Such products can include various types of assets:
- Real estate
- Investment funds
- Shares in mutual funds
- Deposit certificates
- Crypto assets
- Other financial instruments
Investment products can be offered by banks, investment funds, insurance companies, cryptocurrency companies, and other financial organizations.
Each investment product has its own characteristics, risks, and potential returns, and investors choose them based on their own financial goals and the level of risk they are willing to take.
An investment product is a ready-made offering with the opportunity to invest in specially selected assets.
How and for What Are Interest Rates Calculated in Different Types of Investment Products?
Interest rates in different types of investment products are calculated depending on their specifics. Interest rates can be fixed or variable, and their size may depend on several factors, including current market conditions, inflation, and the issuer’s or asset manager’s policy.
Here are a few examples of how interest rates are calculated:
Interest is calculated on the deposit amount in accordance with the bank’s established interest rate.
Interest may be calculated daily, monthly, or on other terms, depending on the deposit conditions.
Interest is credited to the deposit account and can be compounded (added to the principal amount) or withdrawn to another account.
Interest on bonds is calculated based on the nominal rate (coupon rate) specified in the bond.
Bonds are issued with fixed or variable coupon rates.
Interest is paid by the bond issuer, typically once or twice a year.
Interest in the form of dividends is paid to company shareholders based on the company’s profits and management decisions.
Dividends are paid to shareholders on a regular basis (such as quarterly or annually) or at the discretion of the company’s management.
Interest is calculated based on the fund’s performance, which may include various assets such as stocks, bonds, and other financial instruments.
Interest is distributed among investors in proportion to the number of shares they own in the fund.
Interest may be earned in the form of rent from property tenants.
In the case of investing in commercial real estate, interest may be earned based on rental income or property sales.
DeFi platform pools
Interest from investments in pools depends on the type of pool. For pools providing liquidity for decentralized exchanges, returns are generated from fees for transactions conducted through the pool.
On cryptocurrency lending platforms, returns are generated based on the interest rates set by the lender.
Remember that for investments, the golden rule applies: the higher the return, the higher the risks. Risks can vary widely, from product volatility to the stability of a country’s financial system. It’s important to keep this in mind and consider it when choosing an investment direction.
What Are the Types of Income?
Income is divided into two main categories: active and passive.
Active income is generated with your direct involvement. The most common form of active income is a job, where you invest your time and effort in exchange for a salary. In the context of investments, active income includes trading, active reinvestment, monitoring market conditions, and asset analysis.
In essence, active income involves actively participating in the process of earning income. One of the advantages of this type is the high likelihood of receiving a significant return on investment, as you are deeply involved in the process and constantly striving to improve performance. However, there are always risks associated with it that you should be mindful of.
Passive income, on the other hand, is at the opposite end of the spectrum. It involves delegating the investment process or requiring minimal involvement.
Passive income includes investments, real estate rental income, and investments in various products. The advantage of this type is the minimal amount of time and effort required to generate income. While the returns may be lower, you can use your time for other activities, such as earning active income, while passive income continues to work on its own.
What Is an Asset?
An asset is a tool or resource that has value and can be used to generate income. Essentially, an asset encompasses everything that can be used for earning. It is not limited to the physical world, so the term “property” is not entirely accurate when referring to assets.
Assets can be categorized into three main types, each with subcategories:
These are assets that represent resources and instruments that can be bought, sold, and traded in financial markets. Financial assets include:
- Bank deposits
- Shares in funds
In essence, financial assets are directly linked to the financial market.
These are assets with a physical form. They include real estate, transportation, equipment, materials, tools, goods, and more. Financial assets with a physical form, such as cash, are not considered physical assets.
These are intellectual objects without a physical form that have value. Examples include software, intellectual property rights, patents, permissions, technologies, and more.
What Are Bank Deposits?
Bank deposits are funds placed in banks that earn interest. Instead of keeping your money in a personal safe or checking account, you entrust your funds to a bank, and the bank provides compensation for this service.
Deposits allow you to generate additional income from unused funds, which is their primary advantage. Deposits come in various forms, differing in currency, lock-in periods, annual interest rates, withdrawal and replenishment options, and the possibility of refinancing.
However, deposits also have their disadvantages:
- Low interest rates: Banks often offer relatively low interest rates on deposits compared to other financial products, although this is not a universal rule.
- Inflation: If the interest rate on a deposit is lower than the inflation rate, the purchasing power of your money will decrease over time.
- Lock-in of funds: Deposits often involve restrictions on withdrawing money before the maturity date, which can range from 3 to 12 months. Some deposits offer withdrawal options but typically at lower interest rates.
How Hedging Works
Hedging is a financial strategy aimed at reducing risks and protecting against losses resulting from unfavorable changes in financial markets or asset prices.
The main idea behind hedging is to create an investment position that offsets potential losses from another investment or action.
The mechanism of hedging works as follows:
- Investors or companies identify the risks they are exposed to, which could include currency fluctuations, interest rates, commodity prices, stocks, and more.
- They then select tools or strategies that can mitigate or eliminate these risks.
- Depending on market conditions and the effectiveness of the risk reduction approach, the strategy and tools may be analyzed and adjusted.
Key hedging instruments
These allow the fixation of asset prices (e.g., currency or commodities) for future delivery. Investors establish the price in advance and receive a predetermined profit, regardless of market fluctuations, thus protecting against currency or price fluctuations.
These allow for a deferred purchase agreement within a specified period established at the time of the contract. Investors purchase futures on an asset, locking in its price without paying the full amount upfront. The broker reserves only a percentage of the contract as collateral.
These provide the right, but not the obligation, to buy or sell an asset at a specified price in the future. Options can be used to protect against adverse price changes.
These are agreements for mutual payment exchanges between parties. Swaps can be used to manage interest rate risks.
Advantages of hedging
- Risk reduction: The primary benefit of hedging is reducing the risk of capital loss due to adverse market changes.
- Planning and predictability: Hedging enables investors and companies to plan financial flows and budgets more accurately because they know their expenses and income in the future.
- Protection from uncertainty: Hedging can shield businesses from uncertainty related to commodity price fluctuations, currency risks, and other factors.
Disadvantages of hedging
- Cost: Using hedging instruments may require additional expenses.
- Profit limitations: In favorable scenarios, investors may miss out on larger profits because hedging strategies limit profit potential.
- Complexity: Some hedging instruments and strategies can be complex and require specialized knowledge.
Hedging is an essential strategy for reducing risks and ensuring financial stability, both for individual investors and companies.
What Is RWA
RWA (Risk-Weighted Assets) is a concept used to measure the risk associated with assets reported on a bank’s balance sheet.
RWA reflects the risk assessment associated with various assets on the bank’s balance sheet. Different types of assets carry different levels of risk. For example, extending a loan is riskier than investing in government bonds.
Regulators require banks to have enough capital to cover potential losses from high-risk assets. RWA is used to determine the minimum capital that a bank must maintain in accordance with regulatory standards.
If a bank holds an insufficient amount of reserves, it may not be able to cover losses, potentially leading to bankruptcy.
What Is DeFi
DeFi (Decentralized Finance) is decentralized finance, representing an alternative to the traditional financial system. Decentralized finance is built on blockchain technology and utilizes smart contracts to create and manage financial products and services.
The goal of DeFi is to eliminate intermediaries such as banks or other centralized governing bodies when providing services to consumers. Decentralization allows users to access financial instruments without restrictions.
For example, obtaining a loan on a decentralized platform does not require going through a credit scoring process, as is typically the case with banks.
How Income is Generated in DeFi
Income in DeFi is generated depending on the specific instrument. Let’s consider a few examples:
Liquidity pools on a decentralized exchange (DEX)
When providing liquidity to pools, you earn a percentage of the transaction fees conducted through the pool. You supply assets to the exchange for use in other users’ operations, and the exchange shares its revenue with you.
Liquidity pools on decentralized crypto lending platforms
Similar to exchanges, you supply assets to a lending platform, and the platform shares a portion of its earnings from lending those assets to other users.
Are Fixed Rates Available in DeFi?
Yes, fixed rates are available. Fixed rates are provided for depositing assets for a specific period with no early withdrawal option. This is commonly seen on DeFi staking platforms.
If funds are withdrawn before the set time, interest will not be accrued. In essence, it’s an alternative to traditional bank deposits.
Types of Investment Theories
There are numerous investment theories and approaches that guide investors in making decisions on how to allocate their capital. These theories establish frameworks and principles for understanding financial markets and managing investments. Here are some well-known investment theories:
Efficient Market Hypothesis (EMH)
According to this theory, financial markets are efficient, and asset prices already incorporate all publicly available information. EMH suggests that it is impossible to consistently outperform the market because prices adjust instantly to new information.
This approach involves analyzing historical price and volume data to identify trends and patterns. Technical analysts believe that past price movements can help predict future market movements and use charts and technical indicators to make investment decisions.
Fundamental analysts evaluate the intrinsic value of an asset by examining financial metrics such as revenue, earnings, debt, and other factors. They aim to determine whether an asset is overvalued or undervalued and make investment decisions accordingly.
Modern portfolio theory (MPT)
MPT emphasizes the importance of diversification and optimizing the risk-return trade-off. It suggests that investors should construct portfolios that maximize expected returns for a given level of risk, taking into account correlations between assets.
Value investors seek out undervalued assets and believe that the market occasionally misprices securities. They aim to buy assets trading below their intrinsic value, expecting the market to eventually recognize their true worth.
Growth investors focus on companies with high growth potential. They are willing to pay higher prices for stocks of companies expected to have above-average earnings growth.
Dividend investors prefer assets that regularly pay dividends. They aim to generate income from their investments and often seek companies with stable or growing dividend payments.
Behavioral finance takes psychological factors into account when making investment decisions. It recognizes that investors are not always rational and may make decisions based on emotions or cognitive biases.
Passive investors typically adhere to a “buy and hold” strategy and aim to replicate market index or asset class performance. They do not actively select individual securities.
Active investors seek to outperform the market and frequently make buy and sell decisions. They often conduct extensive research and analysis to identify opportunities.
The choice of investment theory or approach depends on individual goals, risk tolerance, time horizon, and market conditions. Many investors combine elements of various theories to create diversified portfolios aligned with their financial objectives. Thorough research and professional advice are essential before making investment decisions, as all investments come with inherent risks.