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Frequently Asked Questions
What is a financial instrument?
Have you ever wondered what a financial instrument is? We'll explain what they are and how they work. Financial instruments are used by both investors and savers in their day-to-day transactions, ranging from equities to derivatives.
So what is a financial instrument? They're documents or contracts that represent ownership of an asset itself. Ownership is acquired by two parties exchanging or buying/selling assets via a physical or digital contract.
Classification: Primary or derivative
Financial instruments are classified according to their characteristics as primary or derivative assets. Primary assets stand out because you own the actual assets. This category includes equities, currencies, cryptocurrencies and exchange-traded funds and bonds.
On the other hand, derivatives are part of contracts for difference (CFDs), where investors trade on the financial instruments without acquiring the underlying assets. That means that you don't buy the security itself but rather speculate on the profit it will generate on the financial market. This category also includes futures, options and forwards.
What are they for?
In the financial market, there are different options of instruments tailored to the investment's purpose and each investor's objectives. Each one has its own advantages and disadvantages, and in each market, they have a certain degree of profit or risk.
Which is best for each investor?
You can find out by taking into account the following:
- Liquidity means converting the asset into cash without incurring large losses. Depending on the market an asset is traded in, it's possible to know the degree of liquidity.
- Confidence is knowing that the contract will be honoured and that the investor will get their money or profit back within the stipulated time.
- Performance is about knowing the market in which the asset operates and the demand for it.
How to build an investment portfolio
If you're an investor or saver, you need to know how to build an investment portfolio. First and foremost, it's a collection of financial assets from different markets.
Many traders decide to invest their money in different financial markets, such as foreign exchange or the stock market, to avoid losses and risks. In other words, they don't put all of their capital in one financial instrument but spread it across different options to achieve a balance. So, how do you build an investment portfolio?
Building an investment portfolio, step by step
To create an asset portfolio, follow these five steps:
Step 1. Risk profile. Investors must know which assets to invest in and how much risk they can take. The amount of money available should also be factored in.
After looking at these factors, the risk profile can be divided into conservative investors, who want to take on less risk and preserve capital; moderate investors, who aren't afraid of risks but are more interested in generating profits; and aggressive investors, who choose the riskiest investment model.
Step 2. Objectives. Before choosing which assets to invest in, investors need to set short- and medium-term objectives.
Once they're set, plan your investments based on them. Objectives could be generating a steady income or earning a large amount in the future. This is where assessment and planning come into play.
Step 3. Assets. After setting objectives, the next step is to choose financial assets, e.g., primary instruments such as equities and bonds or derivative instruments such as futures and contracts for difference.
Step 4. Diversifying. The portfolio strategy calls for diversifying one's investment across different markets. If a downturn occurs, the investor has assets in other financial markets.
Step 5. Investment costs. You must assess how much it costs to invest to be sure about the assets you intend to acquire. Costs include commissions, maintenance fees and transfer fees.
What are financial instruments?
If you've made up your mind and want to start investing, you should know that financial instruments are all the contracts and exchanges made in the markets to acquire an asset. So, what are financial instruments?
To answer the question "what are financial instruments", you need to classify them into primary and derivative assets.
Primary instruments are the actual assets themselves. In this case, you hold the asset in which you invested, e.g. stock. Derivatives, on the other hand, are financial agreements that establish the price of the transaction based on the value of the underlying asset. Essentially, they don't have a value in themselves but depend on the asset they're related to, e.g., futures or CFDs.
Primary financial instruments
- Companies issue shares in their stock to attract additional capital, and investors or savers buy them to receive a monetary return in exchange. The buyer receives dividends from the shares until he/she sells them. Exchange Traded Funds, or ETFs, are also financial instruments.
- These function as a loan. The investor buys a bond from a company, and the company agrees to repay the money at an agreed date with interest.
- Money market instruments. These are similar to bonds, but their maturity dates are less than one year out. Examples of these include certificates of deposit, repurchase agreements, bankers' acceptances and treasury bills.
Derivative financial instruments
- These are contracts between two parties to exchange cash or other assets at an agreed date in the future.
- These give the investor the right to buy or sell an underlying security at a specified price.
- Contracts for Difference (CFD). With this type of asset, you don't purchase the asset itself but rather the asset underlying the CFD. CFDs also have expiry dates.
What does the composition of an investment portfolio look like?
To find outwhat the composition of an investment portfolio looks like, it's important to first note that portfolio investment is one of the most widely used strategies by investors around the world. The main reason is the ability to diversify risks and earnings.
An investment portfolio is a set of financial instruments (stocks, currencies and bonds) purchased by an investor or saver. What does the composition of an investment portfolio look like, and where do you start if you're a beginner?
First, you should know that whenever an investment portfolio is created, it's recommended that the assets being invested in are related to a certain degree.
Second, you can choose to create the portfolio according to the type of financial instrument or your investment objectives. Stocks, bonds and other assets, such as commodities, should be included in an asset portfolio.
- Asset-based. The portfolio starts with equities. These are assets issued by companies listed on the stock exchange, and the investor buys them at a specific price.
Bonds, on the other hand, are a kind of debt generated by the company, and the trader acquires it as a kind of loan. In the end, the latter makes a profit on the interest generated.
- Strategy-based. If the investor creates a portfolio based on strategies or objectives, it can be divided into income and value portfolios.
An income portfolio aims to generate a steady income rather than focusing on speculation of higher profits in the future. A value portfolio is when a traderchooses assets offered by companies in dire straits that have economic potential.
What is it for?
An asset portfolio serves to diversify earnings. It's a financial strategy that seeks to expand investment markets to simultaneously keep losses relatively low and achieve expansion.
The focus is on optimising money and profits without betting everything on one asset.
Characteristics of an investment portfolio
At Libertex, we know that one financial market strategy is to create a portfolio that corresponds to the investor's profile and objectives. To help you can create one, too, here are the characteristics of an investment portfolio.
Also known as an asset portfolio, this type of portfolio is composed of different financial instruments such as equities, bonds, currencies or derivatives. Continue reading to find out what the ccharacteristics of an investment portfolio are.
- Balance. One feature of an investment portfolio is to find a balance in the assets chosen to make up the portfolio.
These should be selected according to the degree of risk the investor is willing to take on, the amount of capital they want to earn, the amount of money they can invest, and the markets to be traded in.
- Yield. It's essential to choose financial instruments according to the return they generate. The assets can be fixed income with lower but secure returns and equity instruments.
This situation is directly related to the investor's objectives as they may acquire assets that generate regular returns and others with higher risk.
- Security. Portfolios offer a higher chance that the investor will turn a profit. This is due to purchasing fixed-income assets, for example.
- Diversification. This process allows the investor to decrease their chance of incurring losses.
For example, when a stock's price falls, the asset portfolio owner may be able to absorb the loss thanks to other financial instruments that generate capital.
If you're considering building an investment portfolio, you should plan your short-, medium- and long-term objectives.
It's crucial to choose the markets you want to invest in, define your investor profile and consider the risks you're ready to take on.
What are the risks of an investment portfolio?
More and more investors and traders are choosing to build portfolios of assets to diversify their gains and cope with potential losses. However, as with any investment, there are certain risks. So, what are the risks of an investment portfolio?
To answer the question, "what are the risks of an investment portfolio?", it's necessary to discuss the investor's objectives and unexpected outcomes. Before building an asset portfolio, an investor needs to define their profile and the degree of risk they're willing to take on. After that, they set their financial objectives.
What are risks?
Most risks to an asset portfolio come from a failure or inability to meet the stated objectives. Risks often aren't related to the investor but rather to the markets in which they operate. Here are different types of risks:
- Changes in the financial market may affect the portfolio.
For example, the price of some assets, such as equities or cryptocurrencies, depends on supply and demand, so their value may drop and thus negatively impact the asset portfolio. The same is true for interest and the exchange rate.
- Liquidity. A lack of liquidity occurs when the investor wants to sell a financial instrument but can't find a buyer to acquire it at a profitable price. You may lose liquidity by selling an asset at a lower value than you'd like to earn.
- This risk impacts countries with economies that have very high inflation.
When inflation is high, the price of goods is devalued because the local currency loses value, and the investment starts to have an increasingly lower worth. This type of risk primarily affects bond and cash transactions.
- Concentration. This risk emerges if the investor decides to invest all their capital in the same type of financial assets instead of diversifying across different instruments.
- This risk occurs when the company or government that issued a bond can't pay the value previously agreed with the investor on the stipulated date.
What is portfolio risk?
If you're thinking about building an asset portfolio, you should know that there is a degree of contingency known as portfolio risk. Investors who choose financial instruments in different markets seek to optimise their returns with the lowest possible percentage of loss. But what is portfolio risk?
Knowing the total risk of the asset portfolio is a way of answering "what is portfolio risk?" because an investor is not taking the risk for each individual financial instrument but rather the sum of them.
In short, portfolio risk corresponds to fluctuations and changes in the return on the selected set of financial assets. This is because each asset's degree of risk is directly related to the other investments. Portfolio risk is the total risk of all assets, not an individual asset's risk.
The correlation of portfolio risk to objectives
Investors build stock portfolios to maximise their profits and avoid losses. They choose to invest in fixed-income assets to have a steady inflow of capital and other equity assets.
But as with any investment, there's always the possibility of risk. Individual risks arise that depend on the market, liquidity and a country's economy. Portfolio risk, on the other hand, refers to the sum of all these individual risks.
Before building a portfolio, investors should analyse their profile and objectives. Choose instruments that are most relevant to your planning. This is when risks come into play that can occur at any time as a variation of the main objectives.
For example, a decline in a company's stock price may entail a risk for the company's investors. The same applies to a drop in a currency's exchange rate or an increase in a country's inflation rate that affects bonds. If these situations occur simultaneously, the portfolio risk is higher.
What is the objective of an investment portfolio?
What is the objective of an investment portfolio? This is one of the most frequently asked questions by people looking to build an asset portfolio for the first time. In the financial world, investors aim to increase their returns while simultaneously mitigating the risks involved.
That's why it's essential to know the answer to the question "what is the objective of an investment portfolio?" before you start creating one. The aim is to diversify returns, i.e., to invest in different financial instruments such as bonds, currencies or equities, to increase capital and reduce risk.
Asset portfolio objectives
The primary objective of building a portfolio is to diversify investments to maximise returns. By doing so, all funds money aren't allocated to one financial instrument because that individual asset could face a severe crisis and result in a large loss. Instead, funds are distributed across different markets to achieve balance.
The second objective is connected to the return on investment. Choosing markets with a fixed income allows the investor to achieve a steady return. Compared to riskier or more volatile markets, fixed income comes from financial instruments that have a lower but safer return.
The third objective is directly related to the previous one, i.e., security and confidence. Investing money across different markets creates a higher chance that there's the possibility of achieving a positive return and running fewer losses in some markets.
That said, portfolio risk is always present and should be considered before entering into any transaction. Generally speaking, each investment comes with its own risk and initial costs that the investor has to be prepared to assume.
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