Question

INITIAL POST: Briefly define and discuss financial instruments, derivatives, and hedges (fair value and cash flow). You can find some initial information in the textbook, Chapter 13, appendix 13.1 but you should use resources other than the textbook for your post.

Answer 1

FINANCIAL INSTRUMENTS, DERIVATIVES AND HEDGES

FINANCIAL INSTRUMENTS

These are the contracts between the parties in monetary terms. Financial instruments can be modified, created , traded and also can be settled. The main advantage of financial instruments are : they helps in the efficient flow and fow of capital throughout the world's investors /users. It is otherwise known by a real or virtual document, representing a legal agreement any kind of monetary value. Tpes of instruments are:

• Cash instruments
• Derivative instruments
• Debt-based financial instruments.
• Equity - based financial instruments.

cash instruments : These are the deposits or loans agrred upon by the lenders and borrowers. These are the instruments, which is directly influences the markets and also helps to determines the market

derivative instruments   : The value and features of such derivatives are to be determined or under the basis of some components like; assets, interest rates etc. Under the same , there will be yet another type of derivative called-over the type derivative . It is otherwise known as the exchange traded derivatives, is a process/market where the pricing and trade of securities which is not listed in the formal exchanges are to be done.

debt-based financial instruments : There are two types of debt-based financial instruments, and they are ; long-term debt-based financial instrument and short- term debt-based financial instrument. Short-term basis instruments will last for a period of one yera or less than that. It includes the t-form based securities and commercial papers. Long-term debt-based financial instruments will last for more than one year. It includes bonds, loans etc.

equity-based financial instruments : Securities of this category are stocks. Stock options and equity futures will be under the category of exchange -traded derivatives.

- the fair value of OTC derivatives will be equal to the future cash flow arising from the instrument, discounted at the date of measurement. It uses the NPV method for calculation

- the fair value of cash and cash equivalents with the central bank is considered as equivalent to it's carrying amount.

- the fair value of held to maturity investments, is equivalent to it's quoted price in markets.

DERIVATIVES

It is an contract between two parties, derives it's price from an underlying asset. It is an financial instrument. Mainly derivatives are of 4 types, and they are :

1. futures
2. options
3. forwards
4. swaps

- the fairvalue of the derivative instruments is the estimated amount that the company would receive or pay to terminate the instrument at the reporting date.

HEDGES

These are the risk management practices/strategies followed by an organization, inorder to offset the losses in investments. Reducing the risk means /resulted in the reduction in potential profit . The hedging strategies involves derivatives, such as; - options & future contracts.

types of hedging

• currency future contracts
• forward exchange contracts for interest
• future contracts for interest
• currency future contracts
• money market operations for currency
• covered calls on equities

- A fair value hedge is an investment position made by an organization inorder to protect the fair value of their specific asset , liability, or other commitments with companies.

- A cash flow hedge is a tool help to mitigate the risks that are related with the sudden changes in cash flow of assets or liabilities.