Q. Consider the following :

  1. Exchange-Traded Funds (ETF)
  2. Motor vehicles
  3. Currency swap

Which of the above is/are considered financial instruments?

  • 1 only
  • 2 and 3 only
  • 1, 2 and 3
  • 1 and 3 only

Answer: (d) 1 and 3 only

Financial instruments:
  • Financial instruments are contracts or documents that act as a financial asset to one organisation and a liability to another.
  • The types of financial instruments are debentures and bonds, receivables, cash deposits, bank balances, swaps, caps, futures, shares, bills of exchange, forwards, FRA or forward rate agreement, and more.
Types of Financial Instruments in India

a) Derivatives

  • The underlying asset, such as resources, currency, bonds, stocks, indexes, and so on, determines the value of derivative instruments. The underlying assets determine the performance of derivatives instruments.
  • The most popular types of derivative instruments are as follows:
    • Forward Contract – It is a personalized arrangement. It involves the exchange of an underlying asset between two parties at a certain exchange during a specific time period. 
    • Future – A derivative contract involving the exchange of derivatives at a predetermined exchange rate on a future date.
    • Options: An option is a kind of derivative contract between two parties. The buyer obtains the right to buy or sell the underlying asset at a set price for a set length of time. However, there is no need to use the right. 
    • SAFE (Synthetic Agreement for Foreign Exchange): This arrangement takes place in the over-the-counter (OTC) market. It ensures a specific exchange rate for a set length of time. 
    • Interest Rate Swap: This is a two-party derivative arrangement. It entails the exchange of interest rates in which one party promises to pay the interest rate on the other party’s loans in various currencies.

b) Cash Instruments

  • Cash instruments are easily transferable and marketable. Furthermore, market conditions have a direct impact on the value of these financial instruments. There are two kinds of cash instruments:
    • Securities are monetary financial instruments that trade on the stock market. When you buy a security (share), you are buying a piece of a publicly traded corporation on the stock exchange. 
    • Deposits and loans are both cash instruments because they reflect monetary assets and bind both parties to a contract. 

c) Foreign Exchange Financial Market Instruments

  • Overseas exchange instruments, which include currency agreements and derivatives, are traded in overseas markets. These are the world’s most liquid and major trading volume markets. The trade volume ranges from billions to trillions of dollars.
  • Since the forex market is open 24 hours a day, seven days a week, many financial institutions, brokers, and banks deal with these instruments. 

d) Mutual Funds

  • A mutual fund is a fund that is created via the contributions of several investors. The funds are subsequently invested in marketable securities such as shares, bonds, money market instruments, and other securities.
  • It provides investors with the chance to participate in diversified and professionally managed assets at a cheap cost. You have the option of having these funds handled by qualified and professional portfolio managers who will conduct extensive studies before investing your money.