What is a Financial Instrument?

Financial instruments are legal documents that embody monetary value. There are a number of different types of documents that are properly identified as a financial instrument, including cash instruments and derivatives.

When most people think in terms of financial instruments, they tend to identify what is commonly known as a cash instrument. This is simply those documents that are recognized as cash that can be utilized for various transactions. Currency is the most easily identified of all cash instruments, although such documents as checks or funds transfers from bank accounts are also seen as cash instruments.

Derivative instruments are another example of the financial instrument. This classification would include such instruments as futures, options, and swaps. Some analysts also prefer to include stocks, bonds, and currency futures within this category as well, while others tend to think of these as cash equivalents, since it is possible to settle debts by transferring ownership of stocks and bonds. In broad terms, a derivative instrument is some type of contract that has value based on the current status of the underlying assets.

Other types of documents are often understood to function as a financial instrument. In the world or real estate funding, the mortgage qualifies as a financial instrument. A commercial paper or stock index also meets the basic definition, as do bills of exchange.

A financial instrument may be a hard copy document, or exist as a virtual document. Currency and checks would represent physical documents that represent specific monetary values and are freely used for transactions. Funds transfers between bank accounts would be an example of a virtual financial instrument. In like manner, stocks and bonds may exist as hard copies or as virtual records that assign rights and privileges to a specific investor.