Emerging financial instruments

Since we have an understanding of the most common financial instruments, we will now briefly explore some of the emerging investment vehicles that exist in the market.

Cryptocurrency

Cryptocurrency is an emerging financial instrument that hit the mainstream towards the second half of 2018, and saw one of the greatest rallies of an investment vehicle in modern times. A cryptocurrency is a digital or virtual currency that is designed to work as a medium of exchange. Cryptocurrencies use cryptography to secure and verify transactions and control the creation of more currency. Cryptocurrencies use blockchain technology in order to be decentralised, transparent, and immutable. The decentralisation aspect is arguably the most important feature of cryptocurrency. It is not controlled by a central authority and in most cases there is a finite amount of the cryptocurrency in circulation. The most well known of these cryptocurrencies is Bitcoin. [1]

Read the following articles that discuss the case of cryptocurrency as an investment:

Read: (Optional)Bitcoin digital currency as an investment asset [2]

Read: (Optional)Are cryptocurrencies an asset class for institutional investors? [3]

Mortgage-backed securities (MBS)

Mortgage-backed securities are a well-discussed investment vehicle that caused the 2008 Financial Crisis. MBS are essentially bonds that are secured by home and other real estate loans, and they are created when a number of these loans, typically with similar characteristics, are pooled together. This pool is then sold to a federal government agency or a quasi-government entity or a securities firm.

Types of MBS

Pass-throughs: In this MBS, the issuer collects a monthly payment from a pool of mortgages and passes on a portion of the principal and interest to the bondholders. Cash flow is generated from the scheduled principal, scheduled interest, and prepaid principal.

Collateralised mortgage obligations (CMOs): CMOs are repackaged pass-through mortgage-backed securities, in which the cash flow is directed in a prioritised order based on the structure of the bond. The MBSs are separated and issued as different MBS pass-through securities with different terms, interest rates, and risks.

For more information on CMOs, you can read the following article:

Read: (Optional)Collateralized mortgage obligations (CMOs) [4]

MBS offers an alternative investment vehicle for investors and allows investors to diversify. MBS typically will have more attractive yields than government bonds, and carry greater returns, but also increased credit and prepayment risk. There is significant credit quality risk involved with MBS because they are made up of a pool of mortgages that are given an overall credit rating; it is difficult to understand each mortgage’s credit rating, thus making it a risk if homeowners default on their loans.

The following video explains the basics of how MBS works.

Watch: Mortgage-backed security overview (2:02) [5]

We have covered two emerging asset classes that have enjoyed significant time in mainstream media for various reasons. It is important to be aware of the trends in financial investments as they can provide different avenues for returns and diversification.

To consolidate what you have learned so far in the week, read the following article on Frontken Corporation Berhad and its success in the market over the past five years.

Read: (Optional)Why Frontken Corporation Berhad has been a 10-bagger stock? [6]

What do you think?

Of the previously discussed emerging investment vehicles that exist in the market, identify which one is of the most interest to you and why.

List the pros and cons of your chosen investment vehicle and consider what you could do to mitigate the cons.

Share your responses in the comments and join the discussion with your fellow learners.

Try to end your responses, perhaps, with an open-ended question so that your fellow learner can respond and you get to build a discussion!

References

_{1. Rosic, A. What is cryptocurrency? [Everything you need to know!] [Internet]. Blockgeeks. Available from: https://blockgeeks.com/guides/what-is-cryptocurrency/}

_{2. Papavassiliou, VG. Bitcoin digital currency as an investment asset [Internet]. International Banker; 2019 Dec 3. Available from: https://internationalbanker.com/brokerage/bitcoin-digital-currency-as-an-investment-asset/}

_{3. Mariathasan, J. Are cryptocurrencies an asset class for institutional investors? [Internet]. IPE; 2020 Feb. Available from: https://www.ipe.com/home/are-cryptocurrencies-an-asset-class-for-institutional-investors/10043517.article}

_{4. Collateralized Mortgage Obligations (CMOs) [Internet]. This Matter. Available from: https://thismatter.com/money/bonds/types/collateralized-mortgage-obligations.htm}

_{5. Mortgage-backed security overview [Video]. Khan Academy. Available from: https://www.khanacademy.org/economics-finance-domain/core-finance/derivative-securities/mort-backed-secs-tut/v/mortgage-back-security-overview}

_{6. Why Frontken Corporation Berhad has been a 10-bagger stock? [Internet]. Value Investasia; 2020 Jul 31. Available from: https://valueinvestasia.com/why-frontken-corporation-berhad-has-been-a-10-bagger-stock/}