Financial Markets Operations Management

CHAPTER 2 Financial Instruments

2.1 INTRODUCTION

Financial instruments are negotiable (i.e. they can be traded) assets that can be divided into cash instruments and derivative instruments. Cash instruments are issued in response to a legal entity, a corporate or a government raising capital and are either securities or loans. We will concentrate on securities.

Derivative instruments derive their value from the value and characteristics of one or more underlying entities, for example, a security, an interest rate or a market index. Derivatives are not created by the issuers of the underlying entity; rather they are created either by a derivatives exchange (known as exchange-traded derivatives – ETDs) or by participants in the market (OTC derivatives – OTCDs).

Another way to look at these examples is to consider the differences between the money markets and the debt and equity markets (both collectively known as the capital markets). We can differentiate the money markets from the capital markets on the basis of maturity, the credit instruments and the purpose of the financing (see Table 2.1).

TABLE 2.1 Money market and capital market differentiators

Differentiator	Market	Description
Maturity	Money	Deals in the lending and borrowing of short-term finance for up to 12 months.
Capital	Deals in the lending and borrowing of long-term finance for more than one year.
Credit instruments	Money	Collateralised cash loans, bankers' acceptances, certificates of deposit, commercial ...