Understand the various types of asset classes, what they are and how can you utilise them.
Here we are going to look at, define and give examples of the various range of financial markets asset classes that can be both invested in and actively traded.
The four leading asset classes we will be looking deeper at will be:
- Stocks and shares, also known as equities (where we will also look at stock averages or share indices)
- Bonds (which can be Government or Corporate)
- Commodity markets
- Foreign Exchange (also known as FX, Forex or currency markets)
Equities, stocks and shares (including indices, or averages)
Equities can also be referred to as stocks or shares. The purchase of a share involves some kind of ownership of a business, typically a public listed company. To have ownership of a portion of a company is known as a “share” and is usually bought in a publicly listed company. This entitles the possessor of said share to voting rights within the company on crucial decisions about the businesses goals and direction at the Annual General Meeting (AGM), along with a dividend in the company, which is effectively a share in the company profits. The size of the dividend is typically determined but the company’s profits and offers a possible income over time as the dividends are paid out usually every quarter (sometimes annually). Ideally, the owned shared would also experience capital growth if the company is run profitably and successfully, which occurs if the stock price of the share rise. Stocks and shares are largely purchased and sold on Stock Exchanges. Examples of some well-known and prevalent shares would be Apple, Amazon and Facebook.
Another way to trade or invest in equities or shares is via equity indices, also known as share or stock averages. Stock averages are used to show the average value of various shares to measure the worth of a section of a stock market. In other words, stock averages usually reflect the fortunes of the corporations in a national economy or a particular sector or segment of an economy. These stock averages could be international, based on shares from numerous global areas. They could also be regional, replicating the value of a particular region, like North America, or Europe. Or they could be national, to echo the strength or potential weakness of a stock market of a country. Examples of these national stock averages are the FTSE 100 for the UK and the S&P 500 for the United States, which is the index of the largest 500 companies on the US stock market.
There are two ways of calculating stock indices; a price-weighted index or a capitalisation-weighted index. In basic terms, a price-weighted index uses the price of the individual stocks to govern the weighting of the stocks in the index, while a capitalisation-weighted index, uses the overall value of the company to determine the weighting of the stock in the index. The S&P 500 a capitalisation-weighted index, whilst the Dow Jones Industrial Average is price-weighted index.
Some of the major indices by region are as follows:
- US – Dow Jones Industrial Average (DJIA), S&P 500, Nasdaq Composite and Nasdaq 100.
- Europe – DAX (Germany), FTSE 100 (UK), EURO STOXX 50 (pan-European)
- Asia/ Pacific – Nikkei 225 (Japan), Hang Seng (Hong Kong), Shanghai Composite (China)
Bonds (Government and Corporate)
Bonds are a form of a debt instrument. They are issued to raise longer-term capital, by both corporates and governments. Since bonds are a form of debt, they are generally viewed as being lower risk than stocks. Government bonds are seen as having little to almost no risk at all as governments almost always pay back their debts (through risk level will vary depending on the issuing government).
Government bonds are generally viewed as long term investments over multiple years. Investors who purchase bonds receive a fixed payment in set time periods (typically yearly). Therefore, bond markets can also be called Fixed Income markets (along with Credit Markets). This fixed payment the buyer collects is known as the coupon.
A commodity is a raw material or agricultural product that can be purchases and sold to others. Commodities, therefore, form the base for all of the everyday products that we use in our daily lives, underlining how important they are in the global economy. Commodities are regularly used as the base for the manufacturing and creation of more complex goods, such as crude oil to produce petrol. Commodities have been exchanged since the start of civilisation, and example of which being livestock traded for gold or wheat. As commodities are standardised, it has become easy for them to be transferred and traded in the modern world. Unlike stocks or bonds, it is unusual for commodities to produce any income for the owner. Instead, investors or traders purchase and sell commodities in an attempt to make capital gains. There are a few distinctive classes that commodities are often split into.
These would include:
- Energy, which incorporates Gas and Oil products
- Agricultural, such as Coffee, Grains and Wheat
- Precious Metals, such as Platinum, Silver and Gold
- Base Metals, such as Iron, Nickel, Copper, Zinc, Aluminium, Lead
Foreign Exchange (Forex, FX and currencies)
Forex, FX or currency markets are all ways in which the Foreign Exchange Markets are referred to. Foreign Exchange markets are the exchange of one currency for another currency and it is this exchange that separates Forex somewhat from the other types of asset classes. This is due to the fact they have a “relative value”, as the investor or speculator acquires one currency and pays with another.
The “Majors” is a term used to describe the currency pairs of some of the largest economies in the world. These include the following currencies: The US Dollar, the Japanese Yen, the Euro, the Pound, the Swiss Franc, along with the New Zealand, Canadian and Australian Dollars. “Cross Rates” are where the US Dollar is not involved, so this could be Australian Dollar to Japanese Yen (AUDJPY) or Euro-GB Pound (EURGBP). The majority of global currencies are free to be traded. Emerging markets currencies can often be more volatile (so riskier) than trading he Majors, but this is not always the case. Examples of Emerging Market currencies are the Indian Rupee (INR), Brazilian Real (BRL) and the Chinese Yuan (CNY).