Financial Markets and Institutions

Chapter 4 Essay

Answer each question briefly. 

1. Differentiate primary financial instruments and derivative financial instruments.

 Primary instruments and easily transferable securities are those whose value can
be determined directly in the markets. Derivative instruments derive their value
and characteristics from an underlying asset, index, or common stock. Stocks,
bonds, and currency are all examples of primary instruments. A primary
instrument is used in any spot market that trades the 'cash' asset. Derivative
instruments, such as options and futures, on the other hand, are frequently
priced based on the value of a primary instrument.

2. Differentiate money market financial instruments and capital market financial

instruments.

 Money markets are used for short-term lending or borrowing, in which the assets
are typically held for a year or less. On the other hand, capital markets are used
for long-term securities. They have an impact on the capital, either directly or
indirectly. The equity and debt markets are examples of capital markets. Time
deposits (TDs), Treasury Bills (T-bills), and pooled funds invested in money
market placements are examples of money market placements.

3. Different debt-based financial instruments and equity-based financial instruments.

 Debt-based financial instruments are loans made by an investor to the asset's

owner that requires a fixed payment to the holder while equity-based financial
instruments represent asset ownership and it allows a company to raise money
without incurring debt. Bonds (government or corporate) and mortgages are
examples of debt instruments. Common stocks, preferred stocks, convertible
debentures, spot foreign exchange, currency futures, and swaps are all
examples of equity-based financial instruments.