Financial Products
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The term 'financial product' refers to a variety of assets created to serve as financial assets or investment vehicles for those who wish to invest in them. A financial product may also be referred to as a financial asset, a financial instrument, or an investment product. Most financial products can be traded and typically consist of elements such as: Interest, profit, yield or return. Usually they also have a specific maturity and are set up in a specific currency. Financial products serve a variety of functions, including protecting liquidity, creating wealth, or hedging risks. The weighting of these factors is determined by the investment objective. As an example, there are financial products that are specifically designed to hedge risk, such as currency risk hedging products.
Generally, financial products facilitate the efficient flow of capital and the transfer of funds for all investors in the capital market. An underlying asset may take the form of cash, a contractual right to receive or deliver cash, or evidence of ownership of a company. In other words, a financial product represents a legal contract for any monetary value. Different areas of the financial industry offer a variety of financial products, for example, banks offer money market funds, real estate funds, hedge funds, as well as swaps, options, structured products, etc. Among the various types of life insurance policies available in the insurance industry is the mixed life insurance policy. This policy combines coverage for certain risks, such as the risk of death or disability, with funds.
There are three main risks associated with financial products: Market risk, which refers to the risk of a change in the market value of a financial product, credit risk, or default risk, and liquidity risk, which refers to the possibility that the financial product is no longer tradable. Furthermore, a fourth risk associated with certain financial products is counterparty risk, which should be addressed with caution, particularly when dealing with structured products. As a result of the 2008 Financial Crisis and the bankruptcy of Lehman Brothers, numerous investors defaulted on financial products purchased from Lehman Brothers, which was no longer able to fulfill its contractual obligations as a counterparty following its bankruptcy.
In the field of asset investment, there is a phenomenon known as the magic triangle. Three factors make up the magic triangle:
- Safety: There should be a minimum level of market risk and credit risk.
- Return: It is important to maximize the return.
- Liquidity: The ability to buy and sell an investment at any time.
It is often the case that investment objectives cannot all be met at the same time, though some sort of compromise must be made.
An increasingly important factor in financial products is sustainability, which is often measured by an ESG ranking. The ESG acronym stands for:
- Environmental - The responsibility to protect the environment.
- Social - The responsibility of the company towards society, its customers and its own employees.
- Governance - The level of transparency and management of the organization.
When investing in financial products, it is important to understand the risks and factors involved. Inform yourself well before investing and, for example, also seek advice from an
independent wealth manager without conflicts of interest.
It is possible to divide financial products into two categories: cash instruments and derivatives.
Cash Instruments
A cash instrument's value is directly influenced and determined by the market. Securities that are easily transferable may be included in this category. Cash instruments may also be defined as deposits and loans between borrowers and lenders. In addition, stocks, bonds, ETFs, and money market instruments may also be considered as examples.
Derivative Instruments
A derivative instrument's value and characteristics are determined by the underlying components, such as assets, interest rates, or indices. Stock option contracts, for example, are derivatives, as their value is dependent on the stock underlying them. An option entitles the holder to buy or sell a particular stock at a specified price and by a specified date, but does not bind the holder to do so. The value of the option changes if the price of the stock rises or falls, although not necessarily by the same amount. There are over-the-counter (OTC) and exchange-traded derivatives. Securities that are not listed on an official stock exchange are traded over-the-counter, or "OTC".
Financial products can be classified by asset class. In this case, it is important to determine whether the asset is based on equity or debt. An equity-based financial product is for example the ownership of a share. A debt-based financial product is a loan, which is issued by the investor. Foreign exchange instruments are also financial products. Most instruments can be classified into different subcategories. Shares, for example, can be classified as preferred shares, common shares, registered shares, or even bearer shares.
Debt-Based Financial Products
There is a distinction to be made between short-term and long-term debt-based financial products: Short-term debt-based financial products have a maturity of one year or less, while long term debt-based financial products have a maturity of more than one year.
Examples of short-term debt-based financial products: Treasury bills, commercial paper, deposits and certificates of deposits (cash instruments), short-term interest rate futures (exchange-traded derivatives), forward rate agreements (OTC derivatives).
Examples of long-term debt-based financial products: bonds, loans (cash equivalents), bond futures, options on bond futures (exchange-traded derivatives), interest rate swaps, interest rate caps and floors, interest rate options, exotic derivative (OTC derivatives)
Equity-Based Financial Products
Shares are often used as the underlying security for financial products. This category includes both equity funds and so-called exchange-traded funds (ETFs). In spite of this, structured products such as barrier reverse convertibles (BRCs) are also based on one or usually several stock options. A stock option and a stock future are examples of exchange-traded derivatives in this category. There are, however, also over-the-counter (OTC) markets for stock options.
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