Financial Products
Financial Products: Contracts that may be negotiated on capital markets are referred to as financial “products” or “instruments.” These goods may be categorized in a variety of ways. This website’s strategy is to concentrate on the technical details of these instruments. We also provide a different categorization based on market segments, but it more accurately represents current economic conditions.
Technical perspective: Derivatives, transactions on the balance sheet, and securities
Securities
Securities include any forms of direct funding used by businesses, banks, governments, or other public institutions. A security is a portion of a medium- or long-term claim (bonds), a short- or medium-term claim (commercial paper), or a portion of a company’s capital (equities or shares). The security serves as a financing tool for the issuer and an investment tool for the buyer. In whole numbers (for shares), decimals (for certain shares in UCITS), or nominal quantities (for bonds), securities may be exchanged over the counter or via organised exchanges (like the NYSE or Euronext).
As long as a counterparty is present for the exchange, securities are negotiable instruments, which means they may be exchanged after being issued in the so-called secondary market. We will cover relevant topics including securitization and corporate activities in this section.
Accounts payable transactions
All transactions (purchase/sale transactions or the issuing of securities, but we have opted to separate the “securities” portion given the scope of the topic…) that result in an immediate or delayed recognition in the balance sheet of operators are considered balance sheet transactions. The simplest component is represented by loans or cash borrowings that are uninsured or secured by collateral (repos). Currency transactions include both spot and futures purchases and sales of currencies that are related to currency markets. There is no online trading of these goods.
Derivatives
All transactions that are often referred to as “off-balance sheet” or not shown in the financial institution’s balance sheet are included in derivative products. Because they have been created from or in some other manner “out of” fundamental financial instruments, they are known as “derivatives.” It is challenging to give an extensive presentation since markets have almost endless creativity, which also makes the quantity and diversity of these items virtually infinite. Derivative products also often combine other forms of fundamental assets, such as currencies, interest rates, and bonds and shares. Interest rate swaps, credit derivatives, and FRAs are examples of derivative products that are traded on organised markets (such as options and futures markets) or over the counter.
Risk Assessment: Economic Characteristic Categorization
Classifying goods by market or by the sort of risk transferred results in a presentation that is more in line with economic reality.
Interest-rate-related goods
All items that rely on interest rates for their revenue and valuation and so change in value in accordance with market rates are considered interest-rate products. Interest rate risk is the corresponding risk. Securities that reflect claims, such as bonds and MTNs, cash loans and borrowings, repos, and derivative instruments with interest-rate-sensitive underlying assets, such as interest-rate swaps, FRAs, interest-rate futures, interest-rate options, and caps and floors, are included in this category.
Equities
Securities (shares, investment securities, and hybrid securities) that represent a portion of a company’s capital or, in the case of hybrid securities, give access form the basis of the equity and equity derivatives markets (convertible bonds, bonds with equity warrants). Equities may temporarily change hands via lending and borrowing of securities in addition to buy and sale operations. Equity derivatives (futures, options, and warrants) allow investors to take a position on market swings or related equity risk or assist in hedging operations.
Foreign currency
The spot or term trading of currencies takes place in the forex market (also known as the foreign exchange market). Prices, or the rate of exchange, may move drastically in this market. Operators may manage foreign exchange risk by hedging against currency swings using FX options and futures. Brokers that specialise in currency exchanges are known as forex traders.
Derivatives for credit
Operators may take a position (speculate or hedge) in relation to the credit risk of a business, nation, or market sector thanks to credit derivatives.
Commodities
Commodities are unprocessed raw commodities that are exchanged on spot markets or, more commonly, as derivative goods (futures) on global marketplaces.
Structural goods
Asset-backed securities (ABS), fund shares, and other structured goods are composite products that are challenging to categorise. The primary risk of an ABS or CDO, for instance, relates to securitized assets and might take many different forms. The quality of the security also relies on the CDS underlying risk or the guarantor if the structure contains a CDS or a guarantee offered by a monoline insurance firm. Due to their composite structure, these instruments cannot be assimilated to a particular economic risk like the others.