Financial instruments

Financial instruments

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Encyclopedia
A financial instrument is a tradable asset of any kind, either cash; evidence of an ownership interest in an entity; or a contractual right to receive, or deliver, cash or another financial instrument.

According to IAS 32 and 39
IAS 39
IAS 39: Financial Instruments: Recognition and Measurement is a measure of instrument of the International Accounting Standards Board ....

, it is defined as 'any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity'.

Categorization


Financial instruments can be categorized by form depending on whether they are cash instruments or derivative instruments:
  • Cash instruments are financial instruments whose value is determined directly by markets. They can be divided into securities
    Security (finance)
    A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...

    , which are readily transferable, and other cash instruments such as loans and deposits, where both borrower and lender have to agree on a transfer.
  • Derivative instruments
    Derivative (finance)
    A derivative instrument is a contract between two parties that specifies conditions—in particular, dates and the resulting values of the underlying variables—under which payments, or payoffs, are to be made between the parties.Under U.S...

     are financial instruments which derive their value from the value and characteristics of one or more underlying entities such as an asset, index, or interest rate. They can be divided into exchange-traded derivatives and over-the-counter (OTC) derivatives.


Alternatively, financial instruments can be categorized by "asset class" depending on whether they are equity based (reflecting ownership
Ownership
Ownership is the state or fact of exclusive rights and control over property, which may be an object, land/real estate or intellectual property. Ownership involves multiple rights, collectively referred to as title, which may be separated and held by different parties. The concept of ownership has...

 of the issuing entity) or debt based (reflecting a loan the investor has made to the issuing entity). If it is debt, it can be further categorised into short term (less than one year) or long term.

Foreign Exchange instruments and transactions are neither debt nor equity based and belong in their own category.

A table


Combining the above methods for categorization, the main instruments can be organized into a table as follows:
Asset Class Instrument Type
Securities Other cash Exchange-traded derivatives OTC derivatives
Debt (Long Term)
>1 year
Bonds
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...

Loan
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....

s
Bond futures
Futures contract
In finance, a futures contract is a standardized contract between two parties to exchange a specified asset of standardized quantity and quality for a price agreed today with delivery occurring at a specified future date, the delivery date. The contracts are traded on a futures exchange...

 
Option
Option (finance)
In finance, an option is a derivative financial instrument that specifies a contract between two parties for a future transaction on an asset at a reference price. The buyer of the option gains the right, but not the obligation, to engage in that transaction, while the seller incurs the...

s on bond futures
Futures contract
In finance, a futures contract is a standardized contract between two parties to exchange a specified asset of standardized quantity and quality for a price agreed today with delivery occurring at a specified future date, the delivery date. The contracts are traded on a futures exchange...

Interest rate swap
Interest rate swap
An interest rate swap is a popular and highly liquid financial derivative instrument in which two parties agree to exchange interest rate cash flows, based on a specified notional amount from a fixed rate to a floating rate or from one floating rate to another...

s
Interest rate caps and floors
Interest rate cap and floor
An interest rate cap is a derivative in which the buyer receives payments at the end of each period in which the interest rate exceeds the agreed strike price...


Interest rate option
Interest rate option
Interest rate option is a derivative financial instrument.Interest Rate Options are a form of Exchange Traded Derivative whose underlying value is the rate on various Financial Interest rates,including treasury bills, and bonds. The exchange of these is monitored and facilitated by the CME Group.An...

s
Exotic instruments
Debt (Short Term)
<=1 year
Bills, e.g. T-Bills
Commercial paper
Commercial paper
In the global money market, commercial paper is an unsecured promissory note with a fixed maturity of 1 to 270 days. Commercial Paper is a money-market security issued by large banks and corporations to get money to meet short term debt obligations , and is only backed by an issuing bank or...

Deposits
Deposit account
A deposit account is a current account, savings account, or other type of bank account, at a banking institution that allows money to be deposited and withdrawn by the account holder. These transactions are recorded on the bank's books, and the resulting balance is recorded as a liability for the...


Certificates of deposit
Certificate of deposit
A certificate of Deposit is a time deposit, a financial product commonly offered to consumers in the United States by banks, thrift institutions, and credit unions....

Short term interest rate future
Interest rate future
An interest rate futures is a financial derivative with an interest-bearing instrument as the underlying asset.Examples include Treasury-bill futures, Treasury-bond futures and Eurodollar futures....

s
Forward rate agreement
Forward rate agreement
In finance, a forward rate agreement is a forward contract, an over-the-counter contract between parties that determines the rate of interest, or the currency exchange rate, to be paid or received on an obligation beginning at a future start date. The contract will determine the rates to be used...

s
Equity Stock
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...

N/A Stock option
Option (finance)
In finance, an option is a derivative financial instrument that specifies a contract between two parties for a future transaction on an asset at a reference price. The buyer of the option gains the right, but not the obligation, to engage in that transaction, while the seller incurs the...

s
Equity futures
Futures contract
In finance, a futures contract is a standardized contract between two parties to exchange a specified asset of standardized quantity and quality for a price agreed today with delivery occurring at a specified future date, the delivery date. The contracts are traded on a futures exchange...

Stock option
Option (finance)
In finance, an option is a derivative financial instrument that specifies a contract between two parties for a future transaction on an asset at a reference price. The buyer of the option gains the right, but not the obligation, to engage in that transaction, while the seller incurs the...

s
Exotic instruments
Foreign Exchange
Currency
In economics, currency refers to a generally accepted medium of exchange. These are usually the coins and banknotes of a particular government, which comprise the physical aspects of a nation's money supply...

N/A Spot
Foreign exchange spot trading
A spot foreign exchange transaction, also known as FX spot, is an agreement between two parties to buy one currency against selling another currency at an agreed price for settlement on the spot date...

 foreign exchange
Currency future
Currency future
A currency future, also FX future or foreign exchange future, is a futures contract to exchange one currency for another at a specified date in the future at a price that is fixed on the purchase date; see Foreign exchange derivative. Typically, one of the currencies is the US dollar...

s
Foreign exchange option
Option (finance)
In finance, an option is a derivative financial instrument that specifies a contract between two parties for a future transaction on an asset at a reference price. The buyer of the option gains the right, but not the obligation, to engage in that transaction, while the seller incurs the...

s
Outright forward
Forward contract
In finance, a forward contract or simply a forward is a non-standardized contract between two parties to buy or sell an asset at a specified future time at a price agreed today. This is in contrast to a spot contract, which is an agreement to buy or sell an asset today. It costs nothing to enter a...

s
Foreign exchange swaps
Forex swap
In finance, a forex swap is a simultaneous purchase and sale of identical amounts of one currency for another with two different value dates .; see Foreign exchange derivative.-Structure:...


Currency swap
Currency swap
A currency swap is a foreign-exchange agreement between two parties to exchange aspects of a loan in one currency for equivalent aspects of an equal in net present value loan in another currency; see foreign exchange derivative. Currency swaps are motivated by comparative advantage...

s


Some instruments defy categorization into the above matrix, for example repurchase agreement
Repurchase agreement
A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is the sale of securities together with an agreement for the seller to buy back the securities at a later date. The repurchase price should be greater than the original sale price, the difference effectively...

s.

Measuring Financial Instrument's Gain or Loss


The table below shows how to measure a financial instrument's gain or loss:
Instrument Type
Categories Measurement Gains and losses
Assets Loans and receivables Amortized costs Net income when asset is derecognized or impaired (foreign exchange and impairment recognized in net income immediately)
Assets Available for sale financial assets Deposit account
Deposit account
A deposit account is a current account, savings account, or other type of bank account, at a banking institution that allows money to be deposited and withdrawn by the account holder. These transactions are recorded on the bank's books, and the resulting balance is recorded as a liability for the...

 - Fair value
Fair value
Fair value, also called fair price , is a concept used in accounting and economics, defined as a rational and unbiased estimate of the potential market price of a good, service, or asset, taking into account such objective factors as:* acquisition/production/distribution costs, replacement costs,...

Other comprehensive income (impairment recognized in net income immediately)

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