A financial instrument is a monetary contract between parties that can be created, traded, modified, and settled. It can be a real or virtual document representing a legal agreement involving any kind of monetary value. Financial instruments can be categorized by "asset class" depending on whether they are equity-based (reflecting ownership of the issuing entity) or debt-based (reflecting a loan the investor has made to the issuing entity) . Foreign exchange instruments and transactions are neither debt- nor equity-based and belong in their own category.
There are two types of financial instruments: cash instruments and derivative instruments. Cash instruments are financial instruments with values directly influenced by the condition of the markets. Within cash instruments, there are two types: securities and deposits, and loans. Debt-based financial instruments are categorized as mechanisms that an entity can use to increase the amount of capital in a business. Examples include bonds, debentures, mortgages, U.S. treasuries, credit cards, and line of credits (LOC) .
Different subcategories of each instrument type exist, such as preferred share equity and common share equity. It is possible that a single instrument is issued that contains both debt and equity elements. An example of this is a convertible bond, where the bond contains an embedded derivative in the form of an option to convert to shares rather than be repaid in cash.
