Reviewed by Jun 10, 2021| Updated on
An instrument refers to a note or paper of value in financial terms. The instrument can be held to maturity or is transferable for a value in the market. The instrument can be tradable in financial markets, such as equity stocks, debentures, bonds, ETF, and others. Certain other instruments are negotiable and traded in the market accordingly.
In economic terms, an instrument is an economic variable whose value can be controlled or changed by government policies. Policymakers often tweak or change policies as per the requirements of the economy and data, such as inflation and GDP numbers. The instrument can also be a legal document including a contract, bill, deed or a will.
An instrument bears a face value at which it can be encashed. In certain cases, such as securities, the instrument bears a market value at which it can be bought and sold. Hence, an instrument is capable of transfer from one party to another. Instruments also include derivatives, options, and index funds.
Instruments can be equity or debt oriented or can be mutual fund units. They can be bought, owned, and sold as per the requirement of the investor. The instruments may carry interest on their face value or may pay dividends on a discretionary basis. For example, bonds carry interest on their face value, whereas equity shares and mutual funds pay dividends.
In the case of legal instruments, the same include purchase agreements, insurance contracts, mortgages, or debt covenants. These legal documents specify the parties involved, events, scope of the contract, and the terms under the contract. A legal instrument creates a contractual relationship between the parties to the contract.
The government, through its policies, influences the scope, terms, value, and other factors of an instrument. Even a change in law alters the value of an instrument. In other cases, the taxes imposed, such as transaction tax, income tax, or goods and services tax, affect the value of instruments and their ability to trade. A higher tax often discourages investor participation in investment and trading activities.