Asset class

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Asset classes are usually discussed in the context of asset allocation within an investment policy statement. Investopedia defines asset class as:

A group of securities that exhibit similar characteristics, behave similarly in the marketplace, and are subject to the same laws and regulations. The three main asset classes are equities (stocks), fixed-income (bonds) and cash equivalents (money market instruments).[1]

As with many concepts in investing, different people use different classifications of asset classes and there is no clear consensus.

Main asset classes

The three main asset classes can be refined further as shown below. Depending on the investor, some of the items below may be considered to fall in more than one class.

Equities

Main article: Equities

Fixed income

Main article: Fixed income

Cash and equivalents

Different classification methods

As an example of an alternative classification method that mutual fund investors should be aware of, the Canadian Investment Funds Standards Committee (CIFSC) publishes Retail Investment Fund Category Definitions[2]. For purposes of the category assignment, security types will be grouped into four broad asset classes: Cash, Fixed Income, Equity, and Other as follows:

Asset class Security types
Cash
  • Cash and Short-Term Notes
Fixed Income
  • Mortgages, Mortgage-Backed Securities, and Asset-Backed Securities
  • Bonds (bonds with a term to maturity of less than one year are considered cash)
  • Convertible Bonds
Equities
  • Common Equities
  • Income Trusts
  • Convertible Preferreds
  • Preferred Shares
  • Futures
  • Options
  • Other Derivatives
  • Rights
  • Warrants
  • Bullion
  • Commodities
  • Real Estate
  • Investment Funds
  • Other Assets and Liabilities
Notes: Preferreds are a hybrid security. In certain circumstances CIFSC may treat preferreds as fixed income exposure on an exception basis.[2]

Options

An option is a financial derivative that represents a contract sold by one party (option writer) to another party (option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date).

Call options give the option to buy at certain price, so the buyer would want the stock to go up.

Put options give the option to sell at a certain price, so the buyer would want the stock to go down.

Options are extremely versatile securities that can be used in many different ways. Traders use options to speculate, which is a relatively risky practice, while hedgers use options to reduce the risk of holding an asset.[3]

An individual investor can be either a buyer of options, or can offer them for sale even if he or she does not own them. The latter is known as writing options, and the trade order is usually entered as a short sale. There are risks involved in various option strategies and a broker would require filling out of specific forms before an investor is allowed to be an option writer.

Further consideration

Some investors might further change the categorization by treating Real Estate and Commodities as separate asset classes rather than including them within equities.

See also

References

  1. Investopedia Asset Class , viewed Jan. 26, 2012.
  2. 2.0 2.1 CIFSC, Retail Investment Fund Category Definitions, viewed July 28, 2012.
  3. Options, viewed May 27, 2012.