Trading assets are securities that firms hold to resell for profit, rather than holding them for investment. They include different account components from the investment portfolio.
Trading assets may include bonds and other fixed-income securities, positive market values from derivative financial instruments, foreign exchange rate contracts, as well as equity shares and other variable-yield securities. Firm-acquired positions that stem from short-term price movements may also constitute trading assets.
Trading assets are debt instruments and marketable equity securities held by a firm in order to be resold at the acquisition date for profits.
In the U.S., banks are permitted to conduct the business of holding trading assets for other banks that are required to submit reports on their financial instruments with the Federal Deposit Insurance Corporation (FDIC).
Trading assets are intended to be resold quickly to provide banks with profits and liquidity required to meet certain commitments; hence, they are considered current assets.
Trading Assets in Banks
Firms acquire trading assets to resell or trade for profit at the date of their acquisition. The assets are valued at their fair value when purchased/sold, and any unrealized gains or losses are recorded periodically on financial reporting dates. Conversely, when held by banks on behalf of other banks, trading assets are valued at a market-to-market rate.
Some banks are allowed to engage in holding trading assets for the benefit of other banks, in which case they are required to file a report with the Federal Deposit Insurance Corporation (FDIC) and the government regulatory agency. Companies report the accumulated values of the adjustments in the trading assets within the shareholder’s equity accounts unless a fair value hedge influences the securities.
Recording Trading Assets
In the financial statements, trading assets are recorded under the balance sheet’s current assets section because they can be liquidated quickly. Since trading assets are valued at a market value, the value is periodically updated on the balance sheet according to price movements. Any unrealized profit or loss resulting from the changes in the value of the trading assets is recorded on the company’s income statement.
For example, a firm that bought Company ABC’s shares for $3 million would update the asset’s value to $1.8 million on the balance sheet if the shares devalued by 40% and record on the income statement a net loss of $1.2 million.
Investment Portfolio vs. Trading Assets
An investment portfolio is the ownership of a group of assets or other financial instruments with the expectation that they will appreciate in value over time. Investment portfolios entail passive ownership of assets rather than an active management role in trading assets.
Furthermore, an investment portfolio covers a wide range of asset classes, including corporate bonds, options, and derivatives. An investment portfolio contains securities such as cash instruments or bonds central to the long-term value of a bank.
On the other hand, the trading assets are separate from the long-term portfolio. Trading assets are bought and sold for the purpose of generating a profits. They are also a source of revenue for banks and provide liquidity to enhance a bank’s long-term objectives.
The most distinguishing feature between an investment portfolio and trading assets is that the former is geared towards the bank’s short-term objective, while the latter is usually meant for a long-term purpose.
Designating Trading Assets at Fair Price
Financial assets that do not qualify to be treated as trading assets are marked at a fair value through profit using the fair value option. Either of the following criteria must be met for the financial assets to be designated at fair value:
1. The designation option removes or reduces recognition or measurement inconsistency.
2. The management and performance of the financial instruments are evaluated based on a fair value pursuant to an investment strategy or a documented risk management.
3. The financial assets include either one or more derivatives unless:
Cash flow is not significantly affected by the embedded derivatives; or
Separation is forbidden either with or without a substantial analysis.
Most companies designate their financial instruments that meet the trading assets definition using the fair value option if a reliable estimate cannot be obtained.
Current Bank Holdings
As of the last quarter of 2019, all U.S. banks’ trading asset values stood at $659 billion. The figure constituted 3.53% of the total bank assets.
The banks were rated according to their total holdings. JPMorgan Chase emerged as the bank with the largest holdings, with trading assets at $263 billion, which was 11.26% of its total assets.
CFI offers the Capital Markets & Securities Analyst (CMSA)® certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below:
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