FINANCIAL

INSTRUMENT
S
Marlyn T. Panganiban, LPT
Nature of Financial Instruments
Financial Instruments is any contract that gives rise to a financial asset of one entity and a financial liability or equity
instrument of another entity.

A financial instrument is a contract that represents the exchange of money or other assets between two or more parties.
Financial instruments can be used for various purposes, such as investing, borrowing, lending, hedging, or speculating.
There are many types of financial instruments, but they can be broadly classified into two categories: cash instruments
and derivative instruments.
Nature of Financial Instruments
Contracts-It is an agreement between two or more parties that has clear
economic consequences that the parties have little, if any, discretion to avoid,
usually because the agreement is enforceable by law.
Primary and derivative financial instruments are two types of financial instruments that have
different characteristics and functions. Here is a brief description of each type:
• Primary financial instruments are financial instruments whose price is based directly on
their market value. They can be any type of financial investment that is priced based on its
own value. Examples of primary financial instruments include stocks, bonds, currencies,
and spot commodities. They are also called cash instruments or underlying instruments.
• Derivative financial instruments are financial instruments whose price is derived from the
performance of an underlying asset, index, rate, or contract. They can be used to hedge
against risks, create leverage, or profit from price movements. Examples of derivative
financial instruments include options, futures, forwards, and swaps. They are also called
derivatives or contingent instruments.
What are FINANCIAL INSTRUMENTS

• Financial assets
• Financial liabilities
• Equity instruments
• Derivatives
FINANCIAL ASSETS
Financial assets are liquid assets that represent a claim of ownership or contractual rights to future cash
flows or underlying assets. They can be used for various purposes, such as investing, borrowing, lending,
hedging, or speculating.
There are many types of financial assets, but they can be broadly classified into two categories:
cash instruments and derivative instruments.
• Cash instruments
are financial assets whose value is determined directly by the marke
t. They can be easily traded or transferred between parties. Example
s of cash instruments are stocks, bonds, mutual funds, certificates of
deposit, and bank deposits
.

• Derivative instruments are financial assets whose value is derived

from the performance of an underlying asset, index, rate, or
contract. They can be used to hedge against risks, create leverage,
or profit from price movements.
Examples of derivative instruments are futures, options, swaps, and
contracts for difference
.
Cash on Hand in Banks
• Petty cash
• Demand, savings, and time deposits.
• Undeposited checks
• Foreign currencies
• Money orders
• Bank drafts.
• Cash on hand in banks is the amount of
money that a bank has in its vaults and ATMs.
It is also known as vault cash or till money.
Cash on hand in banks is used to meet the de
mand for withdrawals by customers and to co
mply with the reserve requirements set by the
central bank
.
• Petty cash is a small amount of money that a
business keeps on hand to pay for minor expenses,
such as postage, office supplies, or snacks. Petty
cash is usually stored in a locked box and
replenished periodically from the main bank
account.
Petty cash transactions are recorded in a petty cas
h book or a petty cash voucher
.
• Demand deposits are bank accounts that allow you to
withdraw money at any time, without penalty or
notice. They are also called checking accounts, current
accounts, or transaction accounts. They are used for
everyday spending, paying bills, or receiving income.
They usually have low or no interest rates but may ha
ve fees or minimum balance requirements
.
• Savings deposits are bank accounts that allow you to
save money and earn interest. They are also called
savings accounts or passbook accounts. They have
some restrictions on the number and frequency of
withdrawals, but they are still accessible on demand.
They usually have higher interest rates than demand
deposits, but lower than time deposits.
They may also have fees or minimum balance requirem
ents
.
• Time deposits are bank accounts that require you to
deposit money for a fixed term and earn a fixed interest
rate. They are also called term deposits, certificates of
deposit (CDs), or fixed deposits. They have penalties
for early withdrawal, but they offer higher interest rates
than demand or savings deposits.
They are used for long-term savings or investments.
• Undeposited checks are checks that have been
received but not yet deposited in the bank.
They are reported as cash on hand in the balance sh
eet
.
• Foreign currencies are money in the form of notes
or coins issued by another country.
They are converted to the functional currency of the
entity at the exchange rate on the date of the transac
tion or the balance sheet date
.
• Money orders are prepaid certificates that can be
used to pay a specified amount to a third party. They
are issued by post offices, banks, or other authorized
agents.
They are similar to cashier’s checks, but usually hav
e a lower limit and a lower fee
.
• Bank drafts are orders to pay a specified amount to
a third party, drawn by one bank on another bank.
They are used for international payments or large
domestic transactions. They are similar to checks,
but have a higher degree of security and reliability.
Accounts, notes, and loans receivable and inves
tment in bonds and other debt instrument

• Trade receivables
• Promissory notes
• Bond certificates
• Accounts, notes, and loans receivable are financial assets that
represent the right to receive cash or other consideration from a
debtor. They are usually classified as current assets if they are
expected to be collected within one year or the operating cycle,
whichever is longer. They are measured at amortized cost using
the effective interest method, unless they are impaired or written
off.
They are subject to the credit loss standard, which requires an e
ntity to estimate expected credit losses over the lifetime of the r
eceivables
.
• Investment in bonds and other debt instruments are financial
assets that represent the right to receive principal and interest
payments from an issuer. They are usually classified as either
held-to-maturity, available-for-sale, or trading, depending on the
entity’s intent and ability to hold them. They are measured at
amortized cost, fair value, or fair value with changes in income,
depending on their classification.
They are also subject to the credit loss standard, which requires
an entity to estimate expected credit losses over the contractual t
erm of the debt instruments
.
***Trade receivables, promissory notes, and bond certificates
are examples of financial assets that represent the right to receive
cash or other consideration from a debtor or an issuer. They are
usually classified as current assets or non-current assets,
depending on their maturity date. They are measured at
amortized cost using the effective interest method, unless they
are impaired or written off.
They are subject to the credit loss standard, which requires an en
tity to estimate expected credit losses over the lifetime of the ass
ets
.
• Trade receivables are amounts owed by customers for
goods or services sold in the ordinary course of
business. They are usually collected within a short
period of time, such as 30 to 90 days.
They are also called accounts receivable or trade debt
ors
.
• Promissory notes are written promises to pay a
specified amount of money at a specified date or on
demand. They are usually issued by borrowers to
lenders as a form of debt financing. They may bear
interest or be discounted.
They are also called notes receivable or notes payable.
• Bond certificates are documents that evidence the
ownership of a bond, which is a debt instrument that
pays a fixed or variable rate of interest and returns the
principal amount at maturity. They are usually issued
by governments, corporations, or municipalities to
raise funds for various purposes. They may have
different features, such as callable, convertible, or
zero-coupon.
• Bond certificates are documents that evidence the
ownership of a bond, which is a debt instrument that
pays a fixed or variable rate of interest and returns the
principal amount at maturity. They are usually issued
by governments, corporations, or municipalities to
raise funds for various purposes. They may have
different features, such as callable, convertible, or
zero-coupon.
Interest in shares or other equity instr
uments issued by other entities.

• Stock certificates.
• Publicly listed securities
Interest in shares or other equity instruments issued by other entities
means an investment that gives the investor a claim on the assets or
profits of the issuer, as well as voting rights or other benefits. Equity
instruments are financial instruments that represent ownership or a
residual interest in another entity.
-An entity that has an interest in shares or other equity instruments
issued by other entities must disclose information about the nature,
extent, and risks of its involvement with those entities, as well as the
effects of those interests on its financial position, performance, and
cash flows.
Stock certificates and publicly listed securities are both examples of
financial instruments that represent ownership or a claim on the assets or
profits of an issuer. However, they have some differences in their features
and functions. Here is a brief comparison of the two:
• Stock certificates are physical pieces of paper that certify a
shareholder’s ownership of a company. They include information such
as the number of shares owned, the date of purchase, an identification
number, a corporate seal, and signatures. They are usually issued by
private companies or by public companies that have not adopted
electronic record-keeping.
They are becoming rare and obsolete in the modern era of online tradin
g and book-entry form
.
Publicly listed securities are financial instruments that are traded on a
public stock exchange, such as the New York Stock Exchange (NYSE) or
the Nasdaq. They include stocks, bonds, exchange-traded funds (ETFs), and
other securities that are registered with the Securities and Exchange
Commission (SEC) and meet the listing requirements of the exchange.
They are recorded electronically and can be easily bought and sold by inves
tors through brokers or online platforms
Derivative Financial Assets

• Futures contracts
• Forward contracts
• Call options.
• Foreign currencies futures
• Interest rate swaps
Derivative financial assets are financial instruments that
derive their value from the performance of an
underlying asset, index, rate, or contract. They can be
used to hedge against risks, create leverage, or profit
from price movements.
• Futures contracts are derivative financial assets that
require the holder of the contract to buy or sell the
respective underlying asset at an agreed price on a
specific date. The parties involved in a futures contract
not only possess the right but also are under the
obligation to carry out the contract as agreed.
Futures contracts are traded on the exchange market and
as such, they tend to be highly liquid, intermediated and
regulated by the exchange
.
Forward contracts are derivative financial assets that require
the holder of the contract to buy or sell the respective
underlying asset at an agreed price on a specific date.
However, forwards contracts are over-the-counter products,
which means they are not regulated and are not bound by
specific trading rules and regulations.
Since such contracts are unstandardized, they are customizable
to suit the requirements of both parties involved
.
Call options are derivative financial assets that give the buyer
the right, but not the obligation, to buy an underlying asset at a
specified price and date. The seller, or writer, of the option
receives a premium for granting this right.
Options can be classified into call options and put options, dep
ending on whether the buyer has the right to buy or sell the und
erlying asset
.
Foreign currencies futures are derivative financial assets that
require the holder of the contract to buy or sell a specified
amount of one currency for another at a predetermined
exchange rate on a specific date.
They are used to hedge against currency risk or to speculate on
currency movements
.
• Interest rate swaps are derivative financial assets that
involve the exchange of fixed and floating interest
payments between two parties, based on a notional
principal amount.
They are used to hedge against interest rate risk or to gain
exposure to different interest rate environments
.
 FINANCIAL
LIABILITIES
Financial liabilities are obligations or debts that an entity owes to
external parties, often involving the repayment of funds or
providing goods or services in the future.
They include loans, bonds, accounts payable, and other contractual
obligations that result in a future cash outflow
.
Financial liabilities are classified into two broad types based on the time period within
which they become payable. These are:
• Current liabilities: These are liabilities that are due within one year or the operating
cycle, whichever is longer.
They are usually related to the normal operations of the entity, such as trade payable
s, accrued expenses, short-term loans, and current portion of long-term debt
.
• Non-current liabilities: These are liabilities that are due after one year or the
operating cycle, whichever is longer.
They are usually related to the long-term financing of the entity, such as long-term lo
ans, bonds, leases, and deferred taxes
.
• Financial liabilities are measured at amortized cost using the effective
interest method, unless they are designated as fair value through profit or
loss (FVTPL) or fair value through other comprehensive income
(FVTOCI). These are two alternative measurement methods that reflect
the changes in the fair value of the liabilities in the income statement or
the statement of comprehensive income.
 • Obligations to deliver own shares worth a fixed amount of cash.

***Obligations to deliver own shares worth a fixed amount of cash are contracts that
require an entity to transfer a fixed number of its own equity instruments to another party
for a specified amount of money.
They are also known as written call options on own shares1.
These contracts are classified as financial liabilities under Financial Instruments: Presenta
tion, because they represent an obligation to deliver cash or another financial asset to anot
her entity
. They are measured at fair value, with changes in fair value recognized in profit or loss.
 • Obligations to deliver own shares worth a fixed amount of cash.

An example of such a contract is a derivative that requires an entity to deliver 100 own sh
ares for a fixed amount of cash subject to an adjustment that will occur in the event of dil
ution so that the holder receives shares worth at least CU100 in all circumstances4
. This contract is a financial liability because the entity has to pay a fixed amount of cash
regardless of the value of its own shares.
 • Some derivatives on own equity instruments
Some derivatives on own equity instruments are financial instruments that derive their value from the
performance of the entity’s own shares or other equity instruments. They can be used to hedge again
st risks, create leverage, or profit from price movements
.

Here are some examples of derivatives on own equity instruments:

• A call option on own shares is a contract that gives the buyer the right, but not the
obligation, to buy a fixed number of the entity’s own shares at a specified price and date.
The seller, or writer, of the option receives a premium for granting this right.
The buyer profits if the share price rises above the strike price, while the seller profits if th
e share price stays below the strike price or the option expires worthless
.
Company: XYZ Corp
Example: Call Option on Own Shares
• Initiation of Call Option:
⚬ XYZ Corp, a publicly traded company, is currently trading at $50 per
share.
⚬ The company believes that its share price will increase in the next three
months and wants to provide an incentive to its employees. To do this,
it decides to issue call options on its own shares.
• Issuance of Call Option Contracts:
⚬ XYZ Corp issues call options with a strike price of $60 per share that
expire in three months.
⚬ Each call option contract gives the buyer the right (but not the
obligation) to purchase 100 shares of XYZ Corp at $60 per share
within the next three months.
• Premium and Obligation:
⚬ Investors interested in participating in this call option need to pay a premium to
XYZ Corp for the option contract.
⚬ XYZ Corp, as the writer (seller) of the call option, receives the premium, and
in return, it assumes the obligation to sell its own shares at the agreed-upon
strike price if the option is exercised.
• Possible Outcomes:
⚬ If, after three months, the share price of XYZ Corp rises above $60, the buyer
of the call option will likely exercise the option. They can buy shares from
XYZ Corp at $60, even though the market price may be higher. The buyer
profits from the difference.
⚬ If the share price stays below $60 or the option expires without being
exercised, the seller (XYZ Corp) keeps the premium received, and the option
expires worthless for the buyer.
 • Impact on Profits:
• Buyer's Perspective: The buyer profits if the market price exceeds the strike price by more
than the premium paid.
• Seller's Perspective (XYZ Corp): XYZ Corp profits by receiving the premium, even if the
share price doesn't rise above the strike price.

***This example illustrates how a company can issue call options on its own shares as a way
to incentivize employees or raise capital while also providing potential benefits to investors
who believe in the company's future growth. However, it also highlights the risks for both
parties involved, depending on the movement of the share price.
2. A futures contract on own shares is a contract that requires the holder of the
contract to buy or sell a fixed number of the entity’s own shares at an agreed price
on a specific date. The parties involved in a futures contract not only possess the
right but also are under the obligation to carry out the contract as agreed.
The holder profits if the share price moves in the direction of the contract, while t
he counterparty profits if the share price moves in the opposite direction
Hedging Scenario:
Suppose a company, ABC Corp, is engaged in the production and sale of electronic goods. The company
is concerned about the volatility in the prices of key raw materials, such as copper, which is a crucial
component in its products. To manage the risk of price fluctuations, ABC Corp decides to enter into a
futures contract to hedge against potential increases in the price of copper.
• Initiation of the Futures Contract:
⚬ ABC Corp enters into a futures contract to buy a specified quantity of copper at a future date
(let's say three months from now) at a predetermined price.
⚬ This contract is considered a financial derivative, specifically a financial liability for ABC Corp
because it obligates the company to make a future payment (the purchase of copper) at the
agreed-upon price.
• Recording the Financial Liability:
⚬ At the initiation of the contract, ABC Corp records a financial liability on its balance sheet. The
liability represents the obligation to pay for the copper at the agreed-upon price in the future.
• Changes in the Market Price:
⚬ Over the next three months, the market price of copper fluctuates.
⚬ If the market price increases beyond the agreed-upon futures price, ABC Corp is protected because
it can buy copper at the lower futures price. In this case, the financial liability on the balance sheet
remains at the predetermined contract price.
• Settlement of the Futures Contract:
⚬ When the contract reaches maturity, ABC Corp is required to settle the futures contract by
purchasing the specified quantity of copper at the predetermined price, regardless of the current
market price.
 • Impact on Financial Statements:
• The financial liability on the balance sheet is adjusted to reflect the actual cost of
purchasing the copper.
• Any gain or loss resulting from the difference between the agreed-upon futures price and
the actual market price is recognized in the income statement.

***In this example, the financial liability associated with the futures contract serves as a risk
management tool for ABC Corp, helping the company mitigate the impact of adverse price
movements in the commodities market.
3. A forward contract on own shares is a contract that requires the holder of the
contract to buy or sell a fixed number of the entity’s own shares at an agreed price
on a specific date. However, forwards contracts are over-the-counter products,
which means they are not regulated and are not bound by specific trading rules
and regulations. Since such contracts are unstandardized, they are customizable
to suit the requirements of both parties involved.
The holder profits if the share price moves in the direction of the contract, while t
he counterparty profits if the share price moves in the opposite direction
Scenario: Wheat Futures Contract
• Parties Involved:
⚬ Buyer (Long Position): A baker who uses wheat as a primary ingredient in bread production.
⚬ Seller (Short Position): A wheat farmer.
• Initiation of the Futures Contract:
⚬ The baker is concerned about the potential increase in the price of wheat, which could impact production
costs.
⚬ The wheat farmer, on the other hand, is uncertain about future market prices.
• Agreement Terms:
⚬ The baker and the wheat farmer enter into a futures contract for 1,000 bushels of wheat.
⚬ The agreed-upon futures price is $5 per bushel.
⚬ The delivery date is set for three months from the initiation of the contract.
• Execution and Margin Requirement:
⚬ The futures contract is executed through a commodity exchange.
⚬ Both parties are required to deposit an initial margin with the exchange to cover potential losses.
• Price Movement:
⚬ Over the next three months, the price of wheat in the open market fluctuates.
• Settlement of the Futures Contract:
⚬ On the delivery date, the futures contract is settled.
⚬ If the market price of wheat is now $6 per bushel, the farmer, who took the short position, incurs a
loss. The difference is paid by the farmer to the baker.
⚬ If the market price is $4 per bushel, the farmer makes a profit, and the baker pays the difference.
Purpose and Outcome:
⚬ Baker's Perspective (Long Position): The futures contract serves as a hedge against rising wheat prices. If
the market price increases, the baker is protected because they can buy wheat at the lower agreed-upon
futures price.
⚬ Farmer's Perspective (Short Position): The futures contract allows the farmer to lock in a selling price,
providing certainty and protection against potential price decreases.
• Role of Futures Market:
⚬ The futures market facilitates price discovery and risk management for both the baker and the farmer.
⚬ It provides a standardized platform for trading, ensuring transparency and liquidity.
In this example, the wheat futures contract helps both the buyer and the seller manage their respective price risks.
The futures market acts as a mechanism for these participants to hedge against adverse price movements,
providing stability and predictability in their businesses.
4. A swap on own shares is a contract that involves the exchange of cash flows or
other obligations between two parties, based on a predetermined formula. For
example, a share-for-share swap is a contract that involves the exchange of a fixed
number of the entity’s own shares for a fixed number of another entity’s shares.
The parties profit if the value of the shares they receive increases more than the v
alue of the shares they deliver
Scenario: Equity Swap as a Financial Liability
• Company: XYZ Inc.
⚬ XYZ Inc. is a publicly traded company with shares listed on a stock exchange.
• Objective:
⚬ XYZ Inc. wants to raise capital without issuing additional shares or taking on traditional
debt.
• Equity Swap Agreement:
⚬ XYZ Inc. enters into an equity swap agreement with a financial institution (Counterparty).
• Terms of the Equity Swap:
⚬ XYZ Inc. agrees to make periodic payments to the Counterparty based on the performance
of its own shares.
⚬ The Counterparty agrees to make payments to XYZ Inc. based on a predetermined fixed or
floating interest rate.
• Notional Amount and Payment Frequency:
⚬ The notional amount is determined, let's say $10 million, representing the value of XYZ
Inc.'s shares.
⚬ Payments are typically made semi-annually.
• Calculation of Payments:
⚬If the value of XYZ Inc.'s shares increases, the Counterparty pays XYZ Inc.
the difference.
⚬If the value of XYZ Inc.'s shares decreases, XYZ Inc. pays the Counterparty
the difference.
• Purpose and Outcome:
⚬For XYZ Inc.:
￭ XYZ Inc. receives a fixed or floating interest rate from the Counterparty,
providing a source of funding without diluting ownership through the
issuance of additional shares.
￭ If the value of its shares increases, XYZ Inc. benefits by receiving
payments from the Counterparty.
￭ If the value of its shares decreases, XYZ Inc. is obligated to make payments
to the Counterparty, but it still has access to the initial funding.
 ⚬ For the Counterparty:
￭ The Counterparty gains exposure to the performance of XYZ Inc.'s shares without owning the shares
outright.
￭ If the value of XYZ Inc.'s shares increases, the Counterparty pays XYZ Inc. the difference.
￭ If the value of XYZ Inc.'s shares decreases, the Counterparty receives payments from XYZ Inc.
• Risk Management:
⚬ XYZ Inc. can use an equity swap to manage its funding costs and exposure to fluctuations in its own stock
price.
⚬ The Counterparty takes on the risk associated with the performance of XYZ Inc.'s shares in exchange for
the potential returns.
***It's important to note that while equity swaps can provide financial flexibility and risk management benefits, they
also involve complex financial arrangements and carry their own set of risks. Companies engaging in such
transactions should carefully evaluate the terms and risks associated with equity swaps and seek appropriate financial
advice.
EQUITY INSTRUMENTS
• Ordinary Shares

• Preference Shares

• Warrants
• Equity instruments are financial instruments that represent ownership or a residual interest
in another entity. They include shares, warrants, options, and other securities that give the
holder the right to receive dividends, vote on corporate matters, and benefit from the
entity’s growth.
Equity instruments are issued by entities to raise capital, reward employees, or acquire othe
r businesses
.
• Equity instruments are classified as either financial assets or financial liabilities, depending
on the nature and terms of the contract. For example, a share issued by a company is an
equity instrument for the company, but a financial asset for the investor who buys it.
A written call option on own shares is an equity instrument for the buyer, but a financial lia
bility for the seller who has to deliver the shares if the option is exercised
.
• Equity instruments are measured at fair value, with changes in fair value
recognized in other comprehensive income or profit or loss, depending on the
classification and designation of the instrument. Equity instruments that are held
for trading or designated as fair value through profit or loss (FVTPL) are
measured at fair value, with changes in fair value recognized in profit or loss.
Equity instruments that are not held for trading and are designated as fair value thr
ough other comprehensive income (FVTOCI) are measured at fair value, with cha
nges in fair value recognized in other comprehensive income, except for dividend
s, which are recognized in profit or loss
.
***Ordinary shares, preference shares, and warrants are different
types of equity instruments that represent ownership or a claim on the
assets or profits of an issuer. They have different features and benefits
for the investors and the issuers.
• Ordinary shares, also known as common shares, are the most common type
of shares issued by companies. The shareholders have the right to receive
dividends, vote on corporate matters, and benefit from the company’s
growth. However, the dividends are not guaranteed and depend on the
company’s profitability.
Ordinary shares are also the last to be paid in case of insolvency.
Company: XYZ Inc.
• Issuance of Ordinary Shares:
⚬ XYZ Inc., a technology company, decides to raise capital by issuing ordinary shares.
⚬ It issues one million ordinary shares at a par value of $1 per share.
• Rights of Ordinary Shareholders:
⚬ Shareholders who purchase these ordinary shares become partial owners of XYZ Inc.
⚬ They have the right to receive dividends, participate in voting on corporate matters,
and benefit from the company's growth.
• Dividend Distribution:
⚬ XYZ Inc. has a profitable year and decides to distribute dividends to its shareholders.
⚬ The board of directors declares a dividend of $0.50 per share.
⚬ Shareholders who own 1,000 shares would receive $500 in dividends (1,000 shares *
$0.50).
• Voting Rights:
⚬ XYZ Inc. proposes a significant change in its business strategy, such as acquiring another
company.
⚬ Shareholders are given the opportunity to vote on this matter during the annual general meeting.
⚬ Each ordinary share typically carries one vote, so shareholders can exercise their voting rights
based on the number of shares they own.
• Company's Growth:
⚬ Over the years, XYZ Inc. experiences growth in its market share and revenue.
⚬ Shareholders benefit indirectly as the value of their ordinary shares may increase.
⚬ If the company's share price rises, shareholders can sell their shares in the secondary market at a
profit.
• Dividend Uncertainty:
⚬ However, in a challenging year where XYZ Inc. faces financial difficulties or reports losses, the
board of directors may decide not to declare dividends.
⚬ Ordinary shareholders are not guaranteed dividends; their distribution depends on the company's
profitability.
 • Insolvency Scenario:
⚬ Unfortunately, XYZ Inc. faces financial distress and is unable to meet its obligations.
⚬ In case of insolvency, ordinary shareholders are the last to be paid during the liquidation process.
⚬ Creditors, bondholders, and preferred shareholders have priority in receiving payments before
ordinary shareholders.

***Ordinary shares represent ownership in a company and provide shareholders with the right to receive
dividends, vote on corporate matters, and benefit from the company's growth. However, the receipt of
dividends is not guaranteed, and in the unfortunate event of insolvency, ordinary shareholders are the last
in line to receive any remaining assets after all other obligations are settled.
2.Preference shares, also known as preferred shares, are a type of share that gives
its holders the advantage of receiving dividends before ordinary shareholders.
Moreover, in the event of a company’s liquidation, preference shareholders have
a higher claim on assets than ordinary shareholders.
However, they typically do not have voting rights and their dividends are fixed an
d limited
.
Company: ABC Corporation
• Issuance of Preference Shares:
⚬ ABC Corporation, a manufacturing company, decides to raise additional capital by
issuing preference shares.
⚬ It issues 100,000 preference shares with a face value of $10 each.
• Preference in Dividend Distribution:
⚬ The preference shareholders of ABC Corporation have the advantage of receiving
dividends before ordinary shareholders.
⚬ The company declares a dividend of $2 per preference share.
⚬ If an investor owns 1,000 preference shares, they would receive $2,000 in dividends
before any dividends are distributed to ordinary shareholders.
• Fixed and Limited Dividends:
⚬ The dividends on preference shares are typically fixed and limited. In this example, let's
assume that the fixed dividend is $2 per share.
⚬ Unlike ordinary shareholders, who may receive variable dividends based on the
company's profitability, preference shareholders have a predetermined dividend
amount.
• Lack of Voting Rights:
⚬ABC Corporation decides to propose a major change in its management
structure during the annual general meeting.
⚬Preference shareholders, unlike ordinary shareholders, typically do not have
voting rights in such matters.
⚬They may not be able to vote on the proposed change, and their influence on
corporate decisions is limited.
• Liquidation Preference:
⚬Unfortunately, ABC Corporation faces financial difficulties and goes into
liquidation.
⚬In the event of liquidation, preference shareholders have a higher claim on the
company's assets compared to ordinary shareholders.
⚬They receive their capital back (the face value of the preference shares) before
any distribution is made to ordinary shareholders.
 • Higher Claim on Assets:
• If ABC Corporation's assets are not sufficient to cover the claims of all shareholders, preference
shareholders are prioritized over ordinary shareholders.
• They have a more secure position in the capital structure, providing a level of protection in case
of financial distress.

***In summary, preference shares provide certain advantages to shareholders, such as preferential
treatment in dividend distribution and a higher claim on assets in the event of liquidation. However,
these benefits come with trade-offs, as preference shareholders typically do not have voting rights, and
their dividends are fixed and limited. The example of ABC Corporation helps illustrate how preference
shares function in various scenarios.
3.Warrants are a type of security that gives the holder the right, but not the
obligation, to buy a certain number of ordinary shares at a predetermined price
and date. The issuer of the warrant receives a premium for granting this right.
The holder profits if the share price rises above the exercise price, while the issue
r profits if the share price stays below the exercise price or the warrant expires w
orthless.
Company: Tech Innovators Inc.
• Issuance of Warrants:
⚬ Tech Innovators Inc., a technology company, is planning to raise additional capital to fund its research and
development projects.
⚬ Instead of issuing more ordinary shares, the company decides to issue warrants.
• Terms of the Warrants:
⚬ Tech Innovators Inc. issues 1 million warrants, each granting the holder the right to buy one ordinary share of the
company at $50 per share.
⚬ The warrants have an expiration date set one year from the issuance date.
• Premium and Exercise Price:
⚬ The company receives a premium of $5 for each warrant sold.
⚬ Therefore, the holder pays $5 per warrant to obtain the right to buy a share at the predetermined exercise price of
$50.
• Holder's Profit Opportunity:
⚬ Assume an investor, Jane, purchases 1,000 warrants for a total premium of $5,000 ($5 per warrant * 1,000
warrants).
⚬ If, within the one-year period, Tech Innovators Inc.'s share price rises above $50, Jane can exercise her warrants and
buy shares at the lower exercise price.
⚬ Let's say the market price is $70 per share when she decides to exercise. Jane can buy shares at $50 each (the
exercise price), and immediately sell them at the market price, making a profit of $20 per share.
 • Issuer's Profit Scenario:
⚬ On the other hand, if the share price remains below $50 during the warrant's validity period or the
warrant expires without being exercised, the issuer (Tech Innovators Inc.) keeps the premium
received.
⚬ This provides the company with additional capital without diluting existing shareholders or
issuing more ordinary shares.
• Expiration and Worthlessness:
⚬ If, at the end of the one-year period, Jane chooses not to exercise the warrants because the share
price is below $50, the warrants expire worthless.
⚬ The issuer retains the premium received, and Jane does not realize a profit from exercising the
warrants.
***In this example, Tech Innovators Inc. uses warrants as a financial instrument to raise capital without
immediately diluting existing shareholders. Warrant holders, like Jane, have the opportunity to profit if
the share price rises above the exercise price. The issuer benefits by receiving a premium for granting this
right and retains the premium if the warrants are not exercised or if the share price remains below the
exercise price.
Importance of Financial Instruments
Financial instruments are important in financial markets because they enable
the efficient flow and transfer of capital among various participants, such as
individuals, businesses, and governments. Financial instruments provide
various benefits, such as:

• Capital raising: Financial instruments allow entities to raise funds for

various purposes, such as starting or expanding a business, investing in
projects, or paying off debts. For example, a company can issue shares
or bonds to the public to obtain capital from investors.
Importance of Financial Instruments
• Risk management: Financial instruments allow entities to hedge against
various risks, such as interest rate, currency, or commodity price fluctuations,
or default or credit risk. For example, a company can use derivatives, such as
futures, options, or swaps, to lock in a favorable rate or price, or to transfer the
risk to another party.

• Financial transactions: Financial instruments allow entities to facilitate

financial transactions, such as payments, settlements, clearing, or transfers.
For example, a company can use cash, cheques, or electronic transfers to pay
for goods or services, or to receive income or revenue.