BAFIN 101B MODULE 1
NATURE OF FINANCIAL INSTRUMENTS
A financial instrument is any contract that gives rise to a financial asset of one entity and a
financial liability or equity instrument of another entity.
The contract in the definition refers to an agreement between two or more parties that has clear
economic consequences that the parties have little, if any, discretion to avoid, usually because
the agreement is enforceable by law. Contracts, and thus financial instruments, may take a
variety of forms and need not be in writing.
Financial instruments include primary instruments and derivative financial instruments. Based on
the definition, financial instruments include financial assets, financial liabilities, equity
instrument and derivatives. Derivatives include financial options, futures and forwards, interest
rate swaps and currency swaps.
A Financial Asset is any asset that is
Cash
Equity instrument of another entity (e.g., investment in ordinary share of a corporation)
Receivable (accounts, notes and loans receivable)
Some of the most commonly encountered Financial Instruments representing Financial Assets
are the following:
(a) Cash on Hand and in Banks
1. Petty cash refers to cash balances kept on hand at various locations to pay for minor
expenditures such as postage and other small out-of- pocket expenditures.
2. Demand, savings and time deposits represent amounts on deposit in checking, savings
and time deposit accounts respectively. Time deposits are placements covering a
relatively long period of time.
3. Undeposited checks are checks payable to the enterprise or bearer but not yet presented to
the bank for payment.
4. Foreign currencies
5. Money orders are financial instruments similar to bank drafts but are drawn generally
from authorized post offices or other financial institutions.
6. Bank drafts are commitments by banking institutions to advance funds on demand by the
party to whom the draft was directed.
(b) Accounts, notes and loans receivable and investment in bonds and other debt instrument
issued by other entities:
1. Trade-receivables (signed delivery receipts and sales invoice)
2. Promissory notes
3. Bond certificates
(c) Interest in shares or other equity instruments issued by other entities.
1. Stock certificates
2. Publicly listed securities
(d) Derivative Financial Assets
1. Futures Contracts
2. Forward Contracts
3. Call Options
4. Foreign Currency Futures
5. Interest Rate Swaps
FINANCIAL LIABILITIES
Financial liabilities encompass contractual obligations that involve:
(a) Delivering cash, another financial asset, or exchanging financial assets/liabilities under
potentially unfavorable conditions with another entity, or
(b) Contracts that may be settled using the entity's own equity instruments, including non-
derivatives obligating variable delivery of equity instruments or derivatives settled in ways other
than a fixed cash amount for a fixed number of equity instruments
Examples include accounts payable, loans, bonds, and other debt instruments issued. Derivative
financial liabilities might involve obligations to deliver shares of fixed value and some equity
instrument derivatives
Derivative Financial Instruments
Derivatives are financial instruments whose value is derived from contractually required cash
flows linked to other securities or indexes.
Examples of Derivatives:
1. Futures Contracts
Agreements between buyers and sellers for the delivery of commodities or financial
instruments at a predetermined price on a designated future date. Used for investment or
hedging.
2. Forward Contracts
Similar to futures contracts but differ in terms of specific delivery dates, lack of trading
on market exchanges, and no daily cash settlement.
3. Call Options
Give holders the right to buy or sell instruments at a specified price within a set time
period. Used for hedging interest rate exposure; holders have no obligation to exercise.
4. Foreign Currency Futures
Used when loans must be repaid in foreign currencies, introducing exchange rate risk.
5. Interest Rate Swaps
Contracts to exchange cash flows on specified dates based on notional amounts and fixed
and floating rates.
Samples and Specimens of Financial Instruments
Local Currency: Philippine Pesos
Foreign Currency: US Dollars
Foreign Currency: Euros
Foreign Currency: Japanese Yen
Foreign Currency: Qatar Riyals
Foreign Currency: Thai Baht
Time Deposit Personal Check
A time deposit is an interest-bearing bank A personal check is a slip of paper that's
account that has a date of maturity, such as a processed from your checking account. On
certificate of deposit (CD). The money in a the check, you write an amount of money
time deposit must be held for the fixed term and the name of the recipient who will
to receive the interest in full. Typically, the receive that money.
longer the term, the higher the interest rate
that the depositor receives.
EQUITY INSTRUMENTS
Example:
Stock Certificate evidencing
Investment in Common Stock or
Fixed Deposit Ordinary Equity Share
A fixed term deposit, also known as FTD, is
a financial product through which an
individual (natural person) or a company
(legal entity) deposits an amount of money
in afinancial entityduring a specific period
of time in exchange for remuneration at a
previously fixed interest rate.
Stock Certificate Evidencing
Investment in Preferred Stock
Corporate Check
corporate cheque means a cheque drawn
against an account we hold with another
financial institution.
DEBT INSTRUMENT
Example:
Certificate evidencing Investment in
Treasury Bonds
Forward Contract
Certificate evidencing Investment in
Bonds
Index Derivative Contract
Specifications
Promissory note evidencing
Receivable of City Finance
Company (Lender) from Jane
Monroe (Borrower)
Insurance Certificate representing
Investment in an insurance policy
