Financial Instrument - Meaning, Types and Importance

A financial instrument is an agreement between two parties with monetary value. In other words, any asset that holds capital and which can be traded is a financial instrument. It is noteworthy that financial instruments can be palpable or virtual documents representing a legal agreement of any monetary value.

Some examples of financial instruments include life insurance policies, shares, bonds, stocks, SIPs, etc. Now, let us understand more about the different types of financial instruments that are popular in India.

Financial Instruments Available in India

There is an array of financial instruments that are available in India. They serve as a medium of wealth creation. People prefer to invest in financial instruments instead of keeping their money in a savings account, as the former has an appreciative trend.

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1. Life Insurance Policies

These are financial instruments offering you protection against different types of financial risks, such as – sudden death and old age. As the untimely demise of a breadwinner places the family members in economic instability, life insurance plans become critical.

Secondly, they are also helpful during retirement, as the income-generating ability of individuals recede. Few popular life insurance plans include:

a) Term Life Insurance:

b) Savings Plans:

c) Pension Plans or Annuities:

d) ULIPs (Unit-linked Investment Plans):

2. Small Savings Schemes

Small Savings Schemes aim to encourage citizens to save regularly as they are generally government-backed. They are popular as they come with a sovereign guarantee of returns and tax benefits. Few saving schemes that you can consider are listed below:

a) Post office recurring deposits
b) Public Provident Fund (PPF)
c) Kisan Vikas Patra
d) National Savings Certificate (NSC)

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3. Fixed Deposits (FDs)

They entail cash investments in banks or post-office and are highly popular. FDs come with a zero risk factor, and you are guaranteed returns. However, the annual returns on FDs can range from 6 to 9 per cent.

4. Certificate of Deposits (CDs)

A certificate of deposits is a negotiable money market instrument issued in dematerialized form and used as a promissory note for funds deposited at a bank for a stipulated period.

a) Financial institutions to raise large sums of money issue CDs.
b) They are available in denominations of INR 1 lakh and multiples.

5. Equity Stocks

It is a type of security that represents the ownership of a company and is traded in stock markets.

a) It represents the money you can return to shareholders of a company if all the assets are liquidated and the entire company debt is paid off.
b) Equity is one of the most typical financial indicators investors use to determine a company's health.

6. Bonds

They are fixed-income instruments you can issue to raise working capital.

• Private entities and government ventures, including the central and state governments, issue bonds to raise funds
• Bonds that the government issues have a lower risk rate but ensure returns; on the other hand, bonds raised by private entities have high risks.

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Tax Benefits of Financial Instruments

Irrespective of the type of savings or investment option you opt for, the chances are that you will be liable for some form of tax on any gains made via investment. Some tax benefits you should consider while looking at your investment options include dirt, stamp duty, exit tax, and capital gains tax.

Likewise, accrued growth is taxed under multiple sections such as 'Income from Transfer of any Capital situated in India, salaries earned in India, Income from Property, Asset, or Source situated in India, and much more. Consequently, paid interests and maturity gains are taxed under 'income from other sources.' However, the maturity gains of NPS, provident fund, etc., are exempt from taxes.