Explain term instruments
11/September/2025 00:08
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Instruments
Meaning
In finance, an instrument refers to a document or contract that represents a financial asset, liability, or ownership interest.
It is essentially a tool for investment, trading, borrowing, or raising funds.
Instruments can be in written, digital, or electronic form and are legally enforceable.
In simple terms: An instrument is a means through which financial transactions are carried out.
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Types of Instruments
Broadly, instruments are divided into two main categories:
1. Financial Instruments
Contracts that give rise to a financial asset for one entity and a financial liability or equity for another.
They include:
Equity Instruments: Shares, stocks (represent ownership).
Debt Instruments: Bonds, debentures, commercial papers (represent borrowing).
Hybrid Instruments: Convertible debentures, preference shares (have both debt & equity features).
Derivatives: Futures, options, swaps, forwards (value derived from underlying asset).
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2. Legal/Negotiable Instruments
Documents that guarantee the payment of money, either on demand or at a future date.
Examples under the Negotiable Instruments Act, 1881 (India):
Cheque
Promissory Note
Bill of Exchange
These are transferable and enforceable by law.
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Nature of Instruments
1. Evidence of Rights/Obligations: Represents ownership, debt, or legal obligation.
2. Transferable: Most instruments can be sold, transferred, or traded.
3. Enforceable by Law: Carries legal backing for claims and obligations.
4. Valuable: Carries monetary worth, either in cash flow, dividends, or ownership rights.
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Features
Formal written or electronic document.
Represents financial value.
Can be short-term or long-term.
Used for investment, raising capital, or ensuring payment.
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Advantages of Instruments
Provides a medium for raising funds (shares, bonds).
Enhances liquidity (can be traded in markets).
Facilitates credit creation (promissory notes, bills).
Offers investment opportunities (equity, mutual funds).
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Disadvantages of Instruments
Value may fluctuate due to market conditions.
Legal disputes may arise (dishonored cheques, defaulted bonds).
Some instruments carry high risk (derivatives, junk bonds).
Complex to understand for small investors.
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Examples
1. Financial Instrument Example:
Reliance Industries issues debentures worth ₹1,000 crore.
Investors buying debentures get a debt instrument (asset for them, liability for Reliance).
2. Negotiable Instrument Example:
Mr. A issues a cheque of ₹50,000 to Mr. B.
The cheque is an instrument ensuring payment from A’s bank account to B.
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✅ In short:
An instrument is any document or contract representing financial value, obligation, or ownership—ranging from shares, bonds, and derivatives to cheques and promissory notes.
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