market and the economy.”
Tara was impressed. “This is fascinating! What other asset classes are there?” she asked eagerly.
3. Real Estate
“Real estate is another asset class that can be exciting,” said Dev with a smile in his voice. “When you invest in real estate, you’re essentially betting on the property’s value increasing over time. There are different ways to invest in real estate, like buying a rental property, investing in a real estate investment trust (REIT), or crowdfunding.”
Tara’s interest was piqued. “Why is real estate so exciting for investors?” she asked.
“Well,” Dev replied, ” Investing in real estate can provide a steady income through rental income or capital gains when the property is sold. Plus, it’s a tangible asset that you can see and touch, which can be appealing to some investors. So, it’s definitely worth considering.”
Tara nodded thoughtfully. “That makes a lot of sense”, she said and waited for Dev to explain to her the next asset class.
4. Commodities
“Commodities are another interesting asset class that can provide diversification to a portfolio and can offer the potential for high returns. They are raw materials like gold, oil or primary agricultural products like corn and wheat that can be traded on exchanges.” Dev explained.
Tara, with her business experience and knowledge about the significance of raw materials, asked, “So, can we say that changes in industrial activity impact the demand and supply of commodities, and hence their prices?”
“Yes, Tara. The demand and supply of commodities generally reflect industrial activity because they are raw materials used to produce goods. An increase in construction activity, for example, can lead to a higher demand for raw materials like steel, cement, and lumber. During an economic recession, there is usually a decrease in demand for commodities like oil and metals because there is less demand for products made with these materials,” explained Dev.
“Commodities are often influenced by global events, making them an exciting way to bet on global economic trends”. Dev added before moving on to another asset class.
5. Cash and Cash Equivalents
“The next asset class is Cash and Cash Equivalents,” Dev said and elaborated further. “They’re assets easily convertible into cash and are highly liquid.
This includes physical cash, checking and savings accounts, money market funds, CDs, and short-term government bonds.”
“But aren’t they low-risk and low-return investments,” Tara inquired.
“Exactly!” Dev said. “Cash and cash equivalents may not be the most exciting investment option, but they are a good choice for short-term goals or for
investors who are risk-averse.”
“Interesting,” said Tara, “but is there anything exciting in this asset class?”
“Actually, yes,” replied Dev. “Currency is a very important asset in this class, and it’s the basis for one of the largest and most liquid markets known as
Forex, or foreign exchange. It involves buying and selling different currencies to profit from changes in their exchange rates. Traders can buy and sell currencies on exchanges or over-the-counter markets. “
Tara nodded in agreement. “Yes, I’ve heard of Forex trading. But isn’t it risky?”
“Correct,” Dev said. “Forex can be included as a part of a broader investment strategy that may involve multiple asset classes, but it’s important to note that forex trading can be highly speculative and risky and is not suitable for all investors.”
“Before we conclude, let me give you some info about the latest asset class that has been making waves in the financial world, cryptocurrency. Have you heard about it?” Dev asked.
“Yes. I have heard about it but am not sure what it is?” Tara responded.
6. Cryptocurrency
“Cryptocurrency is a digital asset that uses cryptography to secure and verify transactions and control the creation of new units,” Dev explained. “It is decentralized and operates independently of traditional financial systems, which makes it highly disruptive to the banking and financial industries. Some experts argue that cryptocurrencies like Bitcoin and Ethereum should be considered a distinct asset class due to their unique characteristics and lack of government or physical asset backing.”
“That’s pretty cool,” Tara replied. “But can you invest in it like other assets, and is it safe to invest in?”
“Yes, you can buy and sell cryptocurrencies on some exchanges,” Dev said.
“However, it’s important to note that investing in cryptocurrency is different from traditional assets like stocks and bonds. It’s highly volatile and lacks regulatory oversight, so investors should be prepared for significant losses.”
Finally, Dev explained to Tara, “Diversifying your investments across different asset classes will help in managing risk and potentially earning greater returns. Before making any investment decisions, you should also consider your own risk tolerance and investment objectives.”
Before concluding their conversation on the different asset classes available in the financial world, Dev suggested that Tara visit his office next time to meet some of his colleagues who have expertise in specific trading instruments and can provide more insights into those.
“Wow, that would be amazing! Thank you for the opportunity, Dev. I’ll definitely take you up on that offer,” said Tara, expressing her excitement and gratitude.
“You’re welcome, Tara. I’m looking forward to seeing you soon and continuing our discussion on investing,” Dev replied.
They bid goodbye and ended the call.
(The author is CEO TradingHeads.com, Yubha.com)
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)
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