Financial instruments are assets that can be traded on the financial markets. They take several forms and serve a variety of functions, including raising funds, hedging risks, and investing. The following are the primary categories of financial instruments:
1. Equity Instruments:
Stocks represent ownership in a corporation. Common equities grant voting rights and possible dividends, whereas preferred stocks provide set income but no voting rights.
Warrants: Grant the right to purchase a company’s stock at a specified price before it expires.
2. Debt Instruments
– Bonds: Long-term debt securities issued by firms and governments. Investors receive periodic interest payments and the principal at maturity.
– Debentures are unsecured bonds that rely on the issuer’s creditworthiness rather than collateral.
– Commercial Paper: Short-term, unsecured promissory notes issued by firms to cover short-term liabilities.
3. Derivative Instruments
– Futures: Contracts requiring buyers to purchase and sellers to sell a specific asset at a predetermined future date and price.
– Options: Offer the right, but not the responsibility, to buy (call option) or sell (put option) an asset at a certain price before it expires.
– Swaps: Parties agree to exchange cash flows or other financial instruments, which are frequently used to control interest rate or currency risks.
4. Hybrid Instruments
– Convertible Bonds: Debt securities that can be converted into a specific number of the
issuer’s shares.
– Preference Shares: Equity shares that pay fixed dividends and have priority over common shares in asset liquidation, but lack voting rights.
5. Cash Instruments
– Cash and Cash Equivalents: Currency, bank deposits, and liquid assets can be easily converted into cash.
– Certificates of Deposit (CDs): Bank time deposits that provide higher interest rates than savings accounts in exchange for locking money away for a set period of time.
6. Foreign Exchange Instruments
– Currency Pairs: Trading one currency against another in the foreign exchange market, for example EUR/USD or USD/JPY.
– Forex Swaps: Agreements to exchange currency amounts and reverse the transaction at a later date.