Types of Asset Classes
“Asset” is something that holds value. A financial asset carries money value, and in most cases, earns return over a period. There are two primary types of financial assets: equity shares and bonds.
Equity Shares: A company is owned by its shareholders. When a company is formed, individual shareholders contribute the equity capital required to form the company. Each individual contributor is granted shares in proportion to the money contributed by them.
Say a company is formed with the capital of EGP 1 million and has 5 shareholders, contributing EGP 200,000 each in the capital. Hence each shareholder has 20% ownership (aka stake) in the company, i.e. owns 20% of the shares in the company. If a company is listed on a stock exchange (aka stock market), these shares may be sold by the original shareholders to others. The shareholders may buy and sell shares as and when they wish (depending on the terms on which the primary investment was made).
The return a shareholder gets from owning a part of a company is by way of dividends given the company or by increase in its share price. Dividends are part of the profit that a company may decide to give every year (or quarter) to its shareholders.
As the fortunes of a company or the business environment change over time, its share price may go up and down. Hence shares carry considerable risk, especially over the short-term. While in the long-term they are likely to (but not guaranteed to) provide higher returns vis-à-vis other asset classes.
Bonds: A company may borrow to invest in business expansion or to run its operations. Debt is the other source of funds for a company, apart from equity. For its borrowing needs, the company may choose to take a loan from a bank or issue bonds. Bonds are tradeable instruments that promise to pay its owner a certain interest over a fixed period. The owner of the bond could sell the bond, if it is listed on an exchange.
Bondholders get their returns by way of interest that the company (the borrower) pays periodically, i.e. every quarter or year.
The key characteristics of a bond are (a) its face value that is the principal to be repaid by the company for one bond, (b) its coupon, i.e. the interest rate the bond pays, and (c) its tenor i.e. the period after it which the principal is fully repaid, or the bond matures.
Though relatively more certain than the returns to the shareholders of a company, the borrower’s ability to pay the interest or repay the principal is affected by its business. Hence bonds do carry risk. The risks could be of two main types: (a) credit risk, i.e. the company’s ability to pay interest and / or principal, and market risk, (b) market risk, i.e. possibility of the price of a bond going up or down with a change in general interest rates in the market.
Bonds could be issued by governments (aka treasury bonds or T-Bonds) or a company. Treasury bonds carry a very low credit risk, as they carry the sovereign risk of the government that issues them. But still, they do carry market risk, as their prices before maturity may vary with a change in general interest rates.
Money market instruments: Money market instruments could be issued by a government (aka treasury bills or T-Bills) or a company. In Egypt, the government is practically the only issuer of money market instruments. T-Bills carry practically zero credit risk and due to their short tenor, minimal market risk. Money market instruments have tenor of up to one year.