A Financial Instrument is an asset that can be traded, transferred, or exchanged as money. However, a financial instrument usually has no intrinsic value; its price is solely derived from the value of the underlying asset. In this context, the word “instrument” refers to a financial instrument rather than to a person who uses instruments to their advantage.For example, Bill has $10 in cash and $10 in instruments that pay interest. He uses the instruments to his advantage by buying something for $20 and then paying with the instruments. The purchase would then result in a profit of $10—a result he could have achieved without using the instruments. In this case, Bill’s use of the instruments resulted in him making profits on his investment decisions.A financial instrument is an asset, but refers specifically to contracts that can be traded, transferred, or exchanged— James Brown used cash but sold bonds to his investors. Additionally, when people speak of owning an instrument such as a piece of paper money or gold, they are referring to owning specific financial instruments rather than owning an asset itself.When investors acquire financial instruments such as stocks or bonds directly through online brokerages or at their bank, they are indirectly owning a company’s stock or bond (such as Apple’s). Likewise, when someone sells you a financial instrument — like when your employer pays you with company stock — you have acquired an instrument through someone else’s use of instruments to their advantage.Using leverage, a financial instrument can be priced at a better approximation of the price of the underlying financial asset— Bill bought 10-to-1 leverage for $100 and doubled his money within six months since he was investing small amounts regularly over time.Similarly, if someone wants to short sell stocks — meaning they expect them to fall — they will do so by buying borrowings from their brokerage firm that correspond with existing securities they want to sell short and then selling those securities back again once they are no longer needed (called “covering”). This strategy allows them to quickly make money by selling what has recently gone up only to buy it back later once it has gone down enough for them to cover their short sale with cash they owe their brokerage firm instead of actual securities anymore.
