Financial Instruments PDF

Lesson 1.4 Financial Instruments Business Finance Accountancy, Business, and Management 1 Suppose you are lending money to people. Would you need proof of the amount of money they owe you? 2 Most people would want a real or virtual do...

Lesson 1.4 Financial Instruments Business Finance Accountancy, Business, and Management 1 Suppose you are lending money to people. Would you need proof of the amount of money they owe you? 2 Most people would want a real or virtual document to serve as proof of their transaction. 3 Investors and creditors also want the value of their assets protected from fluctuations. Hence, the creation of financial instruments. 4 Quick Look The Debtor and the Creditor Instructions: 1. Form a group of three or four members. 2. Discuss the problem situation provided in the next slides. 3. Prepare a Finance Agreement for two parties. You may refer to the sample form provided. You may also refer to the computation of finance charges, interest, total payments, and monthly payments. 5 Quick Look The Debtor and the Creditor Company A, the debtor with Address 1, made a business loan letter request to Company B. Company A attached the documents that show their credibility as a debtor. Company B, the creditor with Address 2, after examining the documents and conducting financial investigation about company A, approved the loan request. 6 Quick Look The Debtor and the Creditor Both parties agreed to a loan amounting to ₱600,000 carrying an annual simple interest of 12%, payable monthly for a year. They also agreed to include finance charges amounting to 1% of the loan. They also agreed that either party can cancel the agreement any time with a 30-day prior notice to the other party. 7 Quick Look The Debtor and the Creditor Today both parties executed a Finance Agreement. The first payment shall begin 60 days after the execution of the agreement. Bank deposits shall be the method of payments through Bank Account No.: 0123-456-789. 8 Quick Look Questions to Ponder 1. How do creditors and debtors differ? 2. What are your important realizations and insights from the activity? 3. Looking at yourself, four or five years from now, in a corporate world, who do you want to be, the creditor or the debtor? Why? 9 Learning Competency Compare and contrast the varied financial instruments (ABM_BF12-IIIa-4). 10 Learning Objectives At the end of this lesson, you should be able to do the following: Define financial instruments. Compare and contrast the varied financial instruments. Determine the financial instrument used in a business transaction. Explain the importance of financial instruments in the financial system. 11 What instrument is the most profitable for investment? 12  Financial Instruments an agreement between parties ○ an asset to one party and a liability to the other an asset, that holds capital and can be created, liquidated, revised, and traded in the market Types of Financial Instruments 14  Cash Instruments instruments whose value is directly established and perceived by the market kinds: ○ securities ○ deposits and loans  Cash Instruments Securities Deposits and Loans considered as cash instruments because fungible or interchangeable they constitute monetary with other assets of similar value value exchanged through an agreement between the parties 16  Cash Instruments Securities entitle the holder to have Stocks a part ownership of a or Equity Securities publicly listed company offered through an IPO 17  Cash Instruments Stocks or Equity Securities stock price may increase over time companies pay dividends to the stockholders stockholders can: ○ participate in annual company’s general meeting ○ access to company reports ○ indirectly influence decisions 18  Cash Instruments Stocks or Equity Securities 19  Cash Instruments Securities offered by companies and governments who Bonds or Debt need funds Securities entitles the holder to get their money back with interest 20  Cash Instruments Bond or Debt Securities affordable, tradable and liquid holders get steady income through coupons at predetermined dates holders are priority when it comes to the liquidation process 21 Classification of Bonds Kinds of Bonds municipal agency corporate government bonds bonds bonds bonds 22  Cash Instruments Municipal Bonds Agency Bonds issued by various issued by the national and government agencies like local government units to Mutual Funds and Unit finance local infrastructures Investment Trust Funds 23  Cash Instruments Corporate Bonds Government Bonds offered by private corporations or issued by the Bureau of companies Treasury represent debt Peso and Dollar obligations rather than denominated securities equity 24  Cash Instruments Cash Deposits the money that people put into their bank account becomes a bank assets, but the bank is liable to return it 25 Cash Instruments Cash Loan borrowing money with an agreement to pay back the full amount plus interest at a certain due date 26  BTr Website as Bond Hub C lo s er Lo o k The Green Land Company owns land and would like to build townhouses in the city. The company issues bonds to the public through the Bureau of Treasury (BTr) to fund their project rather than make bank loans. 27  BTr Website as Bond Hub C lo s er Lo o k The investors who visit the BTr websites can then accomplish the BTr’s requirement to be included in the bond offerings and to finalize the bond contract. In this contract the investors finance such a project and expect to be remunerated through interest. 28  Check Your Progress 1 Differentiate equity-based and debt-based securities Answer area 29  Derivative Instruments its monetary value is derived from another financial asset called the underlying assets ○ bonds, stocks, currency if the value of the underlying asset changes, it affects the value of the derivative instrument Classification of Derivatives Derivative Instruments forward futures options swap contracts contracts 31  Derivative Instruments Forward Contracts Futures Contracts custom-made derivatives custom-made derivatives that compel the seller to sell that take place at the end and the buyer to buy at a of the contract at a specified price lock-in price set at the time of agreement 32  Derivative Instruments Options Swap provides the parties with an parties exchange or swap option (not an obligation) to financial instruments such buy or sell at an exercise as cash flows, interest rates, price within the time frame derivatives and securities 33  Derivative Instruments Forward Futures Options Swap The parties The buyer is Both parties agreed to buy obliged to buy are expected No obligations and sell the and the seller to fulfill each on the parties Obligation asset on the is obliged to others’ to buy or sell agreed sell the asset obligation on the asset. predefined on the agreed the swap date. future date. contracts.  Derivative Instruments Forward Futures Options Swap The buyer has An initial Both parties No initial to pay the margin pay as written Payment payment is premium payment is in the swap required (periodic required contract. payments).  Derivative Instruments Forward Futures Options Swap Can execute On the date On the date the contract Date of On the date of agreed upon agreed upon anytime execution the swap. by the parties. by the parties. before the expiry date.  Derivative Instruments Forward Futures Options Swap Market OTC and the Central- Some are OTC OTC and the Regulations price is exchange traded and some are price is custom-made. and the price is exchange - custom-made. regulated by the traded. trading commission.  Derivative Instruments Forward Futures Options Swap High Low High Reduces the counterparty counterparty counterparty potential loss Risk risk - parties risk-could bring risk - parties and could give may default on unlimited profit may default on unlimited gains. the obligations. or loss the obligations.  A Promise to Buy in the Future C lo s er Lo o k Suppose ION Company produces electronic products like cellphones, laptops, cameras, etc, and need gold in their production. The company then can enter into a future contract with the Mines Company that produces gold to buy the product at the current price and makes initial payment to ensure that their production will not be affected by the fluctuating prices of gold. 39  A Promise to Buy in the Future C lo s er Lo o k At the end of the contract, the buyer, ION Company, is obliged to buy the specified quality and quantity of the gold product and the seller, Mines Company, is obligated to sell the said gold. This situation is an example of a futures contract derivative. 40  Foreign Exchange Instruments also called FX or Forex investors buy and sell currency and exchange them for another currency regulated by the Securities and Exchange Commission (SEC) 41 Categories of Forex Instruments Foreign Exchange Instruments Outright Spot Currency Currency Swap Forward 42  Foreign Exchange Instruments Spot Currency Outright Forward retail or sale of the also known as currency foreign currency on “the forward same day” or 1-2 parties lock in the business days value is based on currency rate and the current exchange rate delivery date 43  Foreign Exchange Instruments Currency Swap two foreign parties exchange currency including the amount of equal value and currency rate 44  Buying Items From Other Countries Online C lo s er Lo o k I would like to purchase a sale item online in USD currency. The sale is only offered until the next day. I need the money in USD and should make a currency spot transaction now so it will be in my account the next day and catch up with the sale. This transaction is an example of spot currency. 45  Locking in the Currency Rate for a Future Purchase C lo s er Lo o k A production company from the US buys imported products from Japan and both parties agree to make two transactions. The two merchants entered into a spot contract on their first transaction and an outright forward contract for the second transaction where the currency rate and date are locked in with the agreed currency rate of USD and JPY and date. With this instrument the two parties and even the investors are protected from the fluctuating currency rates. 46  Check Your Progress 2 What are the four derivatives? Why are they called derivatives? Answer area 47  Solutions in Building and Improving Homes C ase S tu d y The study focused on Project Dungganon (a Hiligaynon word meaning “honorable”) which is the flagship project of Negros Women for Tomorrow Foundation, Inc. (NWTF) that offers group-based loans utilizing the Grameen lending methodology. The said project provides access to collateral-free credit and training and aims to assist the deprived women from rural communities of Negros and help them start their own business and become a self-dependent individual to improve their living conditions. ReferenBea Parungo, Jitendra Balani, and Naeem Razwani, “Improving access to Housing Microfinance Solutions Among Low-income Households in the Philippines,” FinDev Gateway (Terwilliger Center for Innovation in Shelter, October 2020), https://www.findevgateway.org/case-study/2020/10/improving-accsess-housing-microfinance-solutions-among-low-income- households, last accessed on November 6, 2021. ce here and attach the link :) 48  Solutions in Building and Improving Homes C ase S tu d y The project Dungganon tapped several institutions like the Microfinance Council of the Philippines, Inc. (MCPI) which provides microfinance institutions that can help the project progress. The NWTF worked with finance institutions to offer financing solutions for housing units that low-income families can afford. In summary, this study tackles on how the simple household individual can benefit from the private and government institutions by applying the financial instruments available in the Philippines. ReferenBea Parungo, Jitendra Balani, and Naeem Razwani, “Improving access to Housing Microfinance Solutions Among Low-income Households in the Philippines,” FinDev Gateway (Terwilliger Center for Innovation in Shelter, October 2020), https://www.findevgateway.org/case-study/2020/10/improving-accsess-housing-microfinance-solutions-among-low-income- households, last accessed on November 6, 2021. ce here and attach the link :) 49  Solutions in Building and Improving Homes C ase S tu d y In summary, this study tackles on how the simple household individual can benefit from the private and government institutions by applying the financial instruments available in the Philippines. ReferenBea Parungo, Jitendra Balani, and Naeem Razwani, “Improving access to Housing Microfinance Solutions Among Low-income Households in the Philippines,” FinDev Gateway (Terwilliger Center for Innovation in Shelter, October 2020), https://www.findevgateway.org/case-study/2020/10/improving-accsess-housing-microfinance-solutions-among-low-income- households, last accessed on November 6, 2021. ce here and attach the link :) 50 Keep in Mind A financial instrument is an agreement or a contract between parties or individuals which is an asset to one party and a liability to the other party. As an asset it holds capital and can be created, liquidated, revised, and traded to market. The financial instruments can be in the form of cheques, cash, forex (currency), shares, stocks, futures, options, bonds, etc. 51 Keep in Mind Keep in Mind Cash instruments are instruments, whose value is directly established and perceived by the market. These can be securities such stocks (equity securities) and bonds (debt securities), or cash deposits and loans. Derivative instruments are financial instruments whose monetary value is derived or determined from another financial asset, called the underlying assets such as bonds, stocks, and currency. 53 Keep in Mind Foreign exchange instruments or simply called FX or Forex is an OTC market where investors buy and sell currency and exchange them to another currency. 54