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The Indian stock market is a popular investment avenue that provides multiple opportunities to earn good returns and accumulate wealth over a period of time. And investors who want to gain quick returns can trade financial instruments over the short term. As an investor or a trader, you have various financial instruments to choose from. Before we move on to the types of instruments available for trading, let’s take off from the starting line.
Key Takeaways
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Equities, which reflect ownership of a corporation, are among the most actively traded securities on Indian markets.
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Derivatives get their value from underlying assets like stocks, indexes, currencies, and commodities.
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Debt securities, such as bonds and debentures, provide fixed returns and are used by governments and businesses to raise capital.
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Mutual funds and ETFs combine investor funds to invest in a variety of assets; ETFs are traded directly on stock markets.
What is a Financial Instrument?
A monetary contract between two parties that can be traded and settled is known as a Financial Instrument. This contract is an asset to one party (the buyer) and a financial liability to the other party (the seller). However, you should note that not all financial instruments are available for trading on the stock exchange. For example, Cheques are also a financial instrument but are not allowed to be traded on the exchange.
Types of Financial Instruments in India
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Equities
Equities are shares in a company's ownership and are among the most traded financial instruments on the exchange. But why do investors and traders swarm towards equity? This is because it can multiply your capital by generating higher returns than other financial instruments. Other features that make it the most preferred avenue are:
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Buying shares/stocks gives you part-ownership in the company.
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Has better liquidity, which means you can easily sell your shares in the market.
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Its inherent volatility offers investors to book short-term profits based on stock price fluctuations.
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Derivatives
Derivatives are instruments that derive their value from an underlying asset(s) such as currencies, stocks, interest rates, etc. Derivatives contracts are contracts in which a predefined quantity of stocks, commodities, indices, currencies, bonds, etc., are bought and sold on a specific date at a predetermined rate. The most popular derivatives contracts are futures and options contracts with the latter being a right and not an obligation.
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Debt Securities
Securities issued by companies or the government with an objective to generate funds are known as Debt Instruments. Its features are:
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Interest on these instruments can be earned at specific intervals.
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The principal amount invested will be repaid at the end of the contract period.
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They can be both secured and unsecured.
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Issued to raise funds for day-to-day operations, business expansion, acquisitions, paying off debts, or more.
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Yields lower returns as compared to most other instruments like Equity, Gold, and Real Estate over the long run
Debt instruments traded on the exchange can be classified into bonds and debentures.
Bonds
These fixed-income debt instruments are issued by the central and state governments and large corporations to raise funds. They can either be secured by a physical asset or a guarantee. There are various types of bonds, such as floating bonds, inflation-indexed bonds, sovereign gold bonds, and more.
Debentures
Debentures are long-term debt instruments issued by corporates to borrow money from the public. Unlike shares, they do not offer ownership rights but promise a fixed interest rate. In India, public issues of debentures are often Secured (backed by company assets) to protect investor interests, though Unsecured debentures also exist. are long-term debt instruments issued by corporates to borrow money from the public. Unlike shares, they do not offer ownership rights but promise a fixed interest rate. In India, public issues of debentures are often Secured (backed by company assets) to protect investor interests, though Unsecured debentures also exist.
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Mutual Funds
A fund created by contributions from a number of investors is known as a Mutual Fund. The money is then invested in securities like equities, bonds, money market instruments, and other securities available in the market. It offers investors an opportunity to invest in diversified and professionally managed securities at a relatively low cost. You can choose to get these funds managed by expert and professional portfolio managers who will do meticulous research before investing your money.
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Exchange-Traded Funds (ETFs)
ETFs are just like mutual funds, but the major point of difference is that ETFs are traded on the stock exchange. ETFs have a comparatively lower expense ratio. Investors prefer investing in ETFS as these are registered with the Securities and Exchange Board of India (SEBI). Wondering how ETFs differ from mutual funds?
Also read about Mutual Fund vs ETF (Exchange Traded Fund)
Asset Classification of Financial Instruments
Financial instruments are also divided into two fundamental asset classes: equities and debt instruments.
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Equity instruments: They denote ownership in a corporation. These are normally valued at fair value, less issuance expenses. Additional payments made over the face value of shares are reported as share premium (less issuance charges).
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Debt instruments: These are loans to the issuer. They are typically recorded at the acquisition cost, with any discount or premium above par value amortised over the life of the instrument. Transaction costs are capitalised.
These classes are further divided into:
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Spot: Immediate settlement instruments for transactions that are completed within a few working days.
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Outright forwards: These are contracts that call for the exchange of currency or assets at a future date.
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Currency swaps: These are agreements to purchase and sell two distinct currencies on different value dates.
Conclusion
Financial instruments traded in the capital market are structured products that allow participants to access various risk exposures, liquidity levels, and return opportunities. Each category (equity, derivatives, debt securities, mutual funds, and ETFs) has its own process and legal framework, allowing investors to participate in the market depending on their preferences and knowledge of how these instruments function. Price volatility, interest-rate sensitivity, liquidity, and the underlying asset structure all have an impact on how each instrument performs over various market cycles. Market players frequently examine these factors to evaluate what function each product might play in matching their financial strategy.
