What is an Instrument?
An instrument is a universal term with different meanings. In finance, it generally refers to a tradable asset like a stock, bond, or commodity. You can purchase, sell, and hold these as investments. In a broader economic sense, an instrument can be a tool that governments use to shape the economy, like adjusting interest rates or implementing tax policies.
On the other hand, and in a legal sense, an instrument is a formal document, like a contract or will, that designates rights and obligations.
Instrument Explained
A financial instrument is a contract that either represents a claim on an asset or an obligation to deliver one. Essentially, it's anything of value that can be bought, sold, or traded.
While tangible assets like antique furniture or wheat can be traded, they aren't typically classified as financial instruments. Instead, focus on assets that represent a financial claim or obligation. Examples include stocks, bonds, derivatives, and options.
These instruments can be categorized as debt or equity. Debt instruments represent a loan, where the holder is owed money, while equity instruments represent ownership in a company.
The value of many financial instruments, especially those traded on exchanges, is driven by market forces. However, the value of derivatives depends on the performance of an underlying asset like a stock or commodity.