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Main types of financial instruments

Financial instruments are contracts or obligations that directly or indirectly involve the purchase and sale of assets for money. Consider the most liquid and used ones.

Stock

A stock is a security. Its owner has the right to receive part of the profits of the company or participate in the management. Currently, the shares are issued indefinitely and only in electronic form. The paper version is no longer used. You can make profit in two ways - in the form of dividends or by playing at the exchange rate.

Stocks are ordinary and privileged:

  • Ordinary - the main kind that gives the owner the right to vote at meetings, receive dividends and claim for the liquidation of the company for part of its property. One share is equal to one vote.
  • Privileged - priority over ordinary stocks in the division of property after the liquidation of the company. The instrument does not give the holder the right to vote, except for cases of non-payment of dividends.

Types of stock prices:

  • Nominal - is prescribed in the company's charter and is determined when it is created. Calculated as the ratio of the amount of authorized capital to the number of stocks.
  • Emission - at this cost, the asset is placed on the market. It is always above the nominal.
  • Market - the price at which the stock is traded on the stock exchange. The multiplication of the market price by the number of stocks determines the capitalization of the company.
  • The balance sheet can be lower or higher than the market. It is calculated by dividing the value of assets after deduction of liabilities by the number of stocks.

Stocks are sold on the stock exchange. Buy this asset can both a legal entity, and a private one - through a broker.

Currency

A currency is a monetary asset, which is both a commodity and a means of payment. It is used for mutual settlements in various transactions. This is the most liquid financial instrument. Trade in an asset involves the exchange of one currency for another for international settlements or profit from exchange rate differences. The ratio of the price of one currency to another is represented as a pair. The asset in the numerator (base) is bought, but in the denominator (quoted) - is sold. For example, in USD / JPY the dollar is bought, and its payment occurs in Japanese yens. It is in currency pairs that they are more often traded on financial markets.

In the trading specification of the instrument, the data are indicated:

  • Minimum and maximum size of the trading lot;
  • The size of the contract;
  • Type and size of swaps;
  • Margin requirements;
  • Type of orders and execution.

Currency pairs without the participation of the US dollar are called cross-rates. The asset is traded on the foreign exchange market.

Raw material (Commodity)

Raw material is an asset that is part of a group of commodities. It is traded in US dollars per unit - barrel, pound, ton. By type, raw materials are divided into commodity (industrial), fuel and agricultural assets. The first group includes metals - gold, platinum, palladium, silver and others. The fuel group trades oil, gas and fuel oil. Agricultural assets - corn, soy, sugar, wheat and other goods.

For forms of international trade, the division is as follows:

  • Stock goods - cereals, sugar, non-ferrous metals;
  • Non-exchange goods - natural gas, ferrous metals, coal, ores.

Raw material is traded in financial markets in the form of indices, CFDs and derivatives - forward and futures transactions, options.

Futures

Futures is a contract for a future obligation to sell or buy an asset. It serves to determine the price of an asset. Terms of the transaction are determined in advance, the guarantor is the exchange. The asset can be a commodity, currency, stock, stock index or interest rate - it is called a basic one. Futures are used in hedging strategies and as insurance against price risks.

Characteristics of the futures in the exchange specifications:

  • The unit of measure and the size of the asset in the contract.
  • Expiry date is the day when the contract must be executed.
  • The minimum step and cost of price changes.
  • Margin size - the guarantee amount for opening a position under one futures contract.
  • Variational margin is the intermediate result of a transaction, which is calculated and credited daily or debited from the account.
  • Deliverable or settlement method of execution. In the first case, physical delivery of the asset is permissible, in the second case, the parties receive a financial equivalent of the result.
  • Price-strike - on it the contract is executed.

The futures price differs from the value of the contract, which is zero when the deal is concluded. Differences in the prices of futures with different terms of execution are set by real costs. All futures contracts are traded on time sections of regulated exchanges.

Contract For Difference (CFD)

CFD is an agreement to transfer the price difference for underlying assets. It is considered as the difference between the price of the asset at the time of opening the transaction and its value at the end of the contract (closing position). This difference is multiplied by the amount of the underlying asset determined in the contract. If at the moment of closing the position the price of the asset has increased, then the buyer will be the winner, if it has decreased, then the seller will get the difference in price.

Features of CFD:

  • The opportunity to make a profit both at increase and at a decrease in the price of an asset.
  • Trading stocks without redemption and clearance is optimal for short-term deals.
  • Margin trading - the amount of collateral to 15% of the value of the asset. It is convenient if the investor does not have the amount sufficient to open a transaction of a different type.

Contracts for difference are used to hedge investment risks or to trade commodities on simplified terms.

Bonds (Bill, Note, Treasury bond)

A bond is a debt security. It gives the owner the right to receive back its full value, plus a discount or coupon - a percentage, a property equivalent or a fixed income. In fact, it is a question of crediting and obligations of the debtor.

By type of bonds are divided into state, private, municipal and corporate.

  • State - issued by the government. The state attracts funds for its development, and in return gives a percentage of the amount of this loan. For example, in the US it is Treasury or Treasury bonds.
  • Private - are issued by private persons or commercial organizations. Have the lowest reliability.
  • Municipal - issued by the governments of local regional authorities.
  • Corporate - issued by companies. These bonds often appear as private.

Bonds are discounted, with a fixed or floating interest, they can be issued without collateral.

A separate group of bonds is profitable. For these securities, interest income is paid only if the state or enterprise has a profit. Yield bonds have a division by type of payments into simple and cumulative ones:

  • Simple - unpaid earnings are not reimbursed in the future;
  • Cumulative - unpaid earnings are accumulated, future payments on them are mandatory.

If bonds are traded not only domestically, but also abroad, then there is an additional division - for foreign and eurobonds.

Depositary receipt

A depositary receipt is an investment instrument. The document entitles the holder to a share in the pool of securities deposited with a depositary bank.

Depositary receipts can be issued for all types of equity securities: bonds, ordinary or preferred shares, options. Main types of depositary receipts:

  • American (ADR) - depositary receipts for circulation on the US stock market. ADR under the American legislation is regarded as a certificate certifying the right to a security. The instrument itself is not a security. ADR is traded on the NYSE and AMEX.
  • Global (GDR) - global receipts for European markets. The instrument is traded on European stock exchanges.

Despite a clear regional framework, both types of depositary receipts can be used in other countries.

Advantages of ADR and GDR for owners:

  • Access to shares of foreign companies, including from developing countries - risky high-yield investment;
  • Reduction of investment risks;
  • Diversification of the securities portfolio.

The price of depositary receipts varies synchronously with the change in the value of underlying securities. The exception is the difference in exchange rates and the cases when the participation of foreign investors is limited in the local market.

Forward Contract

Forward is a contract that obliges an owner to buy or sell an asset at a fixed price and on a certain date. Forward actually resembles futures.

The difference between the tools is as follows:

  • The parameters and volume of forward contracts are not standardized by the exchange, unlike futures.
  • Forwards are concluded only in the over-the-counter market. The risk of default in this case lies with the counterparties, and in the case of futures - at the exchange.
  • A forward contract can be concluded for an arbitrary future date, while a futures contract is subject to a stock exchange standard.
  • Forward allows transactions with any underlying assets, not just standardized ones.

Variation margin under the contract is not accrued and, as a rule, a guaranteed deposit is not required.

The basic assets of forwards are currencies. At the time of conclusion of the contract, a number of parameters are fixed: the currency, its amount, the exchange rate and the payment date. The exchange rate of the transaction is called forward. Premiums are expressed in percent per annum - this allows you to compare the yield of a foreign currency forward with other instruments.

Every day the Wall Street Journal prints the current and forward rates of major world currencies for several periods ahead.

Options

An option is the right to buy or sell an asset at a fixed price in relation to a specific date. The owner of the option may not exercise his right, if circumstances do not have the opening of the transaction.

Options are traded in terms similar to futures - the same stock exchanges and sections, the availability of specifications, expiration dates and the concept of the underlying asset. The strike price of an option is called strike. The underlying asset of the option may be futures.

Expiration occurs in two versions:

  • An American option may be exercised at any time before the expiration date;
  • The European option is executed only on a fixed date.

The exchange is the guarantor of the performance. It blocks guarantee deposits to ensure that the positions are maintained and the parties fulfill their obligations.

By type, there are two types of options - call and put:

  • Call - the option holder acquires the right to purchase the asset.
  • Put - the holder buys the right to sell the asset at a price-strike.

The second side of the transaction realizes the right of the holder for a price, which is called a premium.

Thus, for one asset with a specific execution date and strike, there are four options for opening deals:

  1. Purchase of Call;
  2. Sale of Call;
  3. Purchase of Put;
  4. Sale of Put.

A bundle of options and futures is implemented according to the following schemes:

  1. Futures + Put = Call;
  2. Call – Futures = Put;
  3. Call – Put = + Futures;
  4. Put – Call = - Futures.

In practice, this means the futility of buying futures with subsequent hedging with Put - it's enough to buy Call.

These features allow you to use options as a powerful hedging tool. Potential losses of the investor are limited to the specific amount paid for the option. The instrument is also used to generate profit through speculation.

Warrants

Warrant is a security that gives the holder the right to purchase a certain number of shares at a fixed price in a remote period of time. The term can reach 1-5 years.

The owner of the warrant is thus insured against dilution of his share in the company - in mergers, acquisitions and in the case of additional issues of shares. Also, warrants are used in speculation. This tool is only available on the over-the-counter market.

The price of the warrant shows the value of the securities that are in its basis. The rate of a warrant for the purchase of a share is usually substantially lower than the price of the stock itself, so less money is required to save the position.

The differences of warrants from Call options are concluded in their issue directly by issuing companies and the validity period. Warrants are designed for long-term retention, they are issued even in perpetuity.

Exchange Traded Funds (ETF)

ETFs are investment funds that are traded on the exchange, a passive index. ETF shares follow the price of the asset that is at the heart of the fund. ETF by its essence is a certificate for a portfolio of shares.

The investor of the fund determines which shares form the basis of the ETF, and places them on the corresponding deposit. Further, the fund issues its shares (shares), and the investor sells them on the stock exchange.

Advantages of ETF:

  • Professional asset management;
  • Wide diversification of the portfolio;
  • Low entrance threshold for investors.

With the shares of ETF, margin trading is permissible.

Disadvantages:

  • Management fees;
  • Commission for administrative expenses;
  • The instability of large investors.

According to these indicators, funds often lose the stock index.

The largest ETFs are traded on NASDAQ, NYSE and LSE exchanges. Shares of these funds are sold as ordinary securities, so to buy them, it's enough to open an account with a broker

Swap

Swap is the right to exchange assets. Under this agreement, the sale of an asset occurs simultaneously and the obligation of its repurchase at a fixed price is given.

Swaps are used to obtain financing on bail or a loan of securities. They are also used to change the composition of the portfolio or exchange payments at fixed and variable rates. The asset is taken on the security of another asset.

Swap contracts are over-the-counter, they are not standardized. Their terms and volumes are fixed by agreement of the parties-participants.