Instruments by George Hernandez

Exploring instruments such as stocks and bonds, as well as financial exchanges. A financial instrument is a document (real or virtual) representing a legal agreement involving some sort of monetary value.

Here is how I categorize financial instruments:

Domestic instruments
- Cash instruments.
  - Interest free. EG: Pocket money.
  - Interest bearing: EGs: Deposit accounts; CDs; Car loans.
- Security instruments.
  - Equity instruments. Investor acquires a degree of ownership of the issuing entity.
    - Stocks.
  - Debt instruments. Investor loans money to the borrowing entity.
    - Bonds.
    - Treasuries.
  - Commodity instruments. An undifferentiated product, good or service.
Foreign instruments
- Currency instruments. Aka Foreign exchange or forex instruments. Especially when exchanging one currency for another.
Funky instruments. Almost all of the above have funky variations.
- Futures contract instruments. A contract to buy or sell certain financial instruments at a certain future date for a specified price.
- Options instruments. A contract between a buyer=holder and a seller=writer, where the buyer has the right=option to buy (a call option) or sell (a put option) certain financial instruments at a set price=strike price on or before a future date=exercise date. The buyer has the "long" position and pays an option premium to the seller who has the "short" position.
- Mutual fund instruments. A collective investment that pools money from many investors usually into a variety of instruments of a particular kind. This isn't actually very funky at all, but there
- Real estate instruments. Real estate is a funky thing that is part equity (ownership) and part debt.
- Collectible instruments. Collectible coins, comics, fine art, antiques, etc. have their own valuation, almost like mementos.

Instruments have a corresponding exchange market (EGs: stock exchange markets, forex markets), either formal or informal, where the traders exchange either directly or through brokers. Informal, immediate exchanges are called "spot exchanges".

One of the key differences between cash instruments and other instruments is taxability.

EG1: If you have a savings account with $100 and you got $3 interest in a year, then that $3 is taxable. However if you have stock that you bought at $100 but it is now worth $103, then that "capital gain" of $3 is "unrealized" and untaxable as long as you don't cash it in. If you do cash it in, then you have "realized capital gain" and it's taxable. If you suffered a realized net captal loss, then some of that amount is deductible.
EG2: Buying gold via Gold exchange-traded funs (GETF) is subject to capital gains tax, whereas buying gold itself is not.

I also find these qualities of instruments interesting:

Tangibility. An asset is tangible if you can touch it. EG: Gold is tangible but stocks are not.
Liquidity. An asset is liquid if it can be sold or cashed quickly with minimum loss in value. EG: Gold is liquid but real estate is not.
Fungibililty. An asset is fungible if it can be easily exchanged or substituted with another instance of that class of good at equal value. EG: Gold is fungible but fine art is not

The famous key thing about exchanging financial instruments is:

BUY LOW. SELL HIGH.

There isn't much more to it. However when it comes to placing orders for buying or selling instrument, I want to summarize it myself even though it is explained everywhere ( http://www.sec.gov/answers/orderbd.htm, http://beginnersinvest.about.com/od/investing101/ss/stocktrading.htm, Order (exchange) [W], etc.). The main problem when others explain it is that they have ambiguous "or" statements that annoy the programmer in me.

Buy orders
- Buy market order. Buy at current market price. Because of lag, the price at execution may be more or less than the price at order placement. EG:
  - Place order at $20 and buy at execution price.
- Buy limit order. Buy if price is less than your specified limit price. This protects against lag but may never execute. EG:
  - Place order at $20 and buy if execution price is less than $30.
- Buy stop order. Buy when price hits your specified stop price. This is an automated trigger. EG:
  - Place order. Wait. At $20, buy at execution price.
- Buy stop-limit order. Buy when price hits your specified stop price, and if price is less than your specified limit price. This is an automated trigger and protects against lag but may never execute. EG:
  - Place order. Wait. At $20, buy if execution price less than $30.
- Buy trailing-stop order. Do not buy until price raises by an amount (or percentage) you specify. This is an automated trigger to allow a downward trend but to catch reversals. EG:
  - Place order at $25 with a stop order of $2. Wait. The stock can drop as much as it wants but if the price ever goes up by more than $2, then you'll buy at execution price.
- Bracketed order. Do not buy until price raises by an amount (or percentage) you specify or drops to price you specify. This is an automated trigger to allow a downward trend (to a limit) but to catch reversals . EG:
  - Place order at $25 with a stop order of $2 and a $10 limit. Wait. The stock can drop as much as it wants but if the price ever goes up by more than $2 or if the price gets as low as $10, then you'll buy at execution price.
Sell orders
- Sell market order. Sell at current market price. Because of lag, the price at execution may be more or less than the price at order placement. EG:
  - Place order at $80 and sell at execution price.
- Sell limit order. Sell if price is greater than your specified limit price. This protects against lag but may never execute. EG:
  - Place order at $80 and buy if execution price is greater than $70.
- Sell stop order. Sell when price hits your specified stop price. This is an automated trigger. EG:
  - Place order. Wait. At $80, sell at execution price.
- Sell stop-limit order. Sell when price hits your specified stop price, and if price is greater than your specified limit price. This is an automated trigger and protects against lag but may never execute. EG:
  - Place order. Wait. At $80, sell if execution price greater than $70.
- Sell trailing-stop order. Do not sell until the price drops by an amount (or percentage) you specify. This is an automated trigger allow an upward trend but to catch reversals. EG:
  - Place order at $75 with a stop order of $2. Wait. The stock can raise as much as it wants but if the price ever goes down by more than $2, then you'll buy at execution price.
- Bracketed order. Do not sell until price drops by an amount (or percentage) you specify or raises to price you specify. This is an automated trigger to allow a upward trend (to a limit) but to catch reversals . EG:
  - Place order at $75 with a stop order of $2 and a $90 limit. Wait. The stock can raise as much as it wants but if the price ever goes down by more than $2 or if the price gets as high as $90, then you'll buy at execution price.

Other modifiers are possible:

All-or-none order (AON order). For an order of many stocks, a broker may spread the trades out. For simplified accounting, an all-or-none order will make the trade as one large trade or not at all.
Day order. Orders placed on a given "day" but not executed will not be carried over and executed later. A "day" is usually the current session: either regular-hours or off-hours.
Good-til-cancelled order (GTC order). Once placed, this order can be executed once the conditions are met, or a given time limit, or the order is cancelled.
Discretionary order. A market order where you also give your broker the discretion to delay executing the order for a better price.

Page Modified: (Hand noted: 2007-10-24 20:08:36Z) (Auto noted: 2007-11-17 06:22:10Z)