Financial Instrument

Will Kenton is an expert on the economy and investing laws and regulations. He previously held senior editorial roles at Investopedia and Kapitall Wire and holds a MA in Economics from The New School for Social Research and Doctor of Philosophy in English literature from NYU.

Marguerita is a Certified Financial Planner (CFP®), Chartered Retirement Planning Counselor (CRPC®), Retirement Income Certified Professional (RICP®), and a Chartered Socially Responsible Investing Counselor (CSRIC). She has been working in the financial planning industry for over 20 years and spends her days helping her clients gain clarity, confidence, and control over their financial lives.

Katrina Ávila Munichiello is an experienced editor, writer, fact-checker, and proofreader with more than fourteen years of experience working with print and online publications. In 2011, she became editor of World Tea News, a weekly newsletter for the U.S. tea trade. In 2013, she was hired as senior editor to assist in the transformation of Tea Magazine from a small quarterly publication to a nationally distributed monthly magazine. Katrina also served as a copy editor at Cloth, Paper, Scissors and as a proofreader for Applewood Books. Since 2015 she has worked as a fact-checker for America’s Test Kitchen’s Cook’s Illustrated and Cook’s Country magazines. She has published articles in The Boston Globe, Yankee Magazine, and more. In 2011, she published her first book, A Tea Reader: Living Life One Cup at a Time (Tuttle). Before working as an editor, she earned a Master of Public Health degree in health services and worked in non-profit administration.

What Is a Financial Instrument?

Financial instruments are assets that can be traded, or they can also be seen as packages of capital that may be traded. Most types of financial instruments provide efficient flow and transfer of capital all throughout the world’s investors. These assets can be cash, a contractual right to deliver or receive cash or another type of financial instrument, or evidence of one’s ownership of an entity.

Key Takeaways

• A financial instrument http://crypto4pro.com/ibt-%d1%82%d0%be%d0%ba%d0%b5%d0%bd-%d0%be%d1%82%d0%b7%d1%8b%d0%b2%d1%8b-%d0%be%d0%b1%d0%b7%d0%be%d1%80-%d0%ba%d1%80%d0%b8%d0%bf%d1%82%d0%be%d0%b2%d0%b0%d0%bb%d1%8e%d1%82%d1%8b-ibt/ is a real or virtual document representing a legal agreement involving any kind of monetary value.
• Financial instruments may be divided into two types: cash instruments and derivative instruments.
• Financial instruments may also be divided according to an asset class, which depends on whether they are debt-based or equity-based.
• Foreign exchange instruments comprise a third, unique type of financial instrument.

Financial Instrument

Understanding Financial Instruments

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 loan made by an investor to the owner of the asset.

Foreign exchange instruments comprise a third, unique type of financial instrument. Different subcategories of each instrument type exist, such as preferred share equity and common share equity.

International Accounting Standards (IAS) defines financial instruments as "any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity."

Types of Financial Instruments

Financial instruments may be divided into two types: cash instruments and 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.
• Cash instruments may also be deposits and loans agreed upon by borrowers and lenders.

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, for example, is a derivative because it derives its value from the underlying stock. The option gives the right, but not the obligation, to buy or sell the stock at a specified price and by a certain date. As the price of the stock rises and falls, so too does the value of the option although not necessarily by the same percentage.
• There can be over-the-counter (OTC) derivatives or exchange-traded derivatives. OTC is a market or process whereby securities–that are not listed on formal exchanges–are priced and traded.

Types of Asset Classes 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 T-bills and commercial paper. Cash of this kind can be deposits and certificates of deposit (CDs).

Exchange-traded derivatives under short-term, debt-based financial instruments can be short-term interest rate futures. OTC derivatives are forward rate agreements.

Long-term debt-based financial instruments last for more than a year. Under securities, these are bonds. Cash equivalents are loans. Exchange-traded derivatives are bond futures and options on bond futures. OTC derivatives are interest rate swaps, interest rate caps and floors, interest rate options, and exotic derivatives.

Equity-Based Financial Instruments

Securities under equity-based financial instruments are stocks. Exchange-traded derivatives in this category include stock options and equity futures. The OTC derivatives are stock options and exotic derivatives.

Special Considerations

There are no securities under foreign exchange. Cash equivalents come in spot foreign exchange, which is the current prevailing rate. Exchange-traded derivatives under foreign exchange are currency futures. OTC derivatives come in foreign exchange options, outright forwards, and foreign exchange swaps.