Risk Management in Trading: Techniques to Drive Profitability of Hedge Funds and Trading Desks

CHAPTER 2 Financial Markets

This chapter introduces many commonly traded financial products like stocks, bonds, futures, and options. These products are broadly grouped into real assets, financial assets, and derivatives. Then, these broad product types are further broken down to describe some unique features of the individual products that make up that general category.

FINANCIAL INSTRUMENTS

Traders, whether individual traders or institutional traders like hedge funds, are in the business of buying and selling special types of contracts, called financial instruments. Financial instrument is a general term that refers to any type of tradable financial contract. Another term for financial instrument is security, as in securities markets. Originally, securities referred to instruments that provided an ownership right like stocks and bonds. However, in many jurisdictions, the term security now includes financial instruments that derive their value from commodities and from other financial instruments (derivatives).

The three main types of financial instruments are real assets, financial assets, and derivatives. Real assets include physical commodities (like gold, oil, corn, or cattle), real estate, and legislatively created rights (like carbon emissions rights). Financial assets are primarily composed of contracts that give an ownership interest in a company (stocks), borrowing (bonds), or currencies. Derivatives are financial contracts that derive their value from other financial ...