What is a Financial Instrument? Understand These Investment Building Blocks

The 2 types of financial instruments:

• Cash 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. Those assets can include commodities and precious metals, including silver and gold, as well as cash instruments, such as currency, stocks and bonds.

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The 2 asset classes for financial instruments:

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

Most investors tend to get involved with financial instruments by buying the cash varieties, including bonds, stocks and guaranteed investment certificates, or shares in 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 can require investors to buy or sell assets at predetermined times and prices, regardless of their actual market value when the contract comes due.

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

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