What are Financial Instruments? Definition and Examples 

financial instruments

If you are an owner of a firm or you own s a couple of shares and stocks, there are great chances that you may have come across the term Financial Instrument many times in your life. 

And with that being said, most of the young generation isn’t familiar with this term.

And tends to remain often confused to understand what does financial instrument really means.

However, you don’t have to look for this term on the web anymore, as we have got you in this regard.

This article is being written down to educate you about what financial instruments are along with their definition and examples.  

What are Financial Instruments?

What are Financial Instruments

In much simpler words, a Financial instrument is an original and virtual type of document that represents the legal agreement between two parties that involves any type of monetary value.

In addition to this, financial instruments tend to be the assets or packages of money that can be traded for the personal cause of the trader. 

With the being said, most of the types of Financial instruments facilitate users by allowing them to flow and transfer the capital with the investors efficiently. 

These assets that you will transfer as financial instruments can be cash, evidence of one’s ownership, and a lot more. 

Understanding Financial instruments:

To keep things simpler for you, a real or virtual set of documents that represents a legal agreement of two parties that involve any type of monetary value is called a financial instrument. 

The instrument that represents the ownership of an asset is known as an equity-based financial instrument.

The instrument that represents a loan of the investor to the owner of the asset is a debt-based financial instrument.

Types of Financial Instruments:

Derivative instruments

Each type of category of financial instrument is divided into further subcategories. However, the financial instrument can be divided into two types of instruments; cash and derivative.

Each of them is being described below to give you an idea of what perks they come in handy with.

Cash Instruments:

  • The quote of the cash instrument is influenced and determined by referring to their value in the current market.
  • Cash instruments can be securities that can be transferred with ease. 
  • On the other hand, the cash instrument can also be the deposits and loan agreement between the borrowers and the lenders.

 

Derivative Instruments:

  • The characteristics and quotes of the derivative instruments are influenced and determined on the behalf of the underlying components of the vehicles, for example, assets indices or interest rates. 
  • With that being said, an equity option contract is considered to be a derivative instrument as its value is been determined by the underlying stock.
  • The equity option doesn’t oblige the user to buy and sell a stock at a specific price on a specific date, and therefore provides them with the right to sell their stock according to their personnel preference.
  • As the price of the stocks gets high or low in the span of time, the same goes for the value of the equity option as well.  
  • In addition to this, there can be over-the-counter derivates as well. This is a process where the stocks aren’t listed on the formal exchange and hence don’t carry a value of their own. These stocks are priced by the seller and then are traded accordingly.

Types of Asset Classes of Financial Instruments:

Types of Asset Classes of Financial Instruments

Moving on further to the topic, financial instruments can also be further divided according to their asset class.

This asset class depends on whether the instruments are equity-based or debt-based. 

Each of them is being described below to give you an idea of what perks they come in handy with. 

Debt-Based Financial Instruments:

Debt-Based Financial Instruments

These debt-based financial instruments are short-termed and can last in the span of 12 months or less.

And having said that, this type of securities often comes in handy in the form of T-bills or commercial papers.

On the other hand, cash of this kind can be classified as deposits and certificates of deposit. 

Debt-based financial instruments can also be classified as short-term interest rate futures, whereas the OTC derivatives can be determined as the forward rate agreements.

However, the debt-based instruments are not limited to short terms only and can be turned into a long-term unit.

These long-term debt-based financial instruments can last for more than the span of twelve months.

Under the securities, these long terms debts can be classified as bonds whereas the cash equivalents are loans.  

With that being said, the exchange-traded derivates tend to be the bond futures and the options that you receive on bond futures.

On the other hand, OTC derivates are considered to be interest rate swaps, interest rate options, and non-native derivatives. 

Equity-Based Financial Instruments:

Equity-Based Financial Instruments

Coming across to the equity-based financial instruments, these are the instruments that reflect the ownership of the organization that has issued this instrument.

Having said that the securities that lie under equity-based financial instruments are considered to be stocks.

In this category, exchange-traded derivatives come in handy with stock options and equity futures.

With that being said, the OTC derivatives are considered to be the non-native derivates that included stock options within the package.

Conclusion!

While wrapping it all up, the above information tends to be comprehensive and therefore covers every highlight that you may want to know about financial instruments

We believe that by reading this article above, you will surely be able to clear your head and would now be familiar with what this term relates to.

Each type is mentioned carefully along with its examples to provide you with a profound experience!

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