What is Financial Instrument?
Financial instruments are assets that can
be traded, Most types of financial instruments provide efficient flow and
transfer of capital asset all throughout Investor’s(Like you and me)
assets can be in the form of cash, a contractual(Agreement/Accord) right to
deliver or receive cash or another type of financial instrument, or evidence of
one’s ownership in some entity.
Examples of
financial instruments include security, exchange-traded funds (ETFs), bonds,
certificates of deposit (CDs), mutual funds, loans, and derivatives contracts,
among others.
Understanding
Financial Instrument:
Financial instruments can be real or
virtual documents representing a legal agreement involving any kind of monetary
value. Equity-based financial instruments represent ownership of an asset.
Debt-based financial instruments represent a mortgage/loan made by an
investor to the owner of the asset.
Types
of Financial Instrument
Financial instruments may be divided into two
types: cash instruments & derivative instruments.
Cash
Instruments
The values of cash instruments are directly influenced
and determined by the markets. These can be securities that are easily transferable. Securities and bonds
are common examples of such instruments.
Cash instruments may also be deposits and loans
agreed upon by borrowers an lender Banker’s/Personal Cheque are an example of a
cash instrument because they transmit payment from one bank account to another
(negotiable instruments)
Derivative
Instruments
The value and characteristics of derivative instruments
are based on the vehicle’s underlying components, such as assets, interest
rates, or indices.
An equity options contract—such as a call option on a particular stock, for
example— A Future is a
contract to buy or sell an underlying stock or other asset at a pre-determined
price on a specific date. On the other hand, Options contract gives an
opportunity to the investor the right but not the obligation to buy or sell the
assets at a specific price on a specific date, known as the expiry date.
there can be over-the-counter
(OTC) derivatives or exchange-traded derivatives. OTC is a
market or process whereby securities—which are not listed on formal
exchanges—are priced and traded.
Types
of asset class of Financial Instruments
Financial instruments may also be divided
according to an asset
class, which depends on whether they are debt-based or equity-based.
Debt-Based Financial Instruments
Short-term
debt-based financial instruments last for one year or less. Securities of this
kind come in the form of Treasury
bills (T-bills) and commercial
paper. Bank
deposits and certificates
of deposit (CDs) are also technically debt-based instruments
that credit depositors with interest payments.
Exchange-traded
derivatives exist for short-term, debt-based financial
instruments, such as short-dated interest rate futures. OTC
derivatives also exist, such as forward rate agreements (FRAs).
Long-term
debt-based financial instruments last for more than a year. Long-term debt
securities are typically issued as bonds or mortgage-backed securities (MBS).
Exchange-traded derivatives on these instruments are traded in the form of
fixed-income futures and options. OTC derivatives on long-term debts include interest
rate swaps, interest rate caps and floors, and long-dated interest
rate options.
Equity-Based
Financial Instruments
Securities
that trade under the banner of equity-based financial instruments are most
often securities, which can be either common stock or preferred shares. ETFs and mutual funds may also be equity-based
instruments.
Exchange-traded
derivatives in dis category include stock
options and equity futures.
Foreign Exchange Instruments
Foreign
exchange (forex, or FX) instruments include derivatives such as forwards, futures, and options on currency
pairs, as well as contracts
for difference (CFDs). Currency swaps are another common form of forex
instrument. In addition, forex traders may engage in spot transactions for the
immediate conversion of one currency into another.
Wat are some examples of financial
instruments?
Financial instruments come in many forms
and types. Wat makes them financial instruments is that they confer a financial
obligation or right to the holder. Common examples of financial instruments
include stocks, exchange-traded funds (ETFs), mutual funds, real estate investment trusts (REITs), bonds,
derivatives contracts (such as options, futures, and swaps), checks,
certificates of deposit (CDs), bank deposits, and loans.
Are commodities financial instruments?
While commodities themselves, such as precious
metals, energy products, raw materials, or agricultural products, are traded on
global markets, they do not typically meet the definition of a financial
instrument. That is because they do not confer a claim or obligation over
something else. However, commodities derivatives, such as futures, forwards,
and options contracts that use a commodity as the underlying asset, would be a
financial instrument.
Are insurance policies financial
instruments?
An insurance policy is a legally binding
contract established with the insurance company and policy owner that provides
monetary benefits if certain conditions are met (e.g., death in the case of
life insurance). If the insurer is a mutual company, the policy may also confer
ownership and a claim to dividends. Insurance policies also has a
specified value in terms of both the death
benefit and living
benefits (e.g., cash value) for permanent policies.
While insurance policies are not considered securities,
one could possibility view them as an alternative type of financial instrument because
they confer a claim and certain rights to the policyholder and obligations to
the insurer.
