Instruments of Financial Markets

Financial Instruments
• Financial instruments are assets that can be traded or exchanged. Some examples of
financial instruments include stock shares, exchange-traded funds (ETFs), bonds,
certificates of deposit (CDs), mutual funds, loans, and derivatives contracts.
• Financial instruments provide efficient flow and transfer of capital among the
world’s investors. They are assets that may be in the form of cash, a contractual right to
deliver or receive cash or another type of financial instrument, or evidence of ownership
in some entity.
Key Features of financial instruments:
➢A financial instrument is a real or virtual document representing a legal agreement that
involves any kind of monetary value.
➢Financial instruments may be divided into two types: cash and derivatives.
➢They also are categorized by asset class, which depends on whether they are debt-based
or equity-based.
➢Foreign exchange instruments comprise a third, unique type of financial instrument.
Types of Financial Instruments
Financial
Instruments

Cash Foreign Exchange Derivatives

Instruments Instruments Instruments

Cash Instruments:
➢ The values of cash instruments are directly influenced and determined by the markets and can be
readily brought and sold. Stocks and bonds are examples of such Cash instruments.
➢ Cash instruments may also be deposits and loans agreed upon by borrowers and lenders. Checks
are an example of a cash instrument because they transmit payment from one bank account to
another
Derivative Instruments:
➢The value and characteristics of derivative instruments are based on
the vehicle’s underlying components, such as assets, interest rates, or
indices.
➢An equity options contract—such as a call option on a particular
stock, for example—is a derivative because it derives its value from
the underlying shares. The call option gives the right, but not the
obligation, to buy shares of the stock at a specified price and by a
certain date. As the price of the underlying stock rises and falls, so
does the value of the option, although not necessarily by the same
percentage.
➢There are over-the-counter (OTC) derivatives and exchange-traded
derivatives. OTC is a market or process whereby securities not listed
on formal exchanges are priced and traded.
• 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.

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.
 Types of Class Based Financial Instruments
Debt Based Financial Instruments:
Debt-based instruments are essentially loans made by an investor to the issuer in return
for a payment of interest.
➢Short-term debt-based financial instruments last for one year or less. Securities of this
kind come in the form of Treasury bills (T-bills) and commercial paper. Bank
deposits and certificates of deposit (CDs) are technically debt-based instruments because
they earn depositors interest payments.
➢Exchange traded derivatives are traded for short-term, debt-based financial instruments
such as short-dated interest rate futures. There also are OTC derivatives such as forward
rate agreements (FRAs)
➢Long-term debt-based financial instruments last for more than a year.
➢Long-term debt securities are typically issued as bonds or mortgage-backed securities
(MBS) viz; CBLO. Exchange-traded derivatives on these instruments are traded in the
form of fixed-income futures and options.
➢OTC derivatives on long-term debts include interest rate swaps, interest rate caps and
floors, and long-dated interest rate options.
Equity-Based Financial Instruments:
• Equity-based instruments represent ownership of an asset.
• Stocks are equity-based instruments, as are ETFs and mutual funds that are invested in stocks.
• Exchange-traded derivatives in this category include stock options and equity futures.
Foreign Exchange Instruments:
• Foreign Exchange(forex or f/x) instruments include derivatives such as forwards, futures,
and options on currency pairs, as well as contracts for difference (CFDs).
A currency pair is the quotation of two different currencies, with the value of one currency being quoted
against the other. The first listed currency of a currency pair is called the base currency, and the second
currency is called the quote currency.

A contract for difference (CFD) is a financial agreement between two parties that specifies the payment of a
difference in asset value. CFDs are used in commodity, security, and foreign exchange markets.

•The buyer pays the seller the difference between the asset's current value and its value when the contract
was created.
•The buyer pays the seller if the asset's price is below the agreed-upon price at maturity.
•The seller pays the buyer if the asset's price is above the agreed-upon price at maturity.
• Currency swaps are another common form of forex instrument.
• In addition, forex traders may engage in spot transactions for the
immediate conversion of one currency into another.
Multicap Funds:
Financial Planners recommend multi-cap funds with a fixed allocation
to large, mid, and small cap stocks for long term investors looking to
create wealth and meet long-term goals
Large Cap- Ranked 1-100
Mid-Cap- Ranked 101-250
Small-Cap- Ranked 251 and above
 Equity-Based Financial Instruments
1. Exchange traded fund: ETFs or "exchange-traded funds" are exactly as the name implies: funds that trade on exchanges,
generally tracking a specific index. When you invest in an ETF, you get a bundle of assets you can buy and sell during market hours—
potentially lowering your risk and exposure, while helping to diversify your portfolio.

E T F
ETFs are bought and sold like a common Like a stock, ETFs are traded and experience ETFs generally hold a collection of stocks ,

stock on a stock exchange. Price changes throughout the day bonds or other securities in one fund or
have exposure to a single stock or bond
through a single-security ETF.

2. Mutual Fund: A mutual fund is a company that pools money from many investors and invests the money in securities
such as stocks, bonds, and short-term debt. The combined holdings of the mutual fund are known as its portfolio.
3. Stock Options: An option is a financial instrument known as a derivative that conveys to the purchaser (the option
holder) the right, but not the obligation, to buy or sell a set quantity or dollar value of a particular asset at a fixed
price by a set date.