A financial instrument is a monetary contract between parties that can be created, traded, modified, and settled. It can be a real or virtual document representing a legal agreement involving any kind of monetary value. Financial instruments can be categorized by "asset class" depending on whether they are equity-based (reflecting ownership of the issuing entity) or debt-based (reflecting a loan the investor has made to the issuing entity) . They can also be categorized as cash instruments or derivative instruments. Foreign exchange instruments comprise a third, unique type of financial instrument.
Examples of financial instruments include:
- Cash instruments: securities, loans, deposits
- Debt-based instruments: bonds, debentures, mortgages, credit cards, line of credits
- Equity-based instruments: common stock, convertible debentures, preferred stock, transferable subscription rights
- Derivative instruments: options, futures, forwards, swaps
- Foreign exchange instruments: currency futures, foreign exchange options, outright forwards, foreign exchange swaps
Financial instruments provide companies with liquid assets, which can be used for quick payments or dealing with contingencies. They are a critical part of the business environment because they enable corporations to increase profitability through growth in capital. Accounting for financial instruments involves issues around classification, initial measurement, and subsequent measurement.
