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Financial Assets

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Financial Assets

Do you have some money you want to save and don't know how to? Do you want to make sure that the money will keep growing? What are some of the ways to invest in today's economy?

You will be able to answer all these questions once you read our explanation of financial assets.

Concept of Financial Assets

While human capital is an extremely important part of economic growth, capital used to generate more capital has been of ever-growing importance for economies worldwide. An economic system that provides efficient channels that move an individual's savings to investment will have a higher possibility of generating more economic growth.

These funds are provided to startups and businesses through individual savings, promoting further development and creating more value in society. A business that takes a loan and then pays back the loan with an interest payment provides a return for the lender and provides income for other people employed in the business or own shares in the business.

Where does this process take place, and what channels in the economy enable the movement of funds from borrowers to savers?

Financial markets are markets where individuals can invest their savings and generate returns. Savings are invested in a financial asset, enabling individuals to create more wealth.

Financial assets definition

We will look at a simple definition of financial assets to get a clear understanding of what it is.

A financial asset is a paper of ownership that allows the buyer to have access to the seller's future income.

There are also physical assets, which involves investing in tangible objects. On the other hand, financial assets are not investments into a real tangible product but rather in financial products created by financial institutions.

A loan is one of the most common examples of a financial asset. As it is a financial asset, a loan is also a liability. How? Well, when you go to the bank and take a loan, you owe money to the bank, which you will have to pay back together with interest on top. This serves as an asset for the bank, but it is a liability for you as you will have to end up paying the loan sooner or later. In addition to loans, other types of financial assets include stock, bonds, and bank deposits. As the financial asset is a claim on another party's future income, it will always be an asset for one side and a liability for the other.

The interest that could be earned from holding financial assets represents the opportunity cost of holding cash. The higher the return, the more expensive it becomes to hold cash.

Financial asset types

There are four main types of financial assets that you should know: loans, bonds, loan-backed securities, and stocks.

Financial assets, Types of financial assets, StudySmarterFigure 1. Types of financial assets- StudySmarter Originals

Loans

We are all familiar with loans. Loans involve two main parties, the lender and the borrower, and are an agreement between the two parties. It consists of allowing the use of funds by the borrower for a certain period of time in exchange for an additional amount of money paid on top of the loan. The majority of individuals come across loans when they take out a mortgage to help them fund their house purchases. Companies may also take out bank loans to expand their inventories or business operations further.

The main advantage of the loan is that it is customized to meet the specific demands a borrower might have. Before a small company gets loan approval, it must fulfill the particular requirement and explain to the lender its business strategy and why they are likely to succeed and can pay the loan back. The same goes for individuals looking to buy a property or a car. This then allows the lender to make a tailored loan according to the needs and demands of the borrower. They agree on the return date and the interest being paid on the loan. This is extremely important for reducing default risk, which is the risk of the borrower not being able to pay back the loan.

Some disadvantages come with loans. Whether it's to an individual or an enterprise, extending credit to someone or something involves a significant amount of transaction costs, such as negotiating loan terms, investigating the borrower's credit history and ability to repay, etc.

Large companies that need huge funds, such as multinational corporates or governments, typically opt for a more streamlined strategy. They sell (or issue) bonds to reduce their borrowing costs.

Bonds

A bond is basically a loan from an investor to a borrower. Bonds are not precisely like commercial bank loans, as they usually involve huge sums. Additionally, large companies and governments decide to take loans from investors instead of taking loans from a bank.

It is an agreement that the borrower makes with the investors to get the funds from them and have them paid back at a future date, together with an extra amount of money for having used their money. This way, bonds serve as a financial asset for the investor and a liability for the company or government that issues the bond.

Key components of the bond include the maturity date, the interest paid on the bond, and the price. The interest on a bond is paid by the issuer monthly or yearly, depending on the type of bond and the maturity date, which is the date when all the funds plus the interest are paid to the investor.

One important thing to note here is that bonds are one of the most liquid financial assets after cash and bank deposits. Being more liquid means that they are easy to sell. That is especially true for government bonds, as investors know that the government will pay back the loan; hence there is demand for it. The bond market, where investors buy and sell different bonds is enormous and way more extensive than the stock market. On the other hand, loans are far more difficult for resale because, unlike bonds, they are not standardized: they vary in size, quality, terms, etc.

Another important aspect of bonds is that the price of previously issued bonds is inversely related to the interest rate on bonds. That means that as the interest rate goes up, the bond price will decline. As the interest rate goes up, bonds that yield higher interest will be more in demand, and the demand for those previously issued bonds with lower interest will drop, which translates into a price decline of the previously issued bond.

Bond investors can receive all the information about the bond issuer before making the transaction. That enables investors to make the best and most informed decision possible. For that reason, you have bond rating agencies, which are independent companies that rate and monitor each bond issuer. The rating of the bond issuer shows the risk that they have in defaulting, the risk of the bond issuer not being able to pay back the bond. Usually, the lower the rating an agency gives, the higher the chance for the bond issuer to default.

Loan-backed securities

As the name suggests, this type of financial asset consists of pools of loans made by banks. To better understand it, imagine there are three people: Lucy, John, and Jim, taking a loan from the Bank of America. The loan agreement is such that each of them will pay the loan back after 5, 6, and 9 years. Bank of America makes a profit on each of these loans, but it might be the case that they could reduce the administration cost of having these loans on their balance sheet and instead give them to someone else to collect the interest payments. Bank of America collects these loans into a pool and makes security out of them, then sells shares of the pooled loans to investors, who would own a part of these loans.

Loan-back securities have grown to be a common practice in financial markets. Mortgage-backed securities, which are made of thousands of mortgage loans, are one of the most common examples. These types of financial assets are also risky, and they are considered the leading cause of the 2008 financial crisis.

Stocks

A stock is a share in the ownership of a company. When you buy stocks, you own parts of the business. Stock is another one of the most liquid forms of money after cash and demand deposits.

To be able to buy stocks, a company should be publicly traded. Large and multinational companies are usually publicly traded, and you can buy shares in these companies via the stock market exchange. However, small companies are often privately held, and shares of these companies are not sold to the public.

The benefit of stocks is that they allow higher returns than other financial assets; however, they are riskier. Shareholders enjoy seeing their stock go up as the market goes up in value. Imagine having bought shares in Tesla years ago; you could have been rich by now – depending on the amount you have invested, of course.

Financial assets examples

There are many examples of financial assets.

Bond: a US treasury bond is a type of financial asset issued by the US government to investors. It has a maturity date of 20 years or 30 years.

Stock: Apple (NASDAQ: AAPL) shares are another example of financial assets.

Loan: a loan taken by your local bank is another example of a financial asset.

There are four main classifications of financial assets on corporate financial statements:

Financial assets at fair value through profit or loss

This involves the types of financial assets that investors hold strictly for the purpose of trading, either making a profit by buying low and selling high or causing a loss by buying high and selling low.

Held to maturity securities

These are an investment in types of financial assets that are held until the date of maturity. Held to maturity securities do not account for changes in the market, and the holder of those possesses them until the date of maturity.

Loans and receivables

This includes a financial asset that contains future payments throughout a fixed period.

Available for sale

Available for sale involves all the other assets that are not classified as one of the above classifications.

Financial Assets - Key takeaways

  • Financial markets are markets where individuals can invest their savings and generate returns. Savings are invested in a financial asset, enabling individuals to create more wealth.
  • A financial asset is a paper of ownership that allows the buyer to have access to the seller's future income.
  • The most liquid forms of money after cash and demand deposits are bonds and stocks.
  • The price of previously issued bonds and the interest rates of bonds have an inverse relationship.
  • The opportunity cost of holding cash is the interest that you could have earned from holding other financial assets.
  • There are four main types of financial assets: loans, bonds, loan-backed securities, and stocks.

Frequently Asked Questions about Financial Assets

A financial asset is a paper of ownership that allows the buyer to have access to the seller's future income. 

US treasury bonds, a bank loan, Apple's shares on the stock market, etc.

There are four main classifications of financial assets: financial assets at fair value through profit or loss, held to maturity securities, loans and receivables, available for sale.

There are also physical assets, which involve investing intangible objects that one can use as their wish. On the other hand, financial assets are not investments into a real tangible product but rather in financial products created by financial institutions in an economy.

Loans, bonds, loan-backed securities, and stocks. 

Final Financial Assets Quiz

Question

What is a financial asset?

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A financial asset is a paper of ownership that allows the buyer to have access to the seller's future income. 

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What are examples of financial assets?

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Bonds, loans, stocks, and loan-backed securities. Examples: US treasury bonds, your loans from the bank, and Apple's shares on the stock market.

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How are financial assets classified on corporate financial statements?


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There are four main classifications of financial assets: financial assets at fair value through profit or loss, held to maturity securities, loans and receivables, available for sale.

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What are the differences between financial and physical asset?


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Physical assets involve investing intangible objects that one can use as their wish.

On the other hand, financial assets are not investments into a real tangible product but rather in financial products created by financial institutions in an economy.

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What are the 4 types of financial assets?


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There are four main types of financial assets that you should know: loans, bonds, loan-backed securities, and stocks. 

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What are financial markets?

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Financial markets are markets where individuals can invest their savings and generate returns. Savings are invested in a financial asset, enabling individuals to create more wealth.

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What is the opportunity cost of holding cash?

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The opportunity cost of having money and not investing it equals the return you would get on the financial asset. The higher the return, the more expensive it becomes to hold cash. Usually, economists use the interest rate to account for the opportunity cost of holding cash.

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Why a financial asset will serve as a liability for one party and as an asset for the other?

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As the financial asset is a claim on another party's future income, it will always be an asset for one side and a liability for the other.  

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Define loans.

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The loan is the agreement between the borrower and the lender, which consists in allowing the use of funds by the borrower for a certain period in exchange for an additional amount of money paid on top of the loan. The majority of individuals come across loans in bank loans to help them fund their house purchases. Companies may also take out bank loans to further expand their inventories or business operations. 

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What are bonds?

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A bond is basically a loan from an investor to a borrower. Bonds are not precisely like commercial bank loans, as they usually involve huge sums. Additionally, large companies and governments decide to take loans from investors instead of taking loans from a bank to reduce transaction costs.

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What are key components of the bond?

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Key components of the bond include the maturity date, the interest paid on the bond, and the price.

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What is the most liquid asset after cash and bank deposits?

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Bonds and stocks are one of the most liquid financial assets after cash and bank deposits.

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What's the relationship between the interest rate on a bond and its price?

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Inverse relationship.

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What is the reason there is an inverse relationship between a bond's price and interest rate?

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As the interest rate goes up, bonds that yield higher interest will be more in demand, and the demand for those previously issued bonds with lower interest will drop, which translates into a price decline of the previously issued bond.

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What are loan-backed securities?

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As the name suggests, this type of financial asset consists of pools of loans made by banks. Banks then sell shares of these pooled loans to investors, who own a part of the loans. 

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What is a stock?

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A stock is basically a share in the ownership of a company.

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What are the benefits of stocks?

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The benefit of stocks is that they allow higher returns than other financial assets; however, they are riskier.

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Who are financial intermediaries?

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Financial intermediaries are the institutions within an economy that collect savings and investment money from individuals in exchange for financial assets. 

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What are the types of financial intermediaries?

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There are many types of financial intermediaries, the most important type of financial intermediaries that you should know include: mutual funds, pension funds, life insurance companies and banks.

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What is an example of financial intermediaries?


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Examples of financial intermediaries include:

  • Commercial bankers and investment bankers.
  • Mutual funds and pension funds.
  • Insurance companies.

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What are the roles of financial intermediaries?


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The three main roles of financial intermediaries include asset storage, loans, and investments.

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What are the disadvantages of financial intermediaries?

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Some disadvantages of investing through a financial intermediary can include lower investment returns (due to fees), mismatched goals, credit risk, and market risk.

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What are non-bank financial intermediaries?

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A financial intermediary that is not a bank does not take deposits from the general public as a deposit. The middleman may provide financial services such as leasing, insurance policies, and other types of financing. 

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What are mutual funds?

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Mutual funds aggregate the money they collect from individuals investors and use it to purchase shares in a large number of companies and build a diversified portfolio. The investors own shares in the mutual fund, which is the owner of the stock portfolio. When mutual funds profit, the profit is distributed amongst all the investors who have placed their money in a mutual fund. 

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What are some benefits of mutual funds?

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Mutual funds have two primary benefits. One is making the purchase of financial assets more efficient in terms of transaction costs, and the other is providing a diversified portfolio, which reduces overall risk.

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What are pension funds?

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Pension funds are a non-profit institution whose function is to collect savings from individuals, invest the savings, and provide the funds back when individuals retire.

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Explain life insurance companies.

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Life insurance companies are another type of financial intermediary. Their primary purpose is to guarantee the delivery of funds to the beneficiaries in the event of an untimely death of the policy holder. The beneficiary is usually the children or family who depend on the policy holder's income.

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Explain banks as financial intermediaries.

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Banks are types of financial intermediaries that facilitate the transaction between lenders who want to save and borrowers who need financing for their projects.

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Explain asset storage.

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Commercial banks provide safety and security by ensuring storage of cash--either in the form of paper money or coins--and other precious materials such as gold or silver.


Individuals who make deposits are offered a variety of tools to help them secure their cash and also to help them access it at any time. These include ATM cards, debit cards, checks, and credit cards. Depositors may also see records of withdrawals, deposits, and direct payments that they have approved via the bank.

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Explain how financial intermediaries may provide lower returns on investment.

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Because financial intermediaries also want to make a profit, they charge a fee for their services. Including this fee can mean the investor ends up with a lower investment return than if they had excluded the intermediary and invested directly with the source. 

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Explain mismatched goals as a disadvantage of financial intermediaries.

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It is possible that a financial intermediary is not acting as an unbiased third party. They may promote investment possibilities fraught with hidden dangers or that may not serve the investor's best interests. Furthermore, there is also some indirect conflict of interest where financial intermediaries have different clients who manage their money and invest in them. They will have the incentive to invest in such companies more.

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Explain credit risk as a disadvantage of financial intermediaries.

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Credit risk is also another disadvantage of financial intermediaries. This involves the risk of clients defaulting on their loans. This is dangerous as the bank uses these funds to pay back the depositors. In such an event, both sides lose. If many loans were to default, it would trigger a financial crisis.

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Explain market risk as a disadvantage of financial intermediaries.

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The performance of financial intermediaries is significantly correlated with the performance of the overall market. If external shocks negatively impact the performance of the market, it will also cause trouble for financial intermediaries, although this is the risk that is inherent with investing.

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Q1

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A1

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Markets, where individuals can invest their savings and generate returns, are known as...

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Financial Markets

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_____ are invested in a financial asset, enabling individuals to create more ____.

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savings; wealth

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Financial assets are investments in ______ products.

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non-tangible

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You are buying a new house and need to take a loan from the bank. This is a _____ for you and a ______ for the bank.

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liability; asset

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Which of the following is NOT a financial asset?

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Land

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The interest that could be earned from holding financial assets represents the ______ of holding cash.


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opportunity cost

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How many main financial assets are there?

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4

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What is the benefit of loans?

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They can be tailor-made to the borrower's needs

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What is the relationship between a bond's prices and interest rates?

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Inverse relationship

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Collecting loans and selling them to an investor is known as...

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Loan-backed securities

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Which financial asset allows you to buy a portion of a company?

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Stocks

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True or False: Stocks are an illiquid financial asset

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False

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True or False: Bonds are liquid financial assets.

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True

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True or False: Mortgage-backed securities are often referred to as the reason for the 2008 financial crash.

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True

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When you take out a mortgage for a home, you are taking out a...

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Loan

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If your loan is collected into a pool of loans sold to investors, then your loan is a part of...

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Loan-backed securities

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