Three Types of Financial Instruments

A financial instrument is a security, or a document, that exists on paper or in cyberspace that has monetary value. Unlike hard assets, such as real estate, computers and cars, financial instruments are usually easily transferable or liquid, meaning you can buy and sell them quickly at the price the market is willing to pay for them at a given time. There are three basic types of financial instruments.

Financial instruments can be broken down into three basic categories. Equity-based instruments are company stock, which represents equity ownership in a company. Debt-based instruments, such as bonds and government treasuries, represent a financial liability to their issuer. The third category of financial instruments consists of currency pairs that trade on the foreign exchange markets.

There are two basic types of equity-based financial instruments -- common and preferred stock. Common stock represents a single unit of ownership in the company that issues it. Preferred stock is sometimes referred to as a debt/equity, because it represents a unit of equity ownership in the company and it comes with guaranteed dividend payments, representing a debt liability to the company that issues it.

When you buy a bond, you essentially take on the role of lender to the company or government that issued it. The face price of a debt-based financial instrument, such as a bond, is guaranteed and will be returned to you when it reaches maturity. In addition, issuers of debt-based instruments pay investors guaranteed interest payments over the life of the instrument.

Foreign exchange, or Forex, is a worldwide currency market, where various country currency is exchanged for other countries' currency. Currencies in Forex are quoted as pairs, which are financial instruments representing the price of one currency denominated in another country's currency. For example, the USD/EUR pair represents the price of the dollar, quoted in Euros.