An instrument is a means through which value is transferred, held, or achieved. In the financial realm, it refers to a tradable asset or a negotiable item such as a security, commodity, derivative, or index, or any item that underlies a derivative.
In other important contexts, an instrument can denote an economic variable manipulated by policymakers to influence other economic markers. It can also describe legal documents like contracts, wills, or deeds.
Key Takeaways
- An instrument is a means to store or transfer value or financial obligations.
- A financial instrument is a tradable or negotiable asset, security, or contract.
- Legal instruments may contain binding terms, rights, and/or obligations.
Delving Into Instruments
The International Accounting Standards (IAS) criteria describe financial instruments as “any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.”
Essentially, any asset an investor acquires can be regarded as a financial instrument, including items like antique furniture, wheat, and corporate bonds. These diverse assets can be bought and sold, producing value in various forms. Instruments may either be debt or equity, representing either future debt repayment or ownership. Fundamentally, an instrument constitutes a contract or medium facilitating value exchange between parties.
Financial Instruments
Financial instruments fall into two primary categories:
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Cash Instruments: These include financial securities that can be exchanged for cash, like a share of stock. Their value is directly influenced by market dynamics. They are usually easily transferable.
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Derivative Instruments: The value and characteristics of derivative instruments arise from their components, such as an underlying asset, interest rate, or index.
Financial instruments are also often classified by asset class based on whether they are debt-based or equity-based.
Economic Instruments
In economics, instruments serve as controllable variables used by policymakers and central banks to attain and stabilize desired economic indicators, such as interest rates, inflation, or unemployment rates. Economic instruments might also encompass performance bonds or pollution taxes designed to drive specific policy outcomes.
For example, a tax can be instituted to internalize costs that are otherwise external, such as environmental impacts. Fees on resource extraction may be imposed to reflect the environmental costs and promote sustainable use of resources.
Legal Instruments
From a legal standpoint, examples of legal instruments include insurance contracts, debt covenants, purchase agreements, and mortgages. These documents outline the involved parties, triggering events, and all relevant terms of the contract, clarifying their scope and intent.
Legal instruments articulate the rights, obligations, acts, or duties enforceable by law, such as the terms laid out in a mortgage contract. They formally present the obligations binding the involving parties, ensuring clear understanding and adherence to the agreed terms.
Related Terms: negotiable, financial asset, equity instrument, debt instrument, economic indicator, contract.
