Understanding Inflation and Financial Assets
Inflation Rates
Depending on the intensity of inflation, the following can be distinguished:
- Moderate Inflation: Characterized by a slight increase in prices, with an inflation rate below 10%, typically between 2% and 3%. This is common in most developed countries.
- Runaway Inflation: Occurs when the rise in prices is between 10% and 100% annually.
- Hyperinflation: Defined by prices rising over 100% in a year. It results in a loss of control over prices and the collapse of the monetary system, rendering money nearly valueless. In these cases, the population no longer relies on their country’s currency and takes refuge in barter or the use of stronger foreign currencies to avoid the rapid reduction of their purchasing power. During episodes of hyperinflation, the phenomenon known as “flight from money” occurs. This involves individuals reducing the amount of money they hold. As hyperinflation makes the possession of money enormously expensive, individuals will try to get rid of the liquid money available to them before prices grow further and the money continues to lose value.
Characteristics of Financial Assets
Financial assets are differentiated by:
- Return: The return of an asset is its performance or the payment an investor will receive. When someone invests in a financial asset, they are essentially lending money, and the return is the reward or compensation required for this loan.
When the reward is known beforehand, it is called a fixed-income security (e.g., a bond). If the performance depends on how the company that issued the asset performs, it is considered equity (e.g., shares).
- Risk: The risk of an asset depends on the repayment period and the guarantees provided by the issuer to meet the debt when due. Therefore, the risk will be lower the greater the certainty of recovering the loan amount. Investments in government bonds have less risk than buying shares of a private company.
- Liquidity: The ability or ease with which an asset can be converted into cash. A more liquid asset is easier to turn into cash without loss. Money is the ultimate liquid asset.
Financial Asset Classes
There are two main types:
Fixed Income Financial Assets
These are securities representing part of a loan or debt. If this loan is to the state, that is, if the assets are issued by the government, we refer to it as public debt. Government assets include treasury bills, government bonds, and obligations. Treasury bills are short-term (6, 12, to 18 months), bonds are medium-term (3 and 5 years), and obligations are long-term (10, 15, and 30 years).
If the loan or debt is issued by private companies, they will issue corporate bonds. Corporate bonds include obligations and commercial paper. Commercial paper is short-term, while bonds are medium and long-term debt securities.
Equity Financial Assets
The most representative are shares, which are securities representing each of the parts into which the capital (contributions by the owners of a company) is divided. Each partner owns a number of shares; the more shares they have, the greater their participation in the capital. Unlike fixed income, the payment provided by equity is not fixed in advance. While bonds provide a fixed interest to those who buy them, shares give their holders the right to participate in the distribution of profits (dividends). The amount of such dividends is subject to the smooth running of the company. Therefore, it is impossible to know the exact amount beforehand, hence the term equity assets. Buying equity makes one the owner, or rather, co-owner, of the company.