Financial instruments are crucial to the operation of the economy.

a. Financial arrangements can be either formal or informal. Industrial economies are dominated by formal arrangements.

b. A financial instrument is the written legal obligation of one party to transfer something of value, usually money, to another party at some future date, under certain conditions.

c. Financial instruments are used primarily as stores of value and means of trading risk.

They are less likely to be used as means of payment, although many of them can be.

d. Financial instruments are most useful when they are simple and standardized.

e. There are two basic classes of financial instruments: underlying and derivative.

i. Underlying instruments are used to transfer resources directly from one party to another.

ii. Derivative instruments derive their value from the behavior of an underlying instrument.

f. The payments promised by a financial instrument are more valuable i. The larger they are.

ii. The sooner they are made.

iii. The more likely they are to be made.

iv. If they are made when they are needed most.

g. Common examples of financial instruments include i. Those that serve primarily as stores of value, including bank loans, bonds, mortgages, stocks, and asset-backed securities.

ii. Those that are used primarily to transfer risk, including futures and options.