Types of Financial Instruments Available For Trading | Espresso

Types of Financial Instruments Available for Trading

As an investor, you have various types of financial markets where you can invest your money and gain profits. There are several types of financial markets, such as the Money Market, Capital Market, Commodity Market, and Currency Market. All these markets have different characteristics and offer different ways to make money.

Published on 15 June 2022

Among these, capital markets are the ones where you can trade in various types of financial instruments and earn profits. A trade involves buying and selling a financial instrument to make profits. The prices of these capital market instruments fluctuate daily, and you can sell or buy them to gain from these fluctuations.

But do you know what the types of financial instruments available for trading in capital markets are? Let’s discuss.

What are Financial Instruments?

Before we move on to the types of financial instruments available in capital markets, let’s first discuss what are financial instruments. They are nothing but monetary contracts between two parties, wherein one party buys and the other party sells. When a single investor completes the process of buying and then selling a financial instrument, it is known as trading.

A financial instrument can be an asset for the buyer and a liability for the seller. It’s crucial to note that not all financial instruments are available for trading. For example, cheques are also a type of financial instrument, but you cannot trade them. Let’s have a look at various types of financial instruments that are available for trading in capital markets.

Types of Financial Instruments

There are five common types of financial instruments that are available for trading in capital markets. These include Equities, Debt Securities, Mutual Funds, Derivatives, and Exchange Traded Funds (ETFs). Continue reading to learn about these financial instruments in detail.

  • Equities

Equities are one of the most popular financial instruments in capital markets. They refer to stocks or shares of companies that are listed on the stock exchanges. Investing or trading in equity shares has become highly popular among retail investors as well as High Net-worth Individuals (HNIs) and investment institutions.

It’s because these instruments can generate very high returns in short periods. That being said, it’s crucial to note that trading in equities involves high risks. Below are a few advantages of equity trading:

  • When you buy stocks of a company, you own a part of that company
  • Equity shares are very liquid, which means that you can sell them anytime to liquidate your money
  • It is highly volatile, and hence, you can make short-term profits
  • Debt securities

Corporations and Governments issue debt securities to raise funds for their expansion or development projects, respectively. You can invest in these securities and earn interest from the issuer. However, unlike equities, you won’t be owning a part of the issuing entity by investing in debt instruments.

Moreover, debt securities are issued for a specific period only. This period can range between three years to 25 years. After the completion of this period, the money invested in debt securities has to be returned to investors along with interest.

Debt securities can be further classified into two categories – bonds and debentures. Bonds are fixed-income debt instruments issued by Government bodies and large corporations. Debentures are unsecured debt instruments issued by corporates to borrow money from the public.

  • Mutual funds

Mutual funds are created by pooling in investments from various investors and then investing those funds in equities, debts, and other money-market instruments. The purpose of mutual funds is to provide risk-adjusted returns to investors in the long term. Professional fund managers manage mutual funds, and hence, they are less risky than pure equity instruments.

In India, there are several Asset Management Companies (AMCs) that offer mutual funds. You can choose a mutual fund scheme to invest your money in after appropriate research. You can also choose from debt, equity, or hybrid funds as per your risk appetite and investment horizon.

  • Derivatives

Derivatives are those financial instruments that derive their values from underlying assets, such as stocks, commodities, currencies, etc. Derivative contracts allow investors to buy or sell a specific quantity of underlying assets at a specific price on or before a pre-determined future date. The most popular derivative products are Futures and Options in the stock markets.

Futures and Options contracts are more or less similar. The only difference between them is that the buyer has the right but not the obligation to exercise their contract in the case of Options.

  • Exchange-Traded funds

ETFs or Exchange Traded Funds are very similar to mutual funds, and the only difference is that ETFs are traded on the stock markets. They also come with three-year lock-in periods and have lower expense ratios. Unlike mutual funds, ETFs are close-ended funds.

To Conclude

Mentioned above are the five common types of financial instruments that you can trade in the capital markets. You should opt for the one that suits your risk appetite, financial capability, and investment goals. Each of these financial instruments has different characteristics and is suitable for different types of investors.

Chandresh Khona
Team Espresso

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