Finance notes 1
• When a user of funds obtains finance from the provider of funds, the user must prepare a
legal document that clearly defines the contractual arrangement. This document is
known as a financial instrument: it acknowledges a financial commitment and represents
an entitlement to future cash flows.
• The financial instrument becomes a financial asset on the balance sheet of the provider
of funds. If the financial asset represents debt that will be repaid, then it also appears as
a liability on the balance sheet of the borrower; however, if it represents equity, it will
appear as part of shareholder funds.
• For example, if a bank customer deposits funds in a term deposit, the bank will
acknowledge this deposit and issue a receipt that will specify the amount of funds
provided, the maturity date when the funds will be repaid, the rate of interest to be paid
and the timing of interest payments.
• The terms and conditions specified in a financial security can vary significantly. For
example, a loan agreement may include an interest rate that is fixed for the term of the
loan, while another loan may have a variable rate of interest that can change on certain
dates.
• One loan may require monthly payments of interest and principal, while another loan
may require half-yearly interest payments with principal only repaid at maturity. Savers,
as the providers of funds, will purchase financial assets that have attributes of risk,
return, liquidity and cash flows that meet their particular needs. In the financial markets,
the saver is said to buy the ‘paper’ of the issuer.
• Financial instruments may be divided into three broad categories: equity (including
hybrid instruments), debt and derivatives. These three categories reflect the nature and
main characteristics of financial instruments.
• The matching principle is one of the fundamental reasons for the existence of a wide
range of
• financial instruments and markets. The principle contends that short-term assets such as
working capital and inventories should be funded with short-term liabilities. For example,
if a company is purchasing stock (asset) that will remain in the company for just a short
period of time before the product is sold, the company should need only a short-term
loan (liability) to fund the purchase of the stock. An example of a short-term loan that can
be used for this purpose is an overdraft facility (see Chapter 9).
• When a user of funds obtains finance from the provider of funds, the user must prepare a
legal document that clearly defines the contractual arrangement. This document is
known as a financial instrument: it acknowledges a financial commitment and represents
an entitlement to future cash flows.
• The financial instrument becomes a financial asset on the balance sheet of the provider
of funds. If the financial asset represents debt that will be repaid, then it also appears as
a liability on the balance sheet of the borrower; however, if it represents equity, it will
appear as part of shareholder funds.
• For example, if a bank customer deposits funds in a term deposit, the bank will
acknowledge this deposit and issue a receipt that will specify the amount of funds
provided, the maturity date when the funds will be repaid, the rate of interest to be paid
and the timing of interest payments.
• The terms and conditions specified in a financial security can vary significantly. For
example, a loan agreement may include an interest rate that is fixed for the term of the
loan, while another loan may have a variable rate of interest that can change on certain
dates.
• One loan may require monthly payments of interest and principal, while another loan
may require half-yearly interest payments with principal only repaid at maturity. Savers,
as the providers of funds, will purchase financial assets that have attributes of risk,
return, liquidity and cash flows that meet their particular needs. In the financial markets,
the saver is said to buy the ‘paper’ of the issuer.
• Financial instruments may be divided into three broad categories: equity (including
hybrid instruments), debt and derivatives. These three categories reflect the nature and
main characteristics of financial instruments.
• The matching principle is one of the fundamental reasons for the existence of a wide
range of
• financial instruments and markets. The principle contends that short-term assets such as
working capital and inventories should be funded with short-term liabilities. For example,
if a company is purchasing stock (asset) that will remain in the company for just a short
period of time before the product is sold, the company should need only a short-term
loan (liability) to fund the purchase of the stock. An example of a short-term loan that can
be used for this purpose is an overdraft facility (see Chapter 9).
