A financial instrument is a real or virtual document-00142

Financial Instrument

Financial instrument is a written obligation of one party to transfer something of value to anther party at a future date under certain conditions.

By written obligation we mean that it is enforced by the government and this obligation is an important feature of a financial instrument.

The party here can be an individual, company or a government

Future date can be specified or when some event occurs.

Examples: Stocks, bonds, insurance etc are examples of financial instruments.

Characteristics of Financial Instruments: There are certain characteristics of financial instruments.

Standardization:

It is a standardized agreement which enables reduction in costs of complexity. So because of this most financial instruments today are similar.

Communicate Information:

Provide certain important information about the issuer which otherwise would have been difficult to gather for the lenders.

Value of Financial Instruments: The value of financial instruments depends on various factors.

Size: Larger the promised payment more valuable is the financial instrument.

Timing: The sooner the payment is made increases the value of financial instrument.

Risk: A financial instrument is more valuable if there are greater possibilities that payment will be made.

Circumstances: Payments made when needed the most makes the financial instrument more valuable.

Uses of Financial Instruments:

Store Of Value:

Stocks: The stock holder is a part owner of the firm and receives part of its profits.

Bonds: A form of loan which promises to make repayment in future dates. Bank loans: Borrowers obtains resources from lenders in exchange of promised payments.

Transfer of Risk:

Insurance: Takes premium to assure payment under particular conditions (accident, death etc)

Future contracts: It is an agreement to exchange fixed quantity of a commodity or an asset at a fixed price. Transfer risk of price fluctuations.