Financial Instruments

Financial Instruments are tradeable assets (claim) for people who hold them and liabilities (obligation) for the issuer. For example, securities like tradable financial instruments such as bonds, stocks, bank loans. For a $1000 government bond: The government owes $1000 to holder & the government has to pay interest

Financial Instruments

How Financial Instruments Get Value

1. Derivative Financial Instruments

Derivative Financial Instruments that derive their value from the underlying financial instrument. For example: Stock Options

2. Cash Instruments

Cash instruments get their value directly by the markets. They can be securities such as loans and deposits, where both borrower and lender have to agree on a transfer.

3. Debt Securities

Debt Securities are tradable financial instruments that pay interests.

 Types of Financial Instruments

1. Money Market Instruments

These are short-term and their maturity is usually less than 1 year

For example, Commercial paper, treasury bills (federal govt. debt), short-term municipal debt, re-purchase agreements (repos), euro dollars.

2. Bonds (Capital Market Instruments)

These are long-term and their maturity is greater than 1 year.

For example, corporate bonds, treasury bonds (finance national debt), municipal bonds (finances substantial and long-term capital projects), stocks, mortgage loans, consumer loans & business loans.

Stocks: holder has a claim on assets and dividends

3. Derivative Securities

It is a type of financial instrument whose price depends on the value of the underlying security

Options – there are two types of options

  • Call – option to buy shares at a set price on a set date
  • Put – option to sell shares at a fixed price on a set date

Futures – one party agrees to sell a particular good to another party at a set price at a future time.

A Financial Instrument is more valuable:

  • If payments made are larger
  • Payments are made sooner
  • More likely to be made
  • Made when needed the most

Uses of Financial Instruments

1. Financial instruments act as a store of value. For example: Life insurance

2. They reduce trade risk.

You might also like