Open Finance Academy

Financial markets and instruments

Learn what the main traded instruments promise, how market prices and orders work, and why some contracts can create losses larger than the money first committed.

← All knowledge areas · Glossary

No trading experience is needed. Basic percentages help. Investing and portfolio management introduces investment choices in the context of goals and risk. New terms are bold, explained on first use, and linked to the glossary; each definition links back to its lesson references.

Example assumptions

All prices, quantities, and rates are invented teaching examples, not live quotes or suggested trades. Examples are independent. Unless stated otherwise, assume no fees, taxes, borrowing costs, or other cash payments. Bond examples assume the issuer pays as promised. Quotes have enough quantity available for each example unless the text says otherwise. Derivative examples simplify real contract terms and identify their quantity and time period explicitly.

The linked U.S. regulator and market sources were checked September 13, 2026. Legal definitions, product access, order handling, and settlement rules vary by market and jurisdiction. We focus on concepts rather than a universal trading rulebook.

In this lesson

  1. Why financial markets exist
  2. Compare the main instruments
  3. Read a bond price and yield
  4. Understand quotes and trading costs
  5. Choose what an order controls
  6. Distinguish derivative contracts
  7. Work through an option payoff
  8. See how leverage changes losses
  9. Read the terms before comparing prices
  10. Check your understanding

Why financial markets exist

A company wants money to build a factory. One investor is willing to supply funds now; another may later want to buy that investor’s holding. These are different transactions.

A financial market is a system for issuing or trading financial claims and contracts. A financial instrument specifies financial rights or obligations, such as ownership in a company or a promise of repayment.

In the primary market, an issuer sells newly issued instruments, typically to raise funding. In the secondary market, investors trade existing instruments with one another. Buying an existing share from another investor generally pays that seller, not the company. Secondary trading can nevertheless make new issues more attractive by offering a way to sell later. See Investor.gov’s primary and secondary market definitions.

Markets also let participants transfer certain risks. A manufacturer may want a more predictable input price, while another participant is willing to accept the price uncertainty. A contract can move risk between them without eliminating it from the system.

Compare the main instruments

A stock is an ownership interest in a company, divided into shares. A dividend is a distribution to shareholders, often in cash. Neither the future share price nor dividends are guaranteed. Shareholders generally stand behind creditors in claims on a failed company’s assets. See Investor.gov on stocks.

A bond is a debt investment whose issuer promises payments under stated terms. The face value is the stated principal amount. A coupon is a contractual interest payment; a fixed coupon rate applies to face value. Maturity is the date the principal becomes due. Repayment depends on the issuer’s ability to meet its obligations; selling beforehand can produce a gain or loss.

The money market covers short-term borrowing and lending, commonly for periods of a year or less. A Treasury bill is short-term government debt; U.S. bills pay face value at maturity and are sold at a discount or face value. Commercial paper is short-term company debt, commonly unsecured. Short maturity does not make every issuer equally safe. See TreasuryDirect on bills and the Federal Reserve’s commercial paper overview.

For example, pay $980 for an invented bill that pays $1,000 after six months. The gain is $20, and the six-month return is $20 ÷ $980 = about 2.04%. This is not an annualized yield. Different quotation conventions can produce different displayed yields for the same cash payments.

A commodity is a basic physical good, such as wheat, oil, or copper. Owning the physical good can involve storage and delivery costs. A financial contract referencing its price is a different holding from owning the good itself.

Holding What the holder has A central question
Stock An ownership interest How could the business and its market value change?
Bond Contractual payment claims Can the issuer pay, and what if the holder needs to sell early?
Short-term debt A near-term repayment claim Who owes the money, and can they repay on time?
Physical commodity The actual good What are its price, storage, quality, and delivery risks?

A money market fund holds a portfolio of short-term instruments. It is not the same as a money market deposit account. In the U.S., money market mutual funds are not FDIC-insured deposits and can lose value. See Investor.gov on money market funds.

Read a bond price and yield

Suppose a fixed-rate bond has $1,000 face value and a 5% annual coupon rate. It pays $1,000 × 0.05 = $50 each year, regardless of a later change in its trading price.

Current yield divides the annual coupon payment by the current market price:

Purchase price Annual coupon Current yield
$1,000 $50 $50 ÷ $1,000 = 5%
$900 $50 $50 ÷ $900 = 5.56%
$1,100 $50 $50 ÷ $1,100 = 4.55%

A lower price gives a higher current yield for the same coupon. This measure excludes the gain or loss between the purchase price and eventual sale or principal repayment. It is not the bond’s complete return. FINRA explains bond yield measures.

For an ordinary fixed-payment bond, a rise in comparable market interest rates generally reduces its price, all else equal: new alternatives offer more attractive payments. Changes in expected repayment risk also affect prices. A high displayed yield may reflect a lower price caused by serious concerns, rather than an unusually favorable deal.

Understand quotes and trading costs

An exchange is an organized trading venue with rules for matching buyers and sellers. A broker arranges or executes customer trades. A market maker stands ready to buy and sell at quoted prices for stated quantities. A firm may act both for customers and on its own account. Trading can also occur through dealer networks outside an exchange. See Investor.gov’s market participants guide.

Imagine the best displayed prices for a share are:

If you buy ten shares at the ask, you pay 10 × $50.10 = $501. If you immediately sell all ten at the unchanged bid, you receive 10 × $49.90 = $499. The difference is $2, even before commissions or other costs. The Investor.gov spread definition describes this price gap.

Price discovery is the process through which information, orders, and trades establish market prices. A quote is available only for its stated quantity and conditions; it is not a permanent promise or proof of fair value.

Liquidity means how easily and quickly a holding can become spendable money without a large loss in value. Wider spreads or little quantity available can make trading more costly. An instrument can be easy to sell while its price changes sharply. During stressed conditions, available trading quantity may shrink just when holders most want to sell.

Choose what an order controls

An order gives instructions, but different instructions control different things.

Order Meaning Limitation
Market order Buy or sell at the best available prices when executed. No specific price is guaranteed. A large order may fill at several prices.
Limit order Buy at the limit or lower; sell at the limit or higher. It may fill partially or not at all.
Stop order Once its stop condition is triggered, it becomes a market order. The eventual execution price can differ substantially from the stop price.

At the $50.10 ask above, a buy limit of $50.00 will not immediately buy from that offer. It might execute later if suitable selling interest appears and the order remains active. A sell stop set at $45 could execute around $40 if the market jumps downward; $45 is a trigger, not a guaranteed sale price. See Investor.gov’s order guide.

Order execution is also different from completing the transfer. Clearing checks transaction details and establishes obligations between participants. Settlement completes the required transfer of money and, for securities trades, securities. Timing and procedures depend on the product and market. Investor.gov’s market participants guide describes the organizations involved. A trading app’s execution notice does not mean all transfers are already final.

Distinguish derivative contracts

A derivative is a contract whose value or payments depend on an asset, price, rate, or other reference. Read the obligation rather than assuming every derivative works like buying a share.

Contract Basic obligation
Forward contract Parties agree today on a price for a future purchase or sale, often using a customized private agreement.
Futures contract A standardized exchange-traded agreement for future delivery or cash settlement, with gains and losses generally settled daily.
Option The buyer obtains a right rather than an obligation; the seller must meet the corresponding obligation if the option is exercised.
Swap Parties exchange payments calculated under agreed formulas, such as fixed-rate payments for variable-rate payments.

The CFTC glossary explains these contract types. Futures differ from a private forward in standardization, trading, and daily cash requirements. See the CFTC’s futures market introduction.

Hedging takes a position intended to offset a particular existing risk. A bakery agrees to buy 100 units of wheat in three months at $5 per unit. Under this forward, the agreed cost is 100 × $5 = $500. Assume the exact wheat and delivery date match what it needs and both parties perform:

The agreement makes that input cost predictable while giving up the benefit of a lower future price. A mismatch in quantity, quality, or date can leave risk unoffset. The other party may also fail to perform. The CFTC explains the economic purpose of hedging.

For a separate simplified one-year interest-rate swap, suppose one party pays 4% and receives a variable rate on a $100,000 reference amount. If the variable rate for that year is 6%, the payments are $4,000 and $6,000; if netted, that party receives $2,000. If the variable rate is 2%, it instead pays $2,000 net. The reference amount is used for calculation and, in this example, is not exchanged. Actual swaps specify reset dates, payment periods, and other conventions.

Work through an option payoff

A call option gives its buyer the right to buy; a put option gives the right to sell. The strike price is the agreed exercise price. The option premium is the price paid for the option.

Buy an invented call covering one share, exercisable only at expiration, with a $50 strike and a $3 premium paid upfront. Real exchange contracts often cover multiple units; check the contract multiplier. At expiration, the buyer’s exercise value is the amount by which the share price exceeds $50, or zero if it does not.

Share price at expiration Call exercise value Buyer profit after $3 premium
$45 $0 −$3
$52 $2 −$1
$60 $10 +$7

At $60: $60 − $50 = $10 exercise value; $10 − $3 = $7 profit. The expiration break-even price is $50 + $3 = $53. A favorable share-price move can still leave a loss if it does not cover the premium.

For a separate one-share put with a $50 strike and $2 premium, a $40 expiration price gives $50 − $40 − $2 = $8 profit. These are expiration calculations, not pricing formulas before expiration. Time remaining and uncertainty also affect an option’s trading price.

The buyer can lose the entire premium. A seller’s obligations differ: an uncovered call seller can face theoretically unlimited losses as the share price rises. Exercise may also create a separate asset purchase or sale requiring cash or delivery. See Investor.gov’s introduction to options.

See how leverage changes losses

Leverage uses borrowing or contracts to create exposure larger than the money initially committed. Suppose you contribute $500 and borrow $500 to buy $1,000 of shares. Ignore loan interest and fees, and assume the loan balance stays $500:

Share value when sold Repay borrowing Your remaining amount Gain or loss on your original $500
$1,100 $500 $600 +$100, or +20%
$900 $500 $400 −$100, or −20%
$400 $500 −$100 −$600, or −120%

A 10% price move creates a 20% change in your own money. In the last scenario, sale proceeds do not repay the loan: you lose the original $500 and still owe $100. A broker may close the position before these illustrated prices are reached; the table is a loss calculation, not a prediction of account handling.

Margin is money or eligible assets supporting a trading position. For securities borrowing, it supports a loan. For futures, it supports performance of the contract rather than buying the underlying asset. Neither amount is necessarily a maximum possible loss.

A margin call demands additional resources when an account falls below its required level. A firm may sell positions without waiting for the customer. See FINRA’s margin risk explanation and the CFTC’s futures basics. Exact requirements depend on the market, instrument, account, and firm.

Read the terms before comparing prices

Before comparing two holdings, identify what each actually gives you:

A familiar name, a low quoted price, or a small upfront payment answers none of these on its own. Connect the instrument’s terms with the purpose and risk limits of the overall investment plan.

Check your understanding

Try these before reading the answers. Use the stated no-cost assumptions; each question is independent.

  1. You buy an existing share from another investor. Does your payment normally fund the issuing company directly?
  2. A bond has $1,000 face value, a 4% annual coupon, and a $950 trading price. What are its annual coupon payment and current yield?
  3. A share has a $19.80 bid and $20.00 ask, with enough quantity. What is the cost of buying 25 shares and immediately selling them at unchanged quotes?
  4. Does a $30 buy limit guarantee a purchase? Does a $25 sell stop guarantee a sale at $25?
  5. The bakery agrees to buy 100 units of wheat at $5. If the later market price is $4, how much does it pay under the forward, and how does that compare with the market?
  6. A one-share call has a $50 strike and costs $3. The share expires at $52. Is the buyer’s net profit $2?
  7. You supply $400 and borrow $600 to buy $1,000 of shares. The shares fall to $800 and you sell. With no interest or fees, how much of your own money remains, and what percentage have you lost?
  8. Does a futures margin deposit cap the loss? Is a U.S. money market mutual fund an FDIC-insured deposit?

Answers

  1. Usually no. This secondary-market payment goes to the selling investor. A sale of newly issued shares is a different transaction.
  2. $40 per year and about 4.21%. $1,000 × 0.04 = $40. Current yield is $40 ÷ $950 × 100 = 4.21%, rounded. It excludes price gains or losses and is not a complete return measure.
  3. $5 before other costs. Buying costs 25 × $20 = $500; selling returns 25 × $19.80 = $495. The $0.20 spread times 25 shares equals $5.
  4. No to both. The buy limit constrains price, not whether a trade happens. The sell stop triggers a market order whose execution price can be lower than $25.
  5. $500, which is $100 above the $400 market cost. The forward fixes the price in both favorable and unfavorable directions.
  6. No: the buyer loses $1. Exercise value is $52 − $50 = $2; subtract the $3 premium to get −$1.
  7. $200 remains, a 50% loss. $800 sale proceeds − $600 loan repayment = $200. Losing $200 from the original $400 is a 50% loss despite a 20% fall in the shares.
  8. No to both. Futures losses can exceed margin posted. A money market mutual fund is an investment product and is not an FDIC-insured deposit account.

Terms introduced in this lesson

Revisit these definitions and follow their links back to the worked examples.

Keep learning

Continue with Investing and portfolio management to connect instrument choices with goals, diversification, and costs. Banking, credit, and lending explains deposits and borrowing. Payments and money movement develops clearing and settlement in payment systems.

Use Accounting and financial analysis to examine an issuer’s financial statements, and Books for further reading.

Planned follow-up lessons