Financial Instruments
Course on Balance of Payments and
International Investment Position Manual
(BPM6)
IMF-PFTAC
Nadi
November 22-December 1
BP08
GENERAL OVERVIEW

I - Introduction
 Main changes from BPM5

II - Definitional issues
 What is a financial instrument ?

III - Classification of financial instruments
 Three broad categories
References: BPM6 Chapters 5, 6, and 8
1
INTRODUCTION

Changes in the treatment of specific instruments:

Special Drawing Right allocations to be classified as a liability.

So-called unallocated gold accounts to be classified as a deposit (or
monetary gold if held in reserves). So gold bullion is the only
financial asset in the system without a counterpart liability.
2
INTRODUCTION (2)

Arrears now recorded as part of the value of the instrument and not a
separate transaction. (Arrears related to Exceptional Financing are a
memorandum item and are included in the “analytical presentation.”)

Employee stock options to be included in the category, “financial
derivatives and employee stock options.”

Investment fund shares to be separately identified. Money market
funds are separately identified as a supplementary item.
3
DEFINITIONAL ISSUES

What is a financial instrument ?

Financial instruments comprise the full range of financial contracts
made between institutional units

Financial instruments are classified as financial assets or as other
financial instruments
4
DEFINITIONAL ISSUES (2)

What is an economic asset ?
Economic assets are resources over which ownership rights are
enforced and from which future economic benefits may flow to the
owner. These benefits include:
(a) the ability to use assets, such as buildings or machinery, in
production;
(b) the generation of property incomes: for example, interest and
dividends received by the owners of financial assets; and
(c) the potential to sell and thus realize holding gains.

5
DEFINITIONAL ISSUES (3)

There are two categories of economic assets: non financial
and financial assets

Distinction between non financial and financial assets: a
financial asset is a claim on another party. The existence
of this counterpart liability distinguishes financial assets
from other economic assets, such as land, dwellings,
machinery and equipment, etc.
6
DEFINITIONAL ISSUES (4)

Scope of financial assets in BPM6


Financial assets consist of claims and the gold bullion component of
monetary gold.
What is the gold bullion component of monetary gold ?: when held as
monetary gold, gold bullion is a financial asset that is not created by
an instrument and that does not represent a claim on another entity. It
is considered to be a financial asset because of its role as a means of
international payments and store of value for use in reserves.
7
DEFINITIONAL ISSUES (5)
Other financial instruments


Besides financial assets, there are other financial instruments which
are not recognized as economic assets. These other instruments are
contingent assets and liabilities

Contingent assets are not recognized as economic assets because
they do not give rise to unconditional requirements either to make
payments or to provide other objects of value. However, by
conferring certain rights or obligations that may affect future
decisions, they can produce an economic impact on the parties
involved.
8
DEFINITIONAL ISSUES (6)

Examples of contingent assets or liabilities:

One-off guarantees of payment by third parties are contingent since
payment is only required if the principal debtor defaults.

Lines of credit, letters of credit, and loan commitments assure that
funds will be made available, but no financial asset (i.e., loan) is
created until funds are actually advanced.

“Provisions” for future liabilities or future expenditures – recorded in
financial accounts but not recognized as economic assets
9
Classification of financial instruments

Three broad categories are used to classify financial assets and
liabilities:
(1) equity and investment fund shares,
(2) debt instruments,
(3) other financial assets/liabilities.

This classification is based primarily on the legal
characteristics that describe the form of the underlying
relationship between the parties to an instrument, which are
also related to their liquidity and economic purpose.
10
Classification of financial instruments
(2)



Equity and investment fund shares

Equity

Investment fund shares/units
Debt instruments

Special Drawing Rights

Currency and deposits

Debt securities

Loans

Insurance, pension, and standardized guarantee schemes

Trade credit and advances

Other accounts payable/receivable
Other financial assets and liabilities

Monetary gold*

Financial derivatives and employee stock options
*Gold bullion has no counterpart liability. However, the counterpart liability of unallocated gold accounts
is in deposits.
The detailed classification of financial assets and liabilities is harmonized
with the SNA
11
Equity and investment fund shares


Equity comprises all instruments and records
acknowledging, after the claims of all creditors
have been met, claims on the residual value of a
corporation or quasicorporation.
Equity is treated as a liability of the issuing
institutional unit (a corporation or other unit).
12
Equity and investment fund shares (2)

Equity: Equity securities and Other equity

Equity securities comprise listed shares and unlisted shares.
Listed shares are those listed on an exchange. They are also
referred to as quoted shares. Unlisted shares can also be
called private equity; venture capital also usually takes this
form.

Other equity is equity that is not in the form of securities. It
can include equity in quasi-corporations, such as branches,
trusts, limited liability and other partnerships, unincorporated
funds, and notional units for ownership of real estate and
other natural resources.
13
Equity and investment fund shares (3)




Investment funds shares
Investment funds shares are collective investment
undertakings through which investors pool funds
for investment in financial and/or nonfinancial
assets.
These funds issue shares (if a corporate structure is
used) or units (if a trust structure is used).
Investment funds include money market funds
(MMF) and non-MMF investment funds.
14
Equity and investment fund shares (4)

Investment fund shares: MMFs and Non-MMFs

MMFs are collective investment schemes invested primarily
in money market instruments, MMF shares/units, transferable
debt instruments with a residual maturity of less than one
year. MMFs shares or units may be regarded as close
substitutes for deposits.

Non-MMF are invested predominantly in long-term financial
assets and nonfinancial assets (usually real estate).
Investment fund shares or units are generally not close
substitutes for deposits.
15
Equity and investment fund shares (5)

Retained earnings of investment funds

Unlike equity investment, investment income
attributable to the owners of investment fund shares
include dividends payable to them as well as
retained earnings.

This is a strong difference from BPM5, where
reinvested earnings where recorded for direct
investment only.
16
Debt instruments

Debt instruments are those instruments that require the
payment of principal and/or interest at some point(s) in the
future.

Debt instruments comprise:
 - Special Drawing Rights,
 - currency and deposits,
 - debt securities,
 - loans,
 - insurance technical reserves and provision for calls
under standardized guarantees,
 - and other accounts receivable/payable
17
Debt Instruments (2)


The term debt instrument applies to liability
and the corresponding claim
Differ from equity and investment fund shares
in nature of liability and risk



Greater risk with equity, depends on economic
performance of issuer
Predefined formula for obligation to pay principal
and interest.
Short or long term classification may be
useful
Special Drawing Rights (SDRs)



SDRs are international reserve assets. They represent
unconditional rights to obtain foreign exchange or other
reserve assets from other IMF members. SDRs are held only
by the monetary authorities of IMF members and a limited
number of international financial institutions that are
authorized holders.
Holdings of SDRs by an IMF member are recorded as an
asset, while the allocation of SDRs is recorded as the
incurrence of a liability of the member receiving them. This
is a change from BPM5.
The holdings and allocations should be shown gross, rather
than netted.
18
Currency and deposits

Currency consists of notes and coins that are of fixed nominal
values and are issued or authorized by central banks or
governments.

Deposits include all claims that are (1) on the central bank, a
deposit-taking corporation other than the central bank, and, in
some cases, other institutional units; and (2) are represented
by evidence of deposit.

3 categories of deposits can be distinguished:

transferable deposits, interbank deposits and other deposits
19
Debt securities

Debt securities are negotiable instruments serving as
evidence of a debt. They include bills, bonds, certificates of
deposit, commercial paper, debentures, asset-backed
securities, and similar instruments normally traded in the
financial markets.

Debt securities include some specific instruments such as
asset backed securities, stripped securities, index-linked
securities, bankers acceptances.
20
Debt securities (2)

Asset-backed securities, collateralized debt obligations, and
collateralized mortgage obligations are arrangements under
which payments of interest and principal are backed by
payments on specified assets or income streams. They are
used for mortgages, home equity loans, student loans, and
other debts as well as pools of leased property.

Index-linked securities are those where the principal and/or
coupons are linked to another non-interest item, such as a
price index or exchange rate.
21
Debt securities (3)

Stripped securities are securities that have been transformed
from a principal amount with coupon payments into a series
of zero-coupon bonds, with a range of maturities matching
the coupon payment date(s) and the redemption date of the
principal amount(s).

Bankers’ acceptances involve the acceptance by a financial
corporation, in return for a fee, of a draft or bill of exchange
and the unconditional promise to pay a specific amount at a
specified date. Much international trade is financed this way.
22
Loans



Loans are financial assets that (1) are created when a
creditor lends funds directly to a debtor, and (2) are
evidenced by documents that are not negotiable.
This category includes all loans including overdrafts,
except accounts receivable/payable, which are treated
as a separate category of financial assets.
Loans that have become debt securities are also
excluded from loans (evidence of secondary market
trading, and frequent quotations of the instrument).
23
Loans (2)
The category of loans includes some specific
transactions:
Financial leases
 Repurchase agreements (Repos) and gold swaps
 Debt assumption
 Credit and loans with the Fund

24
Loans (3)

Securities repurchase agreement and gold swaps

A securities repurchase agreement is an arrangement
involving the provision of securities in exchange for cash
with a commitment to repurchase the same or similar
securities at a fixed price either on a specified future date or
with an open maturity

A gold swap involves an exchange of gold for foreign
exchange deposits with an agreement that the transaction be
reversed at an agreed future date at an agreed gold price.
25
Loans (4)

Financial leases

Under a financial lease, the legal owner is shown as issuing a
loan to the lessee with which the lessee acquires the asset

The asset is shown on the balance sheet of the lessee and not
the lessor

The corresponding loan is shown as an asset of the lessor and
a liability of the lessee
26
Loans (5)



Financial leases (continued)
At inception of the lease a liability is imputed for the lessee,
as counter-entry for the change of ownership of goods in the
current account
The payments during the contract include not only the
principal, but also interest, and FISIM (if financial
intermediary is involved)
27
Insurance, pension, and standardized
guarantee schemes

Insurance, pension, and standardized guarantee schemes
comprise:

(a) nonlife insurance technical reserves;
(b)life insurance and annuity entitlements;
(c) pension entitlements, claims of pension funds on
sponsors, and entitlements to nonpension funds; and
(d)provisions for calls under standardized
guarantees.



28
Insurance, pension, and standardized
guarantee schemes (2)

Nonlife insurance technical reserves comprise:

(a) Reserves for unearned insurance premiums, which are
prepayment of premiums. On an accrual basis, the premiums
are earned through the policy period, so that the initial
payment involves a prepayment or advance.

(b)Reserves against outstanding claims, which are amounts
identified by insurance corporations to cover what they
expect to pay out arising from events that have occurred but
for which the claims are not yet settled.
29
Insurance, pension, and standardized
guarantee schemes (3)

Life insurance and annuity entitlements

Life insurance and annuity entitlements are used to provide
benefits to policyholders upon the expiry of the policy, or to
compensate beneficiaries upon the death of policyholders.

Therefore, these entitlements are kept separate from
shareholders’ funds, and are regarded as liabilities of the
insurance companies and assets of the policyholders and
beneficiaries.
30
Insurance, pension, and standardized
guarantee schemes (4)

Pension entitlements

Pension entitlements show the extent of financial claims both
existing and future pensioners hold against either their
employer or a fund designated by the employer to pay
pensions earned as part of a compensation agreement between
the employer and employee.

The accrued obligations of pension entitlements are
recognized as economic assets and liabilities, including
unfunded pension schemes (para. 5.64)
31
Insurance, pension, and standardized
guarantee schemes (5)

Provisions for calls under standardized guarantees

Standardized guarantees are defined as those that are not
provided by means of a financial derivative (such as credit
default swaps), but where the probability of default can be
well established

These guarantees cover similar types of credit risk for a large
number of cases
Examples include export credit guarantees or student loan
guarantees issued by governments

32
Other accounts receivable/payable

Other accounts receivable/payable consist of (i) trade
credit and advances and (ii) other

Trade credit and advances comprises (1) trade credit
extended directly by the suppliers of goods and services to
their customers and (2) advances for work that is in progress
(or is yet to be undertaken) and prepayment by customers
for goods and services not yet provided.

The other category includes liabilities for taxes, purchase
and sale of securities, wages and salaries, dividends, and
social contributions that have accrued but not yet paid. It
also includes prepayments of those items.
33
Other financial assets and liabilities

This category includes:

- Monetary gold
- Financial derivatives
- Employee stock options


34
Other financial assets and liabilities
(2)


Monetary gold
Monetary gold is gold to which the monetary
authorities (or others who are subject to the effective
control of the monetary authorities) have title and is
held as reserve assets. It comprises gold bullion
(including gold held in allocated gold accounts) and
unallocated gold accounts with nonresidents that
give title to claim the delivery of gold.
35
Other financial assets and liabilities
(3)

Allocated and unallocated gold accounts

Allocated gold accounts provide a record of title to specified
gold. These accounts typically offer purchasing, storing, and
selling investment grade bars and coin to order. Accounts of
this type constitute full outright ownership of the metal.

In contrast, unallocated gold accounts represent a claim
against the account operator to deliver gold. Unallocated
accounts are the method through which much of the trading in
gold is undertaken in financial markets.
36
Other financial assets and liabilities
(4)

Financial derivatives

A financial derivative contract is a financial instrument that
is linked to another specific financial instrument or indicator
or commodity and through which specific financial risks
(such as interest rate risk, foreign exchange risk, equity and
commodity price risks, credit risk, etc.) can be traded in their
own right in financial markets.

There are two broad categories of financial derivatives:
forward contracts and options.
37
Other financial assets and liabilities
(5)

Forward-type contracts

A forward-type contract (forward) is an unconditional
contract by which two counterparties agree to exchange a
specified quantity of an underlying item (real or financial) at
an agreed-upon contract price (the strike price) on a
specified date.

Forward-type contracts include futures and swaps. Futures are
forward-type contracts traded on organized exchanges.
Forward rate agreements and forward foreign exchange
contracts are common types of forward-type contracts.
38
Other financial assets and liabilities
(6)

Option contracts

In an option contract, the purchaser acquires from the seller
a right to buy or sell a specified underlying item at a strike
price on or before a specified date. The purchaser of an
option pays a premium to the writer of the option.

In return, the buyer acquires the right but not the obligation to
buy (call option) or sell (put option) a specified underlying
item (real or financial) at an agreed-upon contract price (the
strike price) on or before a specified date.
39
Other financial assets and liabilities
(7)

Employee stock options

Employee stock options (ESOs) are options to buy the equity
of a company, offered to employees of the company as a form
of remuneration. ESOs are a financial instrument, recognized
at the grant date.

At the time of granting, the entity receiving ESOs incurs a
liability in the form of other accounts payable equal to the
value of the ESOs. The value of ESOs at the time of granting
provides the measure of compensation of employees that
should be accrued during the granting and vesting dates.
40
Other financial assets and liabilities
(8)

Employee stock options

There may be a few cases where the company that issues the
option is a resident of a different economy from the employee
(e.g., the employer is a branch or subsidiary of the company
to which the option relates)

If a stock option granted to employees can be traded on
financial markets without restriction, it is classified as a
financial derivative.
41