Financial instruments are contracts that represent an asset to one party and a liability to another. They can be categorized into two main types: equity instruments, like stocks, which give ownership in a company, and debt instruments, like bonds, which represent borrowed money that must be repaid. These instruments are used for various purposes, including investment, hedging against risks, and raising capital. They can be traded on financial markets, allowing investors to buy and sell them, thus providing liquidity and enabling price discovery.