Home Debt instrument What is a financial instrument? Understand these building blocks of investment

What is a financial instrument? Understand these building blocks of investment

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Assets are traded in the market and take many forms, some common and others more complex

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Financial instruments have a musical name, but no, they’re not money-spitting trumpets. Instead, they play an important role in the flow of money in the economy.

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At the grassroots level, financial instruments are monetary contracts between individuals or organizations that the parties can trade in the open market. Assets take many forms and are categorized in two ways: by type and by asset class.

The two types of financial instruments:

  • Treasury instruments – Deposits and loans, commodities, foreign currencies and securities, such as stocks and bonds.
  • Derivative instruments – Futures, options, swaps and forwards, and assets that get – or derive – their value from the underlying asset they represent. These assets can include commodities and precious metals, including silver and gold, as well as treasury instruments, such as currencies, stocks and bonds.

The two asset classes for financial instruments:

  • Equity-based financial instruments – Provide their owners with a stake in a business. Most common example: actions, both common and preferred.
  • Debt instruments – Involve loans with interest. Examples: mortgages, bonds, leases and notes.

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Most investors tend to get involved in financial instruments by purchasing cash, including bonds, stocks and guaranteed investment certificates, or shares of an exchange traded fund or real estate investment trust. .

Investing in derivatives, such as stock options and futures, is more complex because the contracts involved may require investors to buy or sell assets at predetermined times and prices, regardless of their actual market value at the end of the contract.

Some derivatives can be difficult for investors to access because they are not sold on a centralized exchange, such as the Toronto Stock Exchange. For this reason, they are called over-the-counter derivatives and you would need to work with a broker who specializes in these products.

Even if you didn’t know the definition of financial instruments until today, you’ve probably been playing them since you first started investing.

This article provides information only and should not be construed as advice. It is provided without warranty of any kind.

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