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Financial instrument

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Monetary contract between parties

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Financial instruments are monetarycontracts between parties. They can be created, traded, modified and settled. They can be cash (currency), evidence of an ownership, interest in an entity or a contractual right to receive or deliver in the form ofcurrency (forex); debt (bonds,loans);equity (shares); orderivatives (options,futures,forwards).

International Accounting Standards IAS 32 and39 define a financial instrument as "any contract that gives rise to afinancial asset of one entity and a financialliability or equity instrument of another entity".^[1]

Financial instruments may be categorized by "asset class" depending on whether they are foreign exchange-based (reflecting foreign exchange instruments and transactions), equity-based (reflectingownership of the issuing entity) or debt-based (reflecting a loan the investor has made to the issuing entity). If the instrument is debt it can be further categorized into short-term (less than one year) or long-term.

Types

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Financial instruments can be either cash instruments or derivative instruments:

Cash instruments – instruments whose value is determined directly by themarkets. They can besecurities, which are readily transferable, and instruments such asloans anddeposits, where both borrower and lender have to agree on a transfer.
Derivative instruments – instruments which derive their value from the value and characteristics of one or more underlying entities such as anasset,index, orinterest rate. They can beexchange-traded derivatives andover-the-counter (OTC) derivatives.^[2] Some of the more common derivatives includeforwards,futures,options,swaps, and variations of these such assynthetic collateralized debt obligations andcredit default swaps.

Asset class	Instrument type
Asset class	Securities	Other cash	Exchange-traded derivatives	OTC derivatives
Debt (long term) 1 year	Bonds	Loans	Bondfutures Options on bondfutures	Interest rate swaps Interest rate caps and floors Interest rate options Exotic derivatives
Debt (short term) ≤ 1 year	Bills, e.g.T-bills Commercial paper	Deposits Certificates of deposit	Short-terminterest rate futures	Forward rate agreements
Equity	Stock	N/A	Stockoptions Equityfutures	Stockoptions Exotic derivatives
Foreign exchange	N/A	Spot foreign exchange	Currency futures	Foreign exchangeoptions Outright forwards Foreign exchange swaps Currency swaps

Some instruments defy categorization into the above matrix, for examplerepurchase agreements.

Measuring gain or loss

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The gain or loss on a financial instrument is as follows:

Instrument Type	Categories	Measurement	Gains and losses
Assets	Loans and receivables	Amortized costs	Net income when asset isderecognized or impaired (foreign exchange and impairment recognized in net income immediately)
Assets	Available for sale financial assets	Deposit account –fair value	Other comprehensive income (impairment recognized in net income immediately)

References

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^International Accounting Standard (IAS) 32.11
^Understanding Derivatives Archived 2013-08-12 at theWayback Machine. Federal Reserve Bank of Chicago. Accessed August 2, 2015.