The global financial market is a complex entity that is largely subject to its own laws and principles of development. However, some of its fundamental features have long been studied and brought to a common denominator. Financial instruments are no exception. This is a real document or an officially registered electronic form that may enshrine some kind of legal agreement.
In economics, a slightly different term is adopted. So, according to him, financial instruments are such an agreement that ensures the creation of a financial asset for one of its parties, as well as a financial liability (equity instrument) for another participant. They can be both legal entities and individuals.
What is what?
The concept of them is quite diverse. It is generally accepted that financial instrumentsinclude:
- Financial asset. This is how cash is called, the right to demand it in some situation, as well as the provision of an equity instrument or some other financial instrument.
- Financial obligation. Accordingly, this is the name of an agreement in which one party may demand the financial assets of another participant.
- Equity instrument. It is also an agreement that gives the right to receive a portion of the organization's assets.
Basic concepts
According to IAS 32, assets include all of an entity's foreign currency, customer debt, investments and securities. Liabilities also include accounts payable from suppliers, as well as all other types of such debt. The company is obliged to recognize its assets and liabilities only when it is one of the parties to the contract (financial instrument).
All of these major financial instruments are valued at their fair value only. As a rule, it recognizes the value of the paid-in asset or the liability of the firm.
About fair value
How to determine the size of this cost as objectively as possible? For this, the value of such a transaction is used, which other parties who are well aware of the market obligations and the value of the company are willing to make. The best and easiest way is to use the price of financial assets in free markets.
What to do if there is no such possibility? In this case, you have touse any of the generally accepted assessment methods. Their general essence is the same: two parties are taken who are interested in making a similar transaction, after which its possible value is calculated.
It also provides for the use of market information from independent parties who have recently made similar transactions or were interested in them, an objective analysis of discounted cash flows is made. It is important to use an appropriate option pricing model, otherwise the derivatives market will not be able to form a truly objective value of assets.
Classification of financial assets
To simplify all subsequent assessments (if any), all identified assets are classified as follows:
- Assets to be valued at fair value.
- All investments to be held until full repayment.
- Accounts receivable and all outstanding loans held by the business.
- All holding financial assets that are currently available for sale.
Let's take a closer look at all these positions.
Loans and receivables
Both loans and receivables involve the transfer of goods or net cash to the debtor, provided that the latter has no intention of reselling the debt to third parties. They are evaluated based onamortized cost.
This is understood as the price of a financial instrument from which the amount of debt was deducted or bad debts were written off (full or partial). Most often, it is calculated using the effective interest rate, as this allows you to more adequately determine the value of an asset, even if the latter is partially depreciated.
This makes financial instruments more efficient and more profitable for the company's investors.
Assets held for sale
All assets that can be measured at fair value and held for trading can be classified as follows:
- Purchased for the purpose of resale in the short term.
- If they are part of some financial portfolio, which again is intended to be sold in the short term.
- If the asset is a production tool.
Obligations and rules for their use
No entity is allowed to classify financial instruments into or out of the fair value category. Moreover, this applies to the entire period of ownership of the instrument or at the time of its release.
If we talk about investments that are held to maturity, then they are classified as assets with fixed payments, as well as their maturity. This applies only to those investments that the organization is not only committed to, but able tohold. By the way, debt securities that have a variable interest rate can also fall into this category.
Intention to Hold
It is measured both when the asset is acquired and at each balance sheet date. Moreover, the intention to hold assets is evaluated according to much more stringent criteria when compared with the intention to sell them at the moment. The fact is that all organizations that do otherwise raise doubts about the advisability of long-term cooperation with them, and therefore can automatically be considered unreliable clients.
All this can lead to the formation of a special pen alty portfolio, all investments from which the company is obliged to keep until their full repayment. All other assets are strictly prohibited from applying the definition of "held to maturity", and the restriction can apply immediately to three years after purchase. If an entity already holds these types of financial market instruments, they should be reclassified as being sold at fair value and put on sale.
Profit or loss resulting from such activities should be immediately recognized in assets. Only after (!) the expiration of the prohibition period, the organization has the right to independently assign the concept of “held to maturity” to investments or other funds. Simply put, in this case, an independent assessment of financial instruments is not performed. In case of violation, pen alties may be imposed on the company.
They can be expressed in a complete ban on investing in production, as well as in other measures that, if used, will seriously undermine the economic situation of the company.
Which financial instruments can be considered purchased for sale at fair value?
In this case, the financial instruments of the financial market include all the following concepts and definitions:
- All derivative liabilities that under no circumstances may be used as hedging instruments.
- If they were taken for the delivery of securities or other assets in the event that the latter were received under the condition of "short" positions.
- If they were taken with the intention of buying them back in the very near future.
- All commitments that can only be used in association with each other. In addition, evidence is required of the fact that the organization has already used them in the past, and as a result of such actions, it has received a profit.
All liabilities that are deemed to be held for trading at fair value should immediately show up in the further calculation of all profits and losses of the company for a particular period. All other financial market instruments can be measured at amortized cost, with one exception. These are those liabilities that arose during the period when the financial asset cannot be recognized as “sold at fair value”, and itsmust be used in the future.
In this case, such a liability should be measured taking into account the following conditions:
- If it is a combination of the rights and obligations that the entity has retained from the previous owner, previously measured at amortized cost.
- If it was previously measured at fair value, but was transferred to the organization on some separate terms.
- If the obligation is an agreement with a bank to provide a loan at below market rates.
In this case, it should be evaluated by the highest value of the following indicators:
- The amount determined in strict accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets.
- Initially recognized amount of fair value, even with pre-deducted depreciation cost.
Classification of concept
Today, economists say that all financial instruments can be divided exactly into two large categories. In the first case, these documents should be based on real capital, giving possession of some assets (shares, for example), or they represent debt obligations of one company to another. In this case, bonds are issued. However, most often all of them are considered in a single context, since financial markets and financial instruments in this respect practically cannot be separated.
Each onethe instrument is best seen in the context of a "unit" of money capital. Moreover, each element has its own unique features, structure and conditions of use. It is their wide variety that ensures the rapid movement of capital in the global financial market and its further development. In recent years, the financial instruments market has been developing more actively, the more promising sales directions are opened for manufacturers in Southeast Asia.
And now let's look at one of the types of securities that include the concept of "financial instruments". These are shares. There are simple and privileged varieties.
Common stocks
They not only give the right to vote in the company, but also allow the holder to receive a share of the profits from the entire organization. Of course, this variety is not only the most common in the entire financial market, but also the most interesting for investors. Such securities are a stable and versatile instrument, and therefore their value is formed under the influence of normal market factors. All stock markets allow not only to buy them directly, but also to make a profit using the services of brokers or brokerage companies.
Some benefits come exclusively from these financial policy instruments. For example, the right to vote, which many treat with some disdain, allows you to lobby for the promotion of your candidates to the Board of Directors of the company, and this is an extremely important tool not only for the economy, but alsopolicy.
Among other things, the amount of dividends on classic stocks directly depends on the profitability of the company. Having successfully invested, you will not only receive certain leverage, but also a solid profit. Of course, one should not forget about the growth of their value directly. This happens when the economic condition of the enterprise improves dramatically. However, the value of ordinary shares may also drop sharply, resulting in losses for investors.
Preferred shares
This is a class of securities that provides extended rights to receive dividends and profits from the sale. In addition, their owners receive dividends faster than the owners of ordinary shares. At the same time, one should not forget that the holders of such securities do not have the right to vote, and therefore they cannot directly influence the management of the enterprise. These are financial instruments of financial policy that have a very limited range of real use.
In general, the exact list of the advantages that preferred shares give depends strictly on the characteristics of a particular company. The very essence of this type of financial instrument is that these shares combine the characteristics of debt instruments (as in the case of bonds, there is a fixed percentage on dividends), as well as property instruments. The latter circumstance indicates that these types of financial instruments allow you to receive income already due to the market growth in the value of the shares themselves, which do not even have to be sold.
Of course, they have their advantages and disadvantages. The advantage is the extended right to receive profits and dividends. In addition, you do not have a vote, and the value of preferred shares increases much more slowly than the price of common shares.
Thus, financial instruments are a powerful tool both for making a profit and for influencing enterprises.
