What is a Financial Instrument

Whether the question is, ‘what is a financial instrument’ or if it is ‘what are financial market instruments’ both have the same answer as both questions have the same context.

What is a financial instrument?

A financial instrument is a tradable financial asset. Now, what does that mean?

Financial instruments are assets, which means that they hold some monetary value and are tradable which means you can trade them through a trading system like a stock exchange.

As we’ve discussed in the beginning that ‘financial instrument’ and ‘financial market instrument’ both have the same meaning and you can interpret from the latter term that whatever is traded there in the financial market is a financial instrument.

A securities market (stock market + bond market + derivative market), a forex market, a money market, a commodity market and a cryptocurrency market – all of these markets fall under the umbrella term of the financial market.

So, if you know what is traded in the above-mentioned markets, you know, the types of financial instruments. Take a look at the following list:

  • Shares, bonds and equity derivatives are traded in the securities market.
  • Treasury bills, certificates of deposits, commercial papers and many other money market instruments are traded in the money market.
  • Commodities and their derivatives are traded in the commodity market.
  • Currency derivatives are traded in the foreign exchange market.
  • Cryptocurrency is traded in the cryptocurrency market.
It is important for you to know the relation between securities and the financial instruments, as many people don't know what's the distinction.
Here's the clarity...
Securities are part of financial instruments and a security is anything that is traded in security market, be it stocks, bonds or derivatives. Commodities and Cryptocurrencies are also financial instruments but they're not securities as they are not the part of Security market.
So, you can say that all the securities are financial instruments but all the financial instruments aren't the securities.

Purpose of Financial Instruments

  • Investment purpose:

From a company’s point of view, the issuance of financial instruments helps them to raise capital from the market. And after raising capital from the market in exchange for shares, bonds and derivatives, companies use this money to expand their business or to pay their debt.

  • Trading purpose:

As an investor or a trader, every individual takes a position in the market by investing in financial instruments to get benefitted from the short term market movements.

Advantages of Financial Instruments

  • Short-term debt instruments help companies to raise capital for their immediate needs and the investors are also in a winning position as they’re also getting a fixed return after a specific point of time.
  • Issuance of shares acts as the permanent source of funds for a company. Companies come up with the IPOs to issue shares and to raise money from the general public and this vast amount of money helps the company to fulfil its needs and also act as retained earnings.

Conclusion

A financial instrument or a financial market instrument is any real or virtual document that holds any monetary value and that can be traded. All the instruments that are traded in the financial market are financial instruments.

Now you know, what is a financial instrument? But it is also important to know that which is not a financial instrument and its answer is any kind of financial product doesn’t count as a financial instrument.

A financial product isn’t a financial instrument that is a service offered by a bank or a brokerage firm to you like a brokerage account, bank account, debit & credit card, loan etc. as it is not tradable but a financial instrument can be traded.

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