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New Financial Instuemtns Essay

10612 words - 42 pages

NEW FINANCIAL INSTRUMENTS
Introduction
Finance is an enormous field that's divided into many different sub fields. My topic of new financial instruments falls in the sub field of investments. I choose this topic because I am interested in the investment field and I hope after college to work as a financial planner, market analyst or in a finance department for a company. As financial planner, I will need to help others create an investment strategy or a diversified portfolio using different kinds of financial instruments to improve investment gains. Working as an executive, I might have to hedge against particular risks posed to the company by using different financial instruments. An investment is defined as the sacrifice of certain present value for, possibly uncertain, future value. The main goal of investing is to maximize wealth over time. The maximizing of wealth comes with risk constraints. Investors look to maximize wealth and lower the associated risk. A risk is the uncertainty associated with the end of the period value of an investment.
Initially, banks and brokerages offered only three types of financial instruments: a bank deposit (fixed income security/cash), a bond (Treasury security) and an equity (stock). A bank deposit offers stability of principal and offers an interest rate for keeping your money in the bank. Examples are CDs, money market instruments and bank deposits. A bond is an interest bearing debt obligation issued by corporations, the Federal government and its agencies, and state and local governments. Bonds represent a loan to the issuer and provide income (interest payments) during their lifetime, plus a promise to repay the principal upon maturity. An equity represents ownership interest in a corporation. Stocks offer the potential for current income (dividends) and capital growth (increase in value). Until recently, these were the only financial instruments available to investors. Today, there are many to choose from and each was created from changes in the financial environment.
It is quite hard not to notice the growth and evolution of financial instruments that address the needs of many different end users in a wide range of different market environments. The pace of this growth has been explosive, driven by an underlying demand for risk management products and financial engineering skills that reflect the fact that the overall economic environment within which business is conducted has grown more volatile and unstable. The reasons for the strong emergence of these instruments stem from two underlying factors: environmental and intrafirm factors. Environmental factors are external forces that the firm has no control over and effect the overall performance of the firm. These include increased price volatility, globalization of industry and financial markets, tax and accounting asymmetries, technological advances, advances in financial theory, regulatory changes, increased competition, and transaction costs....

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