Underlying Asset


Underlying Asset

The underlying asset is defined as the asset on which the financial instruments such as derivatives are based and the value of the underlying asset is indirectly or directly related to the contracts of the derivatives. Knowing the value of an underlying asset helps traders determine the appropriate action (buy, sell or hold) with their derivative. Investors use options and the concept of underlying assets for two primary reasons, to speculate and to hedge risk. When you purchase options to speculate on future stock price movements you are limiting your downside risk yet your upside earnings potential is unlimited.


Types of Underlying Assets

Commodities

Grains and oilseeds (wheat, corn, soybeans, and canola)

Livestock and meat (pork bellies, hogs, live cattle, and feeder cattle)

Forest, fiber, and food (lumber, cotton, orange juice, sugar, cocoa, and coffee)

Precious and industrial metals (gold, silver, platinum, copper, and aluminum)

Energy products (crude oil, heating oil, gasoline, natural gas, and propane)


Financial Assets

Equities

Interest Rates

Government Bonds.

Currencies


Types of Asset Classes

Securities that behave similarly in terms of value appreciation and are subject to the same laws and regulations are grouped to form asset classes.


Equity

People invest in equity generally to fulfill their long term goals.

Example: Direct Stocks, Equity oriented MFS, National Pension System (NPS), Equity ULIPS, etc.


Equity characteristics:

  • Average to understand

  • Highly Liquid

  • Above inflation returns

  • Volatile returns


Fixed income

Fixed income investments are for short term goal.

Example: PPF, EPF, VPF,Debt Funds,Bonds(govt., corporate),Post office Schemes, Endowment policies, etc.


Fixed-income assets characteristics:

  • Easy to understand

  • High Liquidity

  • Near inflation returns

  • Low volatility in returns

Cash

Cash asset is generally used as an emergency fund.

Example: Liquid Funds, FDS, Savings account balance


Cash assets characteristics:

  • Simple to understand

  • Very high liquidity

  • Below inflation returns

  • No volatility


Real estate

This asset investment is generally a long term investment.

Example: Residential space, Commercial space, Land, etc.


Real estate assets class characteristics:

  • Complex to understand

  • Very Low liquidity

  • Above Inflation returns

  • High volatility

Gold(Commodity)

As gold is a commodity asset it is more suitable for trading.

Gold assets Characteristics:

  • Complex to understand

  • High Liquidity

  • Near Inflation returns

  • High volatility

Before investing in asset classes one should keep in mind following things.

  1. Risk return associated with the particular asset class.

  2. The liquidity it offers.

  3. Complexity associated with understanding that particular asset.

  4. Need to invest in a particular asset class.


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