6 Types of Financial Instruments

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Investors can use a few different financial instruments when trading in the markets. Before investors can employ any of the following financial instruments in their trading, they must choose between debt and equity.

Debt security

They are very safe but offer lower returns on interest rates to compensate for an assumed higher risk. High credit ratings are needed for this type of instrument to maintain safety. Government debt is considered ultra-safe since it depends on tax income collected from citizens and because not paying back would equal bankruptcy which will hurt many people's interests. Corporates generally enjoy high credit ratings, too, unless they go bankrupt or get dragged into economic downturns that lead to a decline in business revenues/profits leading them to default on their payments.

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Certificates of Deposit

Certificates of deposit, a type of savings account, are low-risk investments for those looking to grow their money. A certificate of deposit is a timed deposit that locks your money into an interest-earning account with a financial institution until the CD's maturity date. The longer the term you choose for your CD, the higher risk and thus the return you can expect on it. Banks typically offer CDs for periods ranging from three months to five years, but it is possible to set up CDs with terms as short as two weeks or as long as ten years or more. CDs are usually insured, and unlike some types of savings accounts, they do not usually come with fees.

Money

Liquid means easily tradable, including direct conversion to fiat money or vice versa. It implies a low transaction fee, and the number of intermediaries between two forms of money involved in a transaction is high, making them easy to do quickly. Cash is a physical representation of money and the most liquid form. It implies that transactions do not need multiple signatures, involve fewer intermediaries, and can be done quickly within seconds.

Equity 

Common stock shares in companies form part of their capital structure. They are risky as the underlying company may not do well, and investors could lose their invested money. The potential for higher returns exists if the company does well, but it also comes with a higher risk of total loss. Preferred shares are less risky since they guarantee regular payments like dividends even if they go bankrupt. In liquidation, the holders of preferred shares would be repaid before common stock shareholders.

Annuities 

They are contracts between an insurer and an individual whereby the latter makes periodic payments to the former in return for a stream of payments that usually begins at some point in the future and continues for the rest of the individual's life. The stream of payments is usually a fixed amount and may continue after the individual's death. They are very risky as investors stand to lose all their invested money if they fail to pay it back due to low profitability or bankruptcy.

Mutual funds

They are investment vehicles that allow many investors to pool their money together and invest it in various assets which the fund holds. The fund is managed by a professional money manager who is paid a fee for expertise like David Geithner On Location Exp. The value of units held by the fund is based on market prices, so investors can sell them anytime, unlike other types of collective investments like gilts that are not tradable.

An interest rate swap is a contract where one party agrees to pay another at a floating rate with reference to another index while receiving fixed rates. It means that you are exchanging future cash flows amongst yourselves, resulting in more stability, predictability and certainty.