Finance Crash Course - Financial Instruments

STOCK

Shares of stock signify ownership in a company. They are classified as equity and represent a claim on assets and earnings of the company. Two main types of stock exist: common and preferred. Generally, only common shares have voting rights. However, preferred shares have a higher claim on said assets and earnings.

BOND

A bond is a certificate of debt, issued by companies in an attempt to raise capital. Many types of bonds exist, including coupon bonds, zero coupon bonds, convertible bonds, and more. Where coupon bonds periodically pay a “coupon”, or interest payment, zero coupon bonds are sold at a discount to face value. Convertible bonds can be exchanged at a certain time for a certain number of stocks in a company. Bonds are also known as fixed-income securities.

Bond yield is the amount of interest realized by a bond holder.

DERIVATIVE

Derivatives are financial instruments whose value track a certain underlying asset, such as commodities, stocks, indexes and more. They are contracts between two or more parties, and may be used for speculation or hedging purposes. Examples of derivatives include forwards, futures, options, and swaps.

FORWARD CONTRACT

A forward contract is a customized agreement between parties to trade an asset for a specified price in the future. They are non-standardized and not traded on an exchange, making them over-the-counter (OTC) instruments.

FUTURES CONTRACT

Futures contracts are also contracts that are used to trade assets at a specified price in the future. However, futures contracts are traded on exchanges and offer the benefit of clearing houses, which have a positive effect on default risk. They are standardized and cannot be customized. Futures contracts also use a mark-to-market accounting process.

OPTIONS

Owners of options contracts have the right, but not the obligation to buy or sell an asset at an agreed upon (strike) price at a certain time in the future. Options to buy an underlying asset are call options, and options to sell are put options.

SWAPS

Swaps are contracts that allow parties to exchange financial instruments. Often, swaps involve exchanging fixed interest rates for floating interest rates.