Financial instruments are securities that are held as a store of value and for the expected return. They represent claims on a stream of income or any other economic unit when traded in a financial market. It holds a monetary value and acts as a financial asset for one party and financial liability to pay to another until it’s settled on the maturity date.
Financial instruments are usually provided by banks like columbia bank Edison and can be traded, modified, or settled as per the individuals involved.
Financial instruments are broadly classified into- primary securities, indirect securities, and derivatives.
- Equity shares: Such type of securities represents ownership and risk capital. They are owned by parties involved in the management of a company.
- Debenture: It is creditorship security. Debenture holders hold the first claim on the firm’s assets and are entitled to a preset interest rate.
- Preference share: Preference shares take a hybrid form by combining the feature of both equity shares and debenture. In contrast with equity shareholders, the preference shareholders have prior rights over a fixed dividend and capital return.
They are financial assets issued by financial intermediaries, such as policies of insurance companies, banks, deposits, or mutual funds investment. Indirect securities are preferred more by small investors as they better suit their investment requirements.
The underlying benefit of indirect securities is that the pooling of funds from small investors adds greatly to financial markets’ effectiveness and efficiency.
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The financial market runs deep into a high degree of risk volatility due to price fluctuations of assets or securities. However, derivative instruments can be used to offset such risk partially or fully by locking the asset prices. This minimizes the possibility of an investor running into huge losses due to variation in the security price.
The most commonly used derivative instruments are futures, forwards, and options that help mitigate the financial loss to investors.
Therefore, financial instruments are one of the financial market components in the financial market that plays a crucial link between savers and investors.