4.1 Financial Assets 💰

The financial sector is the part of the economy made up of institutions that bring together lenders and borrowers. This includes institutions like banks.

Key Vocabulary

• Liquidity💧 —The ease with which a financial asset can be accessed and converted into cash. Cash is the most liquid asset. It can most quickly and easily be converted into other assets. Other assets are not as liquid as cash. For example, if you have invested money into a certificate of deposit (CD), in order to maintain a higher interest rate, you have to keep your money in there for six (6) months. This causes a decrease in access to this money should you need it. Items like real estate, fine art, and other collectible have low liquidity because it takes a while to get your investment out of them.

• Rate of Return—Net gain or loss of an investment over a specified time period. People prefer investments that have a higher rate of return. Many times, this involves looking at the various interest rates on various investments.

• Risk—Chance that an outcome or an investment's actual gains differ from the expected outcome. Different people have different levels of risk they are willing to take on when it comes to investments. Typically, someone closer to retirement would not be as willing to enter into a higher risk investment than a person that is 15 years away from retirement.

• Bond—An interest-bearing asset often issued by businesses or the government. Sometimes they are referred to as securities.

• Stock—A security that gives you ownership in a company.

Bonds and Interest Rates

Bond prices and interest rates have an inverse relationship. People prefer higher interest rates because they are given a greater rate of return. Most bonds pay a fixed rate of interest so as interest rates fall, they become more desirable which will push their price up. The opposite is true if interest rates are on a rise. Consumers are less interested in the fixed-rate interest rates that come with a bond, so they demand less of them, decreasing the price of the bonds.