Deminor Wiki - Financial Instruments

Read below for a definition of the term: "Financial Instruments".

What do we mean when we say "Financial Instruments"?

Financial instruments are assets that can be traded or exchanged, which provide efficient flow and transfer of capital among the world’s investors. They are integral components of the financial markets and are utilised by individuals, businesses, and governments to achieve various financial objectives. Financial instruments can be categorised into two types: cash instruments and derivative instruments, where cash instruments are directly influenced and determined by the markets such as stocks and bonds. In contrast, derivative instruments are based on underlying components such as assets and interest rates.

Types of Asset Classes of Financial Instruments

Debt-Based Financial Instruments:

Loans made by an investor to the issuer, in return for a payment of interest.

Examples:

    1. Treasury bills: Short-term government debt obligation backed by the U.S. Department of the Treasury
    2. Bank Deposits: Bank deposits consist of money placed into banking institutions for safekeeping. These deposits are made to deposit accounts such as savings accounts, checking accounts, and money market accounts at financial institutions. The account holder has the right to withdraw deposited funds, as set forth in the terms and conditions governing the account agreement.
    3. Certificates of Deposit (CDs): A type of savings account that pays a fixed interest rate on money held for an agreed-upon period of time. CD rates are usually higher than savings accounts but lose withdrawal flexibility.

Equity-Based Financial Instruments:

Equity-based instruments represent ownership of an asset.

Examples:

    1. Stocks: Stocks represent ownership in a corporation and constitute a claim on the part of the corporation's assets and earnings. Investors buy stocks to potentially earn dividends and capital gains.
    2. Bonds: Bonds are debt securities issued by corporations, municipalities, or governments to raise capital. Investors lend money to the issuer in exchange for periodic interest payments and the return of the bond's face value at maturity.
    3. Mutual Funds: Mutual funds pool money from multiple investors to invest in a diversified portfolio of stocks, bonds, or other securities. They are managed by professional fund managers.
    4. Exchange-Traded Funds (ETFs): ETFs are similar to mutual funds but trade on stock exchanges like individual stocks. They offer diversification and typically have lower fees compared to mutual funds.

Foreign Exchange Instruments:

Foreign exchange (forex or f/x) instruments include derivatives such as options, futures, and swaps.

Examples:

    1. Options: Options are contracts that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specific period. They are used for hedging or speculative purposes.
    2. Futures: Futures contracts obligate the buyer to purchase, and the seller to sell, an asset at a predetermined price and date in the future. They are commonly used for commodities and financial instruments.
    3. Swaps: Swaps are contracts in which two parties exchange cash flows or other financial instruments. Common types include interest rate swaps and currency swaps.