What Is a Financial Instrument? Types & Asset Classes | SoFi (2024)

By Rebecca Lake ·October 06, 2023 · 7 minute read

We’re here to help! First and foremost, SoFi Learn strives to be a beneficial resource to you as you navigate your financial journey.Read moreWe develop content that covers a variety of financial topics. Sometimes, that content may include information about products, features, or services that SoFi does not provide.We aim to break down complicated concepts, loop you in on the latest trends, and keep you up-to-date on the stuff you can use to help get your money right.Read less

What Is a Financial Instrument? Types & Asset Classes | SoFi (1)

A financial instrument is simply a contract between entities that represents the exchange of money for a certain asset. Financial instruments include most types of investments: cash, stocks, bonds, mutual funds, exchange-traded funds (ETFs), certificates of deposit (CDs), loans, derivatives, and more.

Financial instruments facilitate the movement of capital through the markets and the broader economic system. While this may take different forms, the flow of capital remains a central feature.

What Is a Financial Instrument?

Generally Accepted Accounting Principles (GAAP) defines a financial instrument as cash; evidence of an ownership interest in a company or other entity; or a contract. A financial instrument confers either a right or an obligation to the holder of the instrument, and is an asset that can be created, modified, traded, or settled.

Investors can trade financial instruments on a public exchange. The New York Stock Exchange (NYSE) is an example of a spot market in which investors can trade equity instruments for immediate delivery.

💡 Quick Tip: The best stock trading app? That’s a personal preference, of course. Generally speaking, though, a great app is one with an intuitive interface and powerful features to help make trades quickly and easily.

Financial Instrument vs Security

A security is a type of financial instrument with a fluctuating monetary value that carries a certain amount of risk for the individual or entity that holds it. Investors can trade securities through a public exchange or over-the-counter market.

The federal government regulates securities and the securities industry under a series of laws, including the Securities Act of 1933, the Securities Exchange Act of 1934, and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

All securities are financial instruments but not all financial instruments are securities.

Like financial instruments, securities fall into different groups or categories. The four types of securities include:

Equities. Equities represent an ownership interest in a company. Stocks and mutual funds are examples of equity securities.

Debt. Debt refers to money lent by investors to corporate or government entities. Corporate and municipal bonds are two examples of debt securities.

Derivatives. Derivatives are financial contracts whose value is tied to an underlying asset. Futures and stock options are derivative instruments.

Hybrid. Hybrid securities combine aspects of debt and equity. Convertible bonds are a type of hybrid instrument.

Recommended: Bonds vs. Stocks: Understanding the Difference

Types of Financial Instruments

Financial instruments are not all alike. There are different types of financial instruments in different asset classes. Certain financial instruments are more complex in nature than others, meaning they may require more knowledge or expertise to handle or trade.

1. Cash Instruments

Cash instruments are financial instruments whose value fluctuates based on changing market conditions. Cash instruments can be securities traded on an exchange, such as stocks, or other types of financial contracts.

For example, a certificate of deposit account (CD) is a type of cash instrument. Loans also fall under the cash instrument heading as they represent an agreement or contract between two parties where money is exchanged.

2. Derivative Instruments

Derivative instruments or derivatives draw their value from an underlying asset, and fluctuate based on the changing value of the underlying security or benchmark.

As mentioned, options are a type of derivative instrument, as are futures contracts, forwards, and swaps.

3. Foreign Exchange Instruments

Foreign exchange instruments are financial instruments associated with international markets. For example, in forex trading investors trade currencies from different currencies through global exchanges.

Asset Classes of Financial Instruments

Financial instruments can also be broken down by asset class.

4. Debt-Based Financial Instruments

Companies use debt-based financial instruments as a means of raising capital. For example, say a municipal government wants to launch a road improvement project but lacks the funding to do so. They may issue one or more municipal bonds to raise the money they need.

Investors buy these bonds, contributing the capital needed for the road project. The municipal government then pays the investors back their principal at a later date, along with interest.

5. Equity-Based Financial Instruments

Equity-based financial instruments convey some form of ownership of an entity. If you buy 100 shares of stock in XYZ company, for example, you’re purchasing an equity-based instrument.

Equity-based instruments can help companies raise capital, but the company does not have to pay anything back to investors. Instead, investors may receive dividends from the stock shares they own, or realize profits if they’re able to sell those shares for a capital gain.

Are Commodities Financial Instruments?

Commodities such as oil or gas, precious metals, agricultural products and other raw materials are not considered financial instruments. A commodity itself, such as pork or copper, doesn’t direct the flow of capital.

That said, there are certain instruments whereby commodities are traded, including stocks, exchange-traded funds, and futures contracts.

A futures contract represents an agreement to buy or sell a certain commodity at a specific price at a future date. So, for example, an orange grower might sell a futures contract agreeing to sell a certain amount of their crop for a set price. An orange juice company could then buy a contract to purchase oranges at X price.

For the everyday investor, futures trading in commodities typically doesn’t mean you plan to take delivery of two tons of coffee beans or 4,000 bushels of corn. Instead, you buy a futures contract with the intention of selling it before it expires.

💡 Quick Tip: It’s smart to invest in a range of assets so that you’re not overly reliant on any one company or market to do well. For example, by investing in different sectors you can add diversification to your portfolio, which may help mitigate some risk factors over time.

Uses of Financial Instruments

Investors and businesses may use financial instrument for the following purposes:

1. As a Means of Payment

You already use financial instruments in your everyday life. When you write a check to pay a bill or use cash to buy groceries, you’re exchanging a financial instrument for goods and services.

Likewise, business entities may charge purchases to a business credit card. They’re borrowing money from the credit card company and paying it back at a later date, often with interest.

2. Risk Transfer

Investors use financial instruments to transfer risk when trading options and other derivative instruments, such as interest rate swaps. With options, for example, an investor has the option to buy or sell an underlying asset at a specified price on or before a predetermined date. A contract exists between the individual who writes the option and the individual who buys it. This type of financial instrument allows an investor to speculate about which way prices for a particular security may move in the future.

3. To Store Value

Businesses often use financial instruments in this way. For example, say you default on a credit card balance. Your credit card company can write off the amount as a bad debt and sell it to a debt collector. Meanwhile, businesses with outstanding invoices they’re awaiting payment on can use factoring or accounts receivables financing to borrow against their value.

4. To Raise Capital

Companies may issue stocks or bonds in order to get access to capital that they can invest in their business. In this case, the financial instruments could be a means of raising capital for one party and a store of value for the other.

Importance of Financial Instruments

Financial instruments are central to not only the stock market, but also the financial and economic system as a whole. They provide structures and legal obligations that facilitate the regulated exchange of capital via investing, lending and borrowing, speculation and growth.

In short, financial instruments keep the financial markets moving, and they also help businesses to keep their doors open and allow consumers to manage their finances, plan for the future, and invest with the hope of future gains.

For example, you may also have a savings account that you use to hold your emergency fund, an Individual Retirement Account (IRA) that you use to save for retirement and a taxable brokerage account for trading stocks. Your checking account is one of the basic tools you might use to pay bills or make purchases.

You might be paying down a mortgage or student loans while occasionally using credit cards to spend. All of these financial instruments allow you to direct the flow of money from one place to another.

The Takeaway

Financial instruments are integral to every aspect of the financial world, and they also play a significant part in business transactions and day-to-day financial management. If you trade stocks, invest in an IRA, or write checks to your landlord, then you’re contributing to the movement of capital with various financial instruments. Understanding the different types of financial instruments is the first step in becoming a steward of your own money.

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I am a financial expert with extensive knowledge in various financial instruments, investment strategies, and market dynamics. My expertise is grounded in practical experience and a deep understanding of the complexities within the financial sector.

Now, let's delve into the concepts covered in the provided article by Rebecca Lake:

  1. Financial Instrument Definition:

    • A financial instrument is a contract representing the exchange of money for a specific asset.
    • Examples of financial instruments include cash, stocks, bonds, mutual funds, ETFs, certificates of deposit, loans, and derivatives.
    • These instruments facilitate the movement of capital through markets and the broader economic system.
  2. GAAP Definition:

    • Generally Accepted Accounting Principles (GAAP) defines a financial instrument as cash, evidence of ownership in a company, or a contract.
    • It confers either a right or an obligation to the holder and is an asset that can be created, modified, traded, or settled.
  3. Trading Financial Instruments:

    • Investors can trade financial instruments on public exchanges, such as the New York Stock Exchange (NYSE).
    • The article suggests that a good stock trading app is one with an intuitive interface and powerful features.
  4. Financial Instrument vs Security:

    • A security is a type of financial instrument with fluctuating monetary value and carries risk.
    • Securities, regulated by laws like the Securities Act of 1933, include equities, debt, derivatives, and hybrid instruments.
  5. Types of Securities:

    • Equities represent ownership (e.g., stocks and mutual funds).
    • Debt refers to money lent (e.g., bonds).
    • Derivatives are tied to an underlying asset (e.g., futures and stock options).
    • Hybrid securities combine debt and equity features (e.g., convertible bonds).
  6. Types of Financial Instruments:

    • Cash Instruments: Value fluctuates based on market conditions.
    • Derivative Instruments: Value tied to an underlying asset.
    • Foreign Exchange Instruments: Associated with international markets.
  7. Asset Classes of Financial Instruments:

    • Debt-Based Financial Instruments: Used by companies to raise capital (e.g., municipal bonds).
    • Equity-Based Financial Instruments: Convey ownership interest (e.g., stocks).
  8. Commodities as Financial Instruments:

    • Commodities themselves are not considered financial instruments.
    • However, instruments like stocks, ETFs, and futures contracts can involve commodities trading.
  9. Uses of Financial Instruments:

    • Means of Payment: Everyday use in transactions.
    • Risk Transfer: Used for risk management in trading options and derivatives.
    • Store of Value: Businesses may use instruments to manage outstanding balances.
    • Raise Capital: Companies issue stocks or bonds to access capital for investment.
  10. Importance of Financial Instruments:

    • Central to financial and economic systems, facilitating the regulated exchange of capital.
    • Essential for investing, lending, borrowing, speculation, and growth.
  11. SoFi Invest Mention:

    • SoFi Invest is highlighted as a platform for investing in stocks, ETFs, and more.
    • Important disclosure information about SoFi Invest is provided.
  12. Conclusion:

    • Understanding different types of financial instruments is crucial for effective financial management and investment decisions.
    • Financial instruments play a significant role in day-to-day transactions, business operations, and overall economic activities.

This summary provides a comprehensive overview of the key concepts discussed in the article. If you have any specific questions or need further clarification on any topic, feel free to ask.

What Is a Financial Instrument? Types & Asset Classes | SoFi (2024)


What Is a Financial Instrument? Types & Asset Classes | SoFi? ›

Financial instruments include most types of investments: cash, stocks, bonds, mutual funds, exchange-traded funds (ETFs), certificates of deposit (CDs), loans, derivatives, and more. Financial instruments facilitate the movement of capital through the markets and the broader economic system.

What is financial assets and instruments? ›

Financial instruments are classified as financial assets or as other financial instruments. Financial assets are financial claims (e.g., currency, deposits, and securities) that have demonstrable value.

What is the difference between financial instruments and asset classes? ›

Financial instruments may be divided into two types: cash instruments and derivative instruments. Financial instruments may also be divided according to an asset class, which depends on whether they are debt-based or equity-based. Foreign exchange instruments comprise a third, unique type of financial instrument.

What is classified as a financial instrument? ›

Stock, bonds, and options contracts are some examples of financial instruments. [Last updated in July of 2021 by the Wex Definitions Team] COMMERCE. accounting.

What are the financial asset classes? ›

Historically, the three main asset classes have been equities (stocks), fixed income (bonds), and cash equivalent or money market instruments. Currently, most investment professionals include real estate, commodities, futures, other financial derivatives, and even cryptocurrencies in the asset class mix.

What are financial instruments examples? ›

In simple words, any asset which holds capital and can be traded in the market is referred to as a financial instrument. Some examples of financial instruments are cheques, shares, stocks, bonds, futures, and options contracts.

What are the 4 types of financial assets? ›

financial asset

a contractual claim to something of value; modern economies have four main types of financial assets: bank deposits, stocks, bonds, and loans.

What are the 3 main categories of financial instruments? ›

There are typically three types of financial instruments: cash instruments, derivative instruments, and foreign exchange instruments.

What is financial assets and types? ›

A financial asset is a liquid asset that gets its value from a contractual right or ownership claim. Cash, stocks, bonds, mutual funds, and bank deposits are all are examples of financial assets.

Which is not classified as a financial instrument? ›

The following are examples of items that are not financial instruments: intangible assets, inventories, right-of-use assets, prepaid expenses, deferred revenue, warranty obligations (IAS 32. AG10-AG11), and gold (IFRS 9.

What are the most common types of financial instruments? ›

Financial instruments are assets that can be traded or used for investment purposes. It can be broadly categorized into Equity-based (stocks, representing ownership in a company) and Debt-based (bonds, loans, representing a loan made by an investor to a borrower) securities.

What is not a financial asset? ›

A nonfinancial asset is an asset that derives its value from its physical traits. Examples include real estate and vehicles. It also includes all intellectual property, such as patents and trademarks.

Which financial assets are the safest? ›

Common safe assets include cash, Treasuries, money market funds, and gold. The safest assets are known as risk-free assets, such as sovereign debt instruments issued by governments of developed countries.

What is the riskiest asset class? ›

Why Equities Are the Riskiest Asset Class. Equities are generally considered the riskiest class of assets.

What are examples of asset classes? ›

What is an Asset Class?
  • Stocks or equities – Equities are shares of ownership issued by publicly-traded companies. ...
  • Bonds or other fixed-income investments – Fixed-income investments are investments in debt securities that pay a rate of return in the form of interest.

What asset gives the highest return? ›

Pro tip
  • Mutual funds. Mutual funds are investment tools managed by fund managers, which pool people's money and invest in stocks and bonds of different companies to yield returns. ...
  • Senior citizen Savings Scheme. ...
  • Public Provident Fund. ...
  • National Pension Scheme (NPS) ...
  • Real estate. ...
  • Gold Bonds. ...
  • REITS. ...
  • Government bond.

What is the difference between asset and instrument? ›

Financial instruments refer to a contract that generates a financial asset to one of the parties involved, and an equity instrument or financial liability to the other entity.

Which is not an example of a financial instrument? ›

The following are examples of items that are not financial instruments: intangible assets, inventories, right-of-use assets, prepaid expenses, deferred revenue, warranty obligations (IAS 32. AG10-AG11), and gold (IFRS 9. B. 1).

Are financial instruments assets or liabilities? ›

Let us start by looking at the definition of a financial instrument, which is that a financial instrument is a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of an other entity.

Is a 401k a financial asset? ›

Your 401(k), and any other retirement accounts, are financial assets. These are portfolios in which you hold securities and investment products that have either realized or potential value. This makes your 401(k) portfolio an asset in your name as long as you own the account and as long as it has a positive balance.


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