Assets, contracts and the markets they trade in

How are assets and markets classified?

Ask two questions of any instrument: is it a claim, a contract or a thing, and does it settle now or later? Markets are then split along five lines.

Split	One side	Other side
Financial vs physical	Financial assets: securities, currencies, contracts	Physical assets: commodities and real assets such as land, buildings and equipment
Timing of delivery	spot markets : delivery now	Forward, futures and options markets: delivery or settlement later
Maturity	money market : debt maturing in one year or less	capital markets : longer debt and equity
Who sells	primary market : the issuer sells new securities	secondary market : investors trade with each other
Investor tradition	traditional investment markets : publicly traded debt, equity and pooled funds that hold them	alternative investment markets : hedge funds, private equity, real estate, commodities, infrastructure, collectibles

Assets that trade

• Financial assets
  • Securities Memorize debt, equity, pooled vehicles
  • Currencies Use it money issued by national authorities
  • Contracts Memorize agreements to exchange later
• Physical assets
  • Commodities Use it metals, energy, agriculture, carbon credits
  • Real assets Use it real estate, aircraft, machinery

The usual money market instruments are government bills, commercial paper, negotiable certificates of deposit and repurchase agreements. Alternatives are often hard to trade and hard to value, so they can trade at large gaps from intrinsic value.

Exam tip Money market means one year or less. A two-year note and a 10-year bond are both capital market instruments.

What are the main securities?

securities come in three kinds: fixed income (promises to repay), equity (ownership) and pooled investments (shared ownership of a portfolio). They are also either public or private. public and private securities differ in registration: public ones are registered, can be sold to anyone and usually trade in liquid markets, while private ones go to qualified investors and are hard to resell.

Securitiespublic (registered, liquid) or private (qualified investors, illiquid)

• Fixed income Memorize promises to repay
  • Bills, notes, bonds by term, short to long
  • Commercial paper short-term corporate
  • Repos, deposits, mortgages similar promises
• Equity Memorize ownership
  • Common shares residual claim, votes
  • Preferred shares priority and fixed dividend, usually no vote
  • Warrants issuer-written call options, grouped with equity
• Pooled investments Use it shared ownership of a portfolio
  • Mutual funds open-end or closed-end
  • ETFs and exchange-traded notes (ETNs) open-end, trade in the secondary market
  • Asset-backed securities tranches of a loan pool
  • Hedge and private equity funds limited partnerships

Fixed income. Notes (short to medium term) and bonds (long term) pay interest and repay principal. Commercial paper is short-term corporate debt, and bills are short-term government debt. Repos, bank deposits and mortgages are similar promises. A convertible bond can be swapped for shares.

Equity. Common shares are the residual claim: dividends are paid only after other claims, and holders usually vote. Preferred shares rank ahead of common shares for a specified dividend and usually carry no vote. warrants are call options written by the company on its own shares. The holder pays the exercise price to receive shares, so warrants are grouped with equities.

Pooled investments. pooled investments give shared ownership of a portfolio, so investors get management and diversification they could not easily build alone. Open-end mutual funds issue and redeem shares at net asset value on demand. Closed-end funds issue shares once and then trade in the secondary market, often at a discount to net asset value. Exchange-traded funds are open-end funds whose shares also trade in the secondary market, and large “authorized participants” keep their price close to net asset value. Asset-backed securities pass on the cash flows of a pool of loans, often in tranches. Hedge funds and private equity funds are usually limited partnerships for qualified investors.

Go deeper Open-end versus closed-end funds, and why closed-end funds trade at discounts

With an open-end fund, the fund itself buys and sells shares at net asset value, so the price cannot drift far. A closed-end fund never redeems, so its price is set by supply and demand among investors. It can sit below net asset value when investors doubt the manager or object to the fees, and above it when they like the portfolio. Some analysts treat these gaps as a gauge of investor sentiment. The Market Efficiency module returns to this puzzle.

What are currencies, commodities and real assets?

Among financial assets, currencies are money issued by national monetary authorities. Some are reserve currencies, held in quantity by central banks. They trade in foreign exchange markets, and spot trades settle in about two business days for institutional deals.

Among physical assets, commodities are precious and industrial metals, energy, agricultural products and carbon credits. Producers and users trade them spot, because they can store and deliver the goods. Most financial investors prefer futures, which are more liquid and can be closed before any delivery. Hedgers and information-motivated traders both use them.

real assets are tangible properties such as real estate, aircraft and machinery. Each one is unique, trades in an illiquid market and costs a lot to manage. That is why many investors hold them through securities such as real estate investment trusts and master limited partnerships, which are more uniform, divisible and liquid.

Go deeper Why investors reach real assets through securities

A direct purchase of a building needs a manager, maintenance and a buyer who values that exact location. A real estate investment trust turns many buildings into small, similar shares that trade daily. Investors get the income and the exposure without the upkeep. The same logic applies to infrastructure funds and to shares in an aircraft leasing company.

What are the main contracts?

contracts are agreements to exchange something later. Most derive their value from an underlying asset, which can be a commodity, a security, an index, a currency pair or another contract. They settle by physical delivery or by cash payment.

Contract	What it is	Key feature for the exam
forward contract	Private agreement to trade an asset later at a price set now	Counterparty risk. Not standardized. Hard to exit
futures contract	Standardized forward traded on an exchange	Clearinghouse is the counterparty to both sides. Daily margin
swap contract	Agreement to exchange a series of payments	Interest rate, currency, commodity and equity swaps
option contract	Right, not obligation, to buy (call) or sell (put) at a fixed price	Buyer pays a premium. European exercise only at expiry, American any time
Other	Insurance, credit default swaps	Pay out on a specified event

Contractsmost derive value from an underlying asset

• Forward Memorize private, customized, counterparty risk
• Futures Memorize standardized, exchange traded, clearinghouse guarantee
• Swap Use it exchange of periodic payments
• Option Use it right, not obligation; premium paid
• Insurance and credit default swaps Know the idea pay on a specified event

A forward has two problems: counterparty risk (the other side may walk away after a big price move) and illiquidity (exit needs the other side’s consent). A futures contract solves both. Its terms are standard, so anyone can take the other side, and the clearinghouse stands between buyer and seller.

Go deeper How a clearinghouse replaces counterparty risk with margin

Each futures trader posts initial margin with the clearinghouse. Every day gains and losses are settled: losers pay in, winners are credited. If a trader’s margin falls below the maintenance level, more must be added or the broker closes the position. Because losses are paid daily, they never grow large enough to threaten the guarantee. The Derivatives topic develops this.