Financial Instruments
CLASS
A contract that give rise to a financial asset of
one entity and a financial liability or equity
instruments of another entity
A monetary contract between two parties,
which can be traded and settled
Financial Instruments are traded in the financial
System
A real or virtual documents representing a legal
agreement involving any kind of monetary
value
2 TYPES:
1. According to Value
 Cash Instruments
- Values are determined by the
market
Ex: Deposits, loans/bonds,
equities/stocks
 Derivative Instruments
- Values are based on the
underlying assets
Ex: options, forwards/future, swaps
2. According to investment class
 Debt-Based Instruments
- Represents a loan made by a
surplus unit to a deficit units
- It represents liability by the
borrower/issuer
- The investor earns interest
Ex: Bonds
 Equity-Based Instruments
- Represents ownership
- The investor earns dividends
Ex: Stocks
Investment Class
- A group of investments that
exhibit similar characteristics
- Sometimes called an ASSET
There are 2 most common Investment Classes
1. Equity Securities
Share of stocks – represent part of
ownership then you become the part
owner of that company
What do you expect to receive if you’re an
owner?
Sharing of profit = DIVIDENDS.
For as long as the surplus units
or investors (Share of stocks)
hold on to its investments in
equity shares it has the rights to
receive dividends
But what if the investors decided
to trade the equity shares then it
can get either a profit or loss from
the said trading depending on the
changes of the market price
2. Debt Securities
Bonds – is a fixed income instrument
that represent a loan made BY an
investor TO a borrower
- The investor is the creditor of
the deficit unit
- The investor is not a part
owner but a creditor
Differences:
1. Since the investor is a creditor, he is not
entitled to the profits or the earnings of
the company. He has no rights to the
dividends. But he is a creditor thus, the
external source of funds, the company is
obligated to pay him back
In the distribution of the deficit units assets
in case of liquidation, the creditor will be
given priority over the others
BOND is a liability of an issuing company, it
has maturity date and bears INTEREST
 INTEREST is payments of a used borrowed
funds, therefore, the returned investments
in bonds or debt securities is INTEREST
If the investor decided to HOLD his bond
investments until maturity he is therefore
entitled to receive interest across the term of
the bond
A bond can also be TRADED and if the
investor is able to trade the bonds for more
than its face value then it said to be traded at
a PREMIUM, but if its traded less than its
face value it said to be traded at DISCOUNT
QUESTION:
If you are a Deficit unit, which would you prefer
to issue:
Equity securities or debt securities?