A financial instrument is a tradeable asset of any kind; either cash, evidence of an ownership interest in an entity, or a contractual right to receive or deliver cash or another financial instrument.
Pasted from <http://en.wikipedia.org/wiki/Financial_instrument>
1) Basically, any asset purchased by an investor can be considered a financial instrument. Antique furniture, wheat and corporate bonds are all equally considered investing instruments; they can all be bought and sold as things that hold and produce value. Instruments can be debt or equity, representing a share of liability (a future repayment of debt) or ownership.
2) Commonly, policymakers and central banks adjust economic instruments such as interest rates to achieve and maintain desired levels of other economic indicators such as inflation or unemployment rates.
3) Some examples of legal instruments include insurance contracts, debt covenants, purchase agreements or mortgages. These documents lay out the parties involved, triggering events and terms of the contract, communicating the intended purpose and scope.
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Futures contracts, forward contracts, options and swaps are the most common types of derivatives. Derivatives are contracts and can be used as an underlying asset. There are even derivatives based on weather data, such as the amount of rain or the number of sunny days in a particular region.
Derivatives are generally used as an instrument to hedge risk, but can also be used for speculative purposes. For example, a European investor purchasing shares of an American company off of an American exchange (using U.S. dollars to do so) would be exposed to exchange-rate risk while holding that stock. To hedge this risk, the investor could purchase currency futures to lock in a specified exchange rate for the future stock sale and currency conversion back into Euros.
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A financial contract obligating the buyer to purchase an asset (or the seller to sell an asset), such as a physical commodity or a financial instrument, at a predetermined future date and price. Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a futures exchange.
Pasted from <http://www.investopedia.com/terms/f/futures.asp>
A financial derivative that represents a contract sold by one party (option writer) to another party (option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date).
Pasted from <http://www.investopedia.com/terms/o/option.asp>
The primary difference between options and futures is that options give the holder the right to buy or sell the underlying asset at expiration, while the holder of a futures contract is obligated to fulfill the terms of his/her contract.
Forward contracts are very similar to futures contracts, except they are not exchange-traded, or defined on standardized assets.
Over-the-counter (OTC) or off-exchange trading is done directly between two parties, without any supervision of an exchange. It is contrasted with exchange trading, which occurs via these facilities. An exchange has the benefit of facilitating liquidity, mitigates all credit risk concerning the default of one party in the transaction, provides transparency, and maintains the current market price. In an OTC trade, the price is not necessarily made public information.
Investopedia explains ‘Over-The-Counter – OTC’:
In general, the reason for which a stock is traded over-the-counter is usually because the company is small, making it unable to meet exchange listing requirements. Also known as “unlisted stock”, these securities are traded by broker-dealers who negotiate directly with one another over computer networks and by phone.
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