Financial instrument definition

What is a financial instrument?

A financial instrument is a monetary contract between two parties, which can be traded and settled. The contract represents an asset to one party (the buyer) and a financial liability to the other party (the seller).

An asset class refers to the form that a financial instrument takes, such as commodities, shares, bonds, derivatives or forex. Financial instruments can be separated according to asset class and can be further divided by whether they are complex or non-complex.

Examples of financial instruments

Financial instruments can be split into two categories: complex and non-complex.

Complex financial instruments

Complex financial instruments require an in-depth knowledge for traders to be successful when trading them. The most commonly traded complex financial instruments are derivatives. These can be CFDs, futures contracts and options.

Different derivatives have different benefits. For example, CFDs are good for hedging.* As they are complex financial instruments, it is important that traders make themselves familiar with the nuances of each derivative product before starting to trade them.

Non-complex financial instruments

Non-complex financial instruments can be traded without a vast amount of specialist knowledge. In some instances, they only require an initial investment and then someone else, such as a fund manager, makes investments on your behalf.

Non-complex financial instruments include shares or equity securities, as well as debt securities and certain types of investment funds.

Equity securities refer to shares in companies, while debt securities include both government and corporate bonds. Debt securities can also refer to preferred stock and forms of collateralised securities – such as collateralised debt obligations.

Investment funds include hedge funds and mutual funds. These are all instruments which enable investors to pool their money under a specialist who is in charge of the fund: the fund manager. Typically, the fund manager will make investment decisions on behalf of the investors.

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* Tax laws are subject to change and depend on individual circumstances. Tax law may differ in a jurisdiction other than the UK.

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