Financial Market Instruments: Types, Examples & Uses Explained

For students learning finance, one financial topic that is the most foundational and most important to understand is financial market instruments, as these instruments are central to the financial system and its functioning as it pertains to the role of savings, investments, and overall economic growth.

This blog will address:

• What are financial market instruments?
• Types of financial market instruments.
• Examples of financial market instruments.
• Uses of financial market instruments.
• Money market instruments vs capital market instruments

This educational guide is, for the most part, written for students learning about financial assets in India for the first time.

 

What Are Financial Market Instruments?

Financial market instruments are contracts or documents that are legally recognized and for which an individual or entity is financially valued at and they are used to acquire financing, invest savings, shift risk and receive a return. In other words, instruments of financial market provide an efficient way in which financial markets perform the essential functions of buying, selling, investing and borrowing money. Here are some examples of financial market products:

• Stocks
• Fixed income securities
• T-Bills
• ETFs
• Commercial paper
  
  

What Is The Importance Of Financial Market Instruments?

These products are important for the following reasons:

• Allow businesses to obtain funding.
• Allow investors to gain a profit.
• Help grow the economy.
• Inject cash into the economy.
• Assist nations with their public services.

These products are the backbone of the financial market

Types of Financial Market Instruments

The financial market products can be divided into two broad categories:

1. Money Market instruments.

2. Capital Market instruments.

This metric considers the duration of the financial market products and the level of risk.

Money Market Instruments

Money market securities are financial securities with a maturity of less than 1 year. These consist of:

• Very low risks
• Very liquid
• Fit for short-term investing.

These products are mainly used by:

• Financial Institutions.
• Corporates.
• Government.
• Mutual fund managers

Types of Money Market Instruments

Here are the various kinds of instruments within the money market.

1. Treasury Bills (T-Bills)

• - Short-term government borrowing.
• - Issues from the Government of India.
• - Maturities: 91 days, 182 days, 364 days.
• - Very low risk.
• - Mainly used for:
• - Parking surplus funds.
• - Managing government cash inflow.

2. Commercial Paper (CP)

• - Short-term business borrowing from companies.
• - Issues from large companies.
• - Slightly riskier than T-Bills.
• - Higher return than a fixed deposit.

3. Certificate of Deposit (CD)

• - Issues from banks.
• - Has a specific maturity date.
• - Can be traded in the secondary market.
• - Less risk than corporate instruments.

4. Call Money Market

• - Short-term or overnight loans.
• - Helps banks manage their cash liquidity
  
  

Uses of Money Market Instruments

• - Short-term investments.
• - Cash management.
• - Maintaining liquidity.
• - Low-risk returns
  
  

Capital Market Instruments

Capital market instruments are longer-term financial instruments ranging from more than 1 year to a lifetime.

They aid in:

1. - Raising funds for the long term.
2. - Wealth creation through investments.
3. - Economic growth support.

There exists a higher risk paired with higher returns.

 

 

Types of Capital Market Instruments

Now, let's focus on the primary capital market instruments.

1. Equity Shares

Equity shares are ownership in a company.

Key features:

• These are owners.
• No guarantees, but dividends and price appreciation are possible.
• High risk, but returns are greater.
• These are listed on stock exchanges.

Example: Shares can be bought from companies such as TCS or Reliance

2. Preference Shares

• Have a guaranteed fixed dividend.
• Equity shareholders have less risk.
• Have slightly fewer voting rights.
• Less risky than equity.

3. Debentures

• Issued for a long period by companies as loans.
• Income for a fixed period through interest.
• Less risky than equity.

4. Bonds

• Issued by companies or governments.
• For income that isn't heavily affected by fluctuations and for lower risk than shares.
• Have regular interest payments.

Examples: Corporate bonds and Government bonds.

5. Mutual Funds

They gather funds from several investors and allocate shares, bonds or other money market items. They are managed by professionals and cater more for beginners They are some of the most heavily invested financial instruments in India.

Difference Between Money Market and Capital Market Instruments

Feature	Money Market Instruments	Capital Market Instruments
Time period	Up to 1 year	More than 1 year
Risk	Low	Medium to High
Return	Low	Higher
Liquidity	Very High	Moderate
Examples	T-Bills, CP	Shares, Bonds

 

Financial Market Instruments in India

In India, financial market instruments are regulated by:

1. – SEBI (for the capital market)
2. – RBI (for money market)
3. – Government of India

Indian investors can invest in:

1. – Shares via stock exchanges.
2. – Mutual funds via AMCs.
3. – Bonds via RBI Retail Direct.
4. – Money market funds.

These instruments together form financial assets in India.

How Financial Market Instruments Are Used

Let us understand their practical uses.

Companies

• Initiate collecting money to enhance your business.
• Control your finances efficiently.
• Lessen the expenditure on the cost of loans.

Governments

• Fund projects to build new facilities.
• Control budget expenditures.
• Control the money supply in the country.

Investor Liabilities

• Increase your wealth.
• Receive payments on time every time.
• Manage risk efficiently.
• Protect your wealth from decreasing in value.

Guide Financial Market Instruments to Students

The easiest to understand for new learners, especially students, are:

• Mutual Funds
• Bonds
• Treasury Bills
• Equity Index Funds

This way, students learn the basic and necessary concepts of the financial market and understand the methods of low risk.

Benefits of Financial Market Instruments

• Provide choices for investment.
• Increase the overall money available in the economy.
• Increase the ease of exchanging assets.
• Promote the accumulation of wealth.
• Strengthen the economy
  
  

Financial Market Instruments Risks

Though these suggestions have many good points, these instruments of financial market have certain problems, such as:

• Market issues.
• Borrowing money.
• Risks of interest rate changes.
• Problems of money supply over time.

This is why having a variety of options is important.

Financial Asset India: Real-Life Examples

Instrument	Type	Risk Level
Shares	Capital Market	High
Bonds	Capital Market	Medium
T-Bills	Money Market	Low
Mutual Funds	Hybrid	Varies

These are commonly used financial assets in India.

Importance of Financial Market Instruments in Economic Development.

The financial market instruments are able to :

• transfer savings to investment.
• Provide entrepreneurial support.
• Assist in the growth of various industries.
• Help in the stability of the financial infrastructure.
• If the financial market is developed, the economy is developed.
  
  

Overview of Financial Market Instruments

• Financial market instruments are the ways to invest and gather financial resources.
• They are divided into money market instruments and capital market instruments.
• The money market is where short-term and low-risk financial transactions are carried out.
• The capital market, on the other hand, is long-term and has higher returns.
• They are used by the government, companies and investors.
  
  

Conclusion

It is the right of every finance student to know what financial market instruments there are. Financial market instruments are the bedrock of investment, saving, and growing the economy. The more a student understands the financial market instruments, the more informed financial choices they will be able to make.

Before putting your money into investments, understand what financial market instrument aligns best with your goals, the time frame, and your risk threshold.