Financial instruments – definition, types & other introductory concepts

Financial instruments are indispensable for the world of trading. But how much do you know about them?

You can't discuss trading without mentioning financial instruments. At the end of the day, people trade them day in and day out.

So, let’s jump into the concepts of financial instruments and see what they mean, how they work, and, more importantly, why you need to know as much as possible about them.

Get ready, because we will prepare an entire series of articles on financial instruments!

Financial instrument – a brief overview

Marketbusinessnews.com defines a #financial instrument as a contract established between parties, acting as evidence of ownership of an asset (in shares, currencies, commodities, or others).

Further examples of financial instruments include futures, options contracts, securities. The list doesn’t end here, as financial instruments can consist of a more comprehensive array of things, such as cash, deposits, all kinds of loans, and more.

People can trade financial instruments and exchange them depending on their mutual goals. For this reason, we see financial instruments as a package of capital that we give value to, and we trade it.

Investopedia.com expands the definition from marketbusinessnews.com, noting that financial instruments can be either real or virtual documents representing a legal agreement involving any kind of monetary value.

Furthermore, financial instruments can be divided in three, by asset class: equity-based, debt-based, and foreign exchange instruments.

Equity-based financial instruments grant ownership of assets, like stock options or equity futures.

Debt-based financial instruments represent loans that investors make to owners of assets. Short-term debt-based financial instruments have a duration of a maximum of a year. They include complex elements such as commercial paper and T-bills*. Long-term debt-based instruments can last even for decades and include bonds, bonds, futures, or options.

*T-bills are short-term U.S. government debt obligation with a maturity of maximum a year. T-bills are backed by the Treasury Department.

Foreign exchange instruments act as unique type of financial instruments, with different subcategories of each instrument —more on this complex type of financial instruments in a future post. Just make sure you stay tuned to CAPEX.com Featured Articles section!

A different classification of financial instruments

Getting back to marketbusinessnews.com, we learn that experts split financial instruments into derivative and cash instruments.

Derivative instruments

Derivative instruments draw their value from at least one underlying entity, such as assets or even interest rates. Essentially, people dub them as derivatives because their performance is strictly connected to other entities.

CFDs (contracts for difference) fall into the derivatives category of financial instruments, as they are linked to securities like #shares, #indices, or #cryptos. Here at CAPEX.com, you get the opportunity to try out trading on more than 2.100 CFDs, grouped in 8 asset classes. Go here to discover them!

Cash instruments

The markets value cash instruments directly, without drawing their value from a second party. Securities, deposits, or loans all fall into the cash instruments category. Special mention for securities - these are investments traded on secondary markets such as the New York Stock Exchange, according to thebalance.com. We will dedicate an entire article to them since they can often be misunderstood or less explained.

Why so many different types of financial instruments?

Before concluding the first part of our series on financial instruments, you probably want to answer the question from above.

As we explained, the markets get flooded continuously with numerous types and categories of financial instruments, because investors or traders need a diversified list of options to choose from. Some of them favor safer investments, such as bonds, while others prefer riskier solutions, like stocks. At the end of the day, the more choices we have, the better.

Reaching the end of our article, we can only hope you learned some things about financial instruments and their essential role in the markets. Again: keep a close eye on CAPEX.com to follow our series

Sources: marketbusinessnews.com, investopedia.com, thebalance.com