Financial Instrument (2024)

Contractual monetary assets that can be purchased, traded, created, modified, and even settled for

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Written byCFI Team

What is a Financial Instrument?

Financial instruments are contracts for monetary assets that can be purchased, traded, created, modified, or settled for. In terms of contracts, there is a contractual obligation between involved parties during a financial instrument transaction.

Financial Instrument (1)

For example, if a company were to pay cash for a bond, another party is obligated to deliver a financial instrument for the transaction to be fully completed. One company is obligated to provide cash, while the other is obligated to provide the bond.

Basic examples of financial instruments are cheques, bonds, securities.

There are typically three types of financial instruments: cash instruments, derivative instruments, and foreign exchange instruments.

Types of Financial Instruments

Financial Instrument (2)

1. Cash Instruments

Cash instruments are financial instruments with values directly influenced by the condition of the markets. Within cash instruments, there are two types; securities and deposits, and loans.

Securities: A security is a financial instrument that has monetary value and is traded on the stock market. When purchased or traded, a security represents ownership of a part of a publicly-traded company on the stock exchange.

Deposits and Loans: Both deposits and loans are considered cash instruments because they represent monetary assets that have some sort of contractual agreement between parties.

2. Derivative Instruments

Derivative instruments are financial instruments that have values determined from underlying assets, such as resources, currency, bonds, stocks, and stock indexes.

The five most common examples of derivatives instruments are synthetic agreements, forwards, futures, options, and swaps. This is discussed in more detail below.

Synthetic Agreement for Foreign Exchange (SAFE): A SAFE occurs in the over-the-counter (OTC) market and is an agreement that guarantees a specified exchange rate during an agreed period of time.

Forward: A forward is a contract between two parties that involves customizable derivatives in which the exchange occurs at the end of the contract at a specific price.

Future: A future is a derivative transaction that provides the exchange of derivatives on a determined future date at a predetermined exchange rate.

Options: An option is an agreement between two parties in which the seller grants the buyer the right to purchase or sell a certain number of derivatives at a predetermined price for a specific period of time.

Interest Rate Swap: An interest rate swap is a derivative agreement between two parties that involves the swapping of interest rates where each party agrees to pay other interest rates on their loans in different currencies.

3. Foreign Exchange Instruments

Foreign exchange instruments are financial instruments that are represented on the foreign market and primarily consist of currency agreements and derivatives.

In terms of currency agreements, they can be broken into three categories.

Spot: A currency agreement in which the actual exchange of currency is no later than the second working day after the original date of the agreement. It is termed “spot” because the currency exchange is done “on the spot” (limited timeframe).

Outright Forwards: A currency agreement in which the actual exchange of currency is done “forwardly” and before the actual date of the agreed requirement. It is beneficial in cases of fluctuating exchange rates that change often.

Currency Swap: A currency swap refers to the act of simultaneously buying and selling currencies with different specified value dates.

Asset Classes of Financial Instruments

Beyond the types of financial instruments listed above, financial instruments can also be categorized into two asset classes.The two asset classes of financial instruments are debt-based financial instruments and equity-based financial instruments.

1.Debt-Based Financial Instruments

Debt-based financial instruments are categorized as mechanisms that an entity can use to increase the amount of capital in a business.Examples include bonds, debentures, mortgages, U.S. treasuries, credit cards, and line of credits (LOC).

They are a critical part of the business environment because they enable corporations to increase profitability through growth in capital.

2. Equity-Based Financial Instruments

Equity-based financial instruments are categorized as mechanisms that serve as legal ownership of an entity.Examples include common stock, convertible debentures, preferred stock, and transferable subscription rights.

They help businesses grow capital over a longer period of time compared to debt-based but benefit in the fact that the owner is not responsible for paying back any sort of debt.

A business that owns an equity-based financial instrument can choose to either invest further in the instrument or sell it whenever they deem necessary.

Additional Resources

Thank you for reading CFI’s guide on Financial Instrument. To help you become a world-class financial analyst and advance your career to your fullest potential, the additional resources below will be very helpful:

  • Debentures
  • Interest Rate Swap
  • Preferred Shares
  • Synthetic Cash
  • See all wealth management resources
  • See all capital markets resources
Financial Instrument (2024)


What is an example of a financial instrument? ›

Common examples of financial instruments include stocks, exchange-traded funds (ETFs), mutual funds, real estate investment trusts (REITs), bonds, derivatives contracts (such as options, futures, and swaps), checks, certificates of deposit (CDs), bank deposits, and loans.

How do I choose a financial instrument? ›

Choosing the right financial instrument involves assessing risk, purpose, and understanding its attributes for effective trading. Best Financial Instruments for Trading: For trading, financial instruments like Forex and stock CFDs are popular. They offer potential short-term gains.

What is the most important financial instrument? ›

The two most prominent financial instruments are equities and bonds. Equities (or shares) are the ownership of a portion of a company, which can then be traded. The value of this portion may fluctuate depending on the company's performance and market conditions, making equities a potentially risky investment.

What is a financial instrument for dummies? ›

A financial instrument refers to any type of asset that can be traded by investors, whether it's a tangible entity like property or a debt contract. Financial instruments can also involve packages of capital used in investment, rather than a single asset.

What is a basic financial instrument? ›

The most common basic financial instruments are cash, trade debtors, trade creditors and most bank loans. For a debt instrument (receivable or payable) to be basic, returns to the holder must be: •a fixed amount; •a positive fixed rate or a positive variable rate; or.

What are the 3 main categories of financial instruments? ›

Basic examples of financial instruments are cheques, bonds, securities. There are typically three types of financial instruments: cash instruments, derivative instruments, and foreign exchange instruments.

Which is the best financial instrument? ›

Here Are A Few Low-Risk Investment Options
  • Money Market Funds. Money Market Funds are short-term debt funds. ...
  • Municipal Bond. A Municipal Bond or Muni-Bond is a debt instrument issued by municipal corporations or associated bodies in India. ...
  • Certificate of Deposit. ...
  • Treasury Bills.
Feb 16, 2024

What is a financial instrument in simple words? ›

In simple words, any asset which holds capital and can be traded in the market is referred to as a financial instrument. Some examples of financial instruments are cheques, shares, stocks, bonds, futures, and options contracts.

How do you create a financial instrument? ›

Design your own Financial Instrument
  1. Identify the proposed amount and the expected leverage effect;
  2. Choose the proposed financial products;
  3. Identify and describe the proposed target group of final recipients;
  4. Describe the expected contribution to the specific objectives.
Feb 27, 2020

What are the riskiest financial instruments? ›

The 10 Riskiest Investments
  1. Options. An option allows a trader to hold a leveraged position in an asset at a lower cost than buying shares of the asset. ...
  2. Futures. ...
  3. Oil and Gas Exploratory Drilling. ...
  4. Limited Partnerships. ...
  5. Penny Stocks. ...
  6. Alternative Investments. ...
  7. High-Yield Bonds. ...
  8. Leveraged ETFs.

How to make money from financial instruments? ›

This type of income is paid by several different types of investments, listed as follows:
  1. Fixed-income securities, such as CDs and bonds. ...
  2. Demand deposit accounts, such as checking, savings, and money market accounts. ...
  3. Fixed annuities, which pay a set rate of interest on a tax-deferred basis until maturity.

What are the most complicated financial instruments? ›

Examples of these products are warrants and certificates. These products, as well as options and futures, are not suitable for the beginning investor because they are complex, volatile by nature, and risky.

What is the main purpose of a financial instrument? ›

They serve as a medium of wealth creation. People prefer to invest in financial instruments instead of keeping their money in a savings account, as the former has an appreciative trend.

How are financial instruments valued? ›

In market approach, the value of the financial instrument is determined by considering traded prices of such instrument in an active market; or prices and other relevant information generated by market transactions involving identical or comparable (similar) assets.

Is an invoice a financial instrument? ›

The definition of a financial instrument describes financial instruments as contracts, and therefore financial instruments are in essence pieces of paper. For example, an entity that sells goods on credit issues an invoice (piece of paper).

What is classified as a financial instrument? ›

In simple words, any asset which holds capital and can be traded in the market is referred to as a financial instrument. Some examples of financial instruments are cheques, shares, stocks, bonds, futures, and options contracts.

What are instruments in finance? ›

An instrument is a means by which something of value is transferred, held, or accomplished. In the field of finance, an instrument is a tradable asset, or a negotiable item, such as a security, commodity, derivative, or index, or any item that underlies a derivative.

What is an example of a financial instrument in the money market? ›

Money markets include markets for such instruments as bank accounts, including term certificates of deposit; interbank loans (loans between banks); money market mutual funds; commercial paper; Treasury bills; and securities lending and repurchase agreements (repos).

Is a financial instrument a type of asset? ›

A financial instrument is any asset that retains capital and may be traded on the market. Cheques, stocks, shares, bonds, futures, and options contracts are all types of financial instruments.


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