555. The portfolio investment component of the financial account covers transactions in equities, other securities, and financial derivatives—except when these transactions relate to the direct investment or reserve assets components of the financial account. Both short- and long-term instruments are covered under portfolio investment. The essential characteristic of instruments classified as portfolio investment is that such instruments are traded or tradable. That is, the instruments offer investors the flexibility to shift, regardless of the underlying maturity of the instrument, invested capital from one instrument to another. Portfolio investors are more concerned than direct investors about rates of return that are independent of any influence investors may have and about being able to move funds quickly if circumstances so dictate.
556. Portfolio investment transactions are classified as those involving an economy’s financial assets and those involving an economy’s financial liabilities. Within these asset and liability classifications, portfolio investment transactions are classified by type of instrument. Four types of instruments are included in the BOP standard components: (1) equities, (2) bonds and notes, (3) money market instruments, and (4) financial derivatives. Transactions recorded in these categories are subsequently discussed in more detail. Within each instrument category, classification of transactions by resident sector is recommended in the BPM.
Equity
557. Equity securities are instruments acknowledging the holder’s claim to the residual value or residual income of the issuing enterprise after the claims of all other creditors have been met. Shares or similar documents (such as American Depositary Receipts) usually denote ownership of equity. Preferred stock or shares that provide for participation in the distribution of residual earnings or in the residual value upon liquidation are included as equity. However, preference shares are not considered equity when the specified return and fixed value at maturity to which the holder is entitled are both independent of the underlying profitability of the issuing enterprise. Instead, transactions in these instruments should be classified as bonds and notes.21
558. Regardless of the types of investment made by the trust or fund, the ownership of trusts, mutual funds, and other similar investments also represents equity investment. For example, if a resident of Clintonstan invests in a cash management trust in Coonawarra, which in turn invests only in debt securities issued by the government of Nostaw, Clintonstan’s balance of payments would reflect an equity investment. Coonawarra’s balance of payments would reflect an equity liability and a debt asset, while Nostaw’s balance of payments would show a debt liability.
559. The ownership of life insurance policies or similar claims on commercially operated pension funds is also considered equity investment as these claims generally entitle the holder to the residual income of the life insurance or pension fund. However, as these insurance policies are typically not tradable, such policies are not considered portfolio investments. Instead, transactions in these instruments are classified as other assets or other liabilities under other investment.
Bonds and Notes
560. In the BOP standard components, the category for bonds and notes includes debt securities with original contractual maturities of more than one year (long-term). Generally, the portfolio investment instruments classified in this category are debt securities that give the holder the unconditional right to a fixed money income or to a contractually determined variable money income that is not dependent on the earnings of the issuer. However, some securities with this characteristic should be classified as money market instruments if the securities are issued with maturities of one year or less (short-term). Similarly, some debt securities with characteristics similar to money market instruments (which are discussed subsequently) should be classified as bonds and notes if the securities are issued with long-term maturities.
561. Apart from bonds and notes, other securities—if issued with maturities of more than one year—recorded in this classification are debentures; nonparticipating preference shares; convertible bonds; perpetual bonds; negotiable certificates of deposit; collateralized mortgage obligations; dual currency, zero coupon, and other deep discounted bonds; floating rate bonds; and index-linked bonds.
562. Perpetual bonds are bonds that never mature. That is, such a bond theoretically provides the holder with an infinite stream of income payments. In a number of countries, perpetual bonds are classified as second-tier equity in the balance sheets of the issuing enterprises. Nevertheless, as the income payable on these bonds is typically independent of the earnings of the issuing enterprise, perpetual bonds are classified as bonds and notes, rather than equity, in the balance of payments.
563. Collateralized mortgage obligations and other asset-backed securities are instruments that specifically relate to an asset or group of assets held by the issuing enterprise. For example, a bank might issue securities based on mortgage loans made by the bank to households. The income that the bank earns from lending activities is used to pay interest on the securities and the mortgages are used as collateral for the securities. The holder of the asset-backed security does not own the asset backing the security; the collateral provided with the security is contingent. Securities based on mortgage obligations are favored by lending institutions as it is possible with such securities to match the maturity of an enterprise’s assets (its mortgages) with the maturity of its liabilities (the securities). There are other types of asset-backed securities that enable the issuing enterprise to have access to cash before the related assets mature.
564. Index-linked securities are instruments for which coupon payments or principal amounts payable at maturity are linked to a commodity price index, an exchange rate index, or some other index. Such securities are often used to conserve the purchasing power of an investment during periods of inflation.
565. Transactions recorded in the balance of payments for bonds and notes are those relating to issues, redemptions, purchases, sales, and the offset to interest accrued but not due for payment. With regard to the accrual of interest, the financial transaction represents the offset to the income entry recorded in the current account. This accrual of interest is likely to be most significant for zero coupon and other deep discounted bonds and for index-linked securities for which repayments of principal at maturity are linked to specific indexes. For discounted bonds, the amount of interest accrued in a particular period is based on prevailing interest rates and adjusted for any coupon payments made during the period. (However, the issuer of the security will often accrue interest on the basis of the interest rate prevailing at the time the security was issued.) For index-linked securities, the interest accrued in a particular period is based on the movement that occurs in the underlying index during that period. Chapter 6 provides further elaboration, including examples of the recording of accrued interest on securities. The issue price is recorded as the value of a transaction at the time the security is issued and the redemption price is recorded as the value of a transaction at the time of maturity.
566. Bonds, notes, and similar instruments—with the exception of perpetual bonds—entitle the holder to the right to a specified amount at redemption. This amount is generally, but not necessarily, paid in cash. Some bonds convert to other instruments, such as equity, upon redemption. Until such a conversion occurs, these instruments are treated as bonds, not equity, in the balance of payments. At conversion, the withdrawal of investment in bonds and the offsetting increased investment in equity are recorded in the balance of payments. The withdrawal in bonds is valued at the current market value of the equity acquired.
Money Market Instruments
567. Money market instruments are debt securities issued with maturities of one year or less. These short-term instruments generally give holders the unconditional rights to receive stated amounts on maturity. Money market instruments are usually issued and traded in organized markets at discounts to redemption values. It is the discounts, rather than coupon payments of interest, that provide holders of these instruments with income on their investments. However, instruments that share the characteristics of money market instruments but are issued with maturities of more than one year are classified as bonds and notes. Short-term tradable instruments that provide investors with returns by means of coupon payments, rather than discounts, are treated as money market instruments.
568. Types of instruments generally classified as money market instruments include treasury bills, commercial paper, bankers’ acceptances, short-term negotiable certificates of deposit, and short-term notes issued under note issuance facilities (NIFs)—even though these facilities are typically long-term in nature. Entries are recorded in the BOP financial account for (1) transactions relating to the issue, purchase and sale, and redemption of money market instruments and (2) offsets to interest income accrued but not due for payment on these instruments.22 However, “purchases” and “sales” of money market instruments under repurchase (repo) agreements should not be recorded as transactions in money market instruments. These agreements represent collateralized borrowing and are recorded as part of other investment-loans in the financial account. Repurchase agreements are discussed in paragraph 597 of chapter 11.
569. A note issuance facility (NIF) is a form of revolving credit consisting of the periodic issuance of paper by an enterprise when the enterprise requires funds.23 NIFs are usually long-term agreements in which an enterprise (generally a bank) or a group of enterprises underwrites notes issued by another enterprise. The notes are generally short-term instruments. The underwriters purchase any of the notes that cannot be sold in the marketplace. For their services, the underwriters receive fees and, on any notes that they are required to purchase, the underwriters receive interest.
570. For BOP recording, the NIF itself is a contingent facility that does not generate any entries in the financial account. (However, any fees paid to the underwriters are recorded in the current account as financial services.) Only the actual issuance of notes and any subsequent trading and redemption of these notes are recorded as financial transactions in the balance of payments. Any notes purchased by underwriters are treated by underwriters as investments.
571. The following example illustrates the treatment of NIFs in the balance of payments. A bank in Coonawarra provides a three-year NIF for an enterprise resident in Clintonstan. The enterprise in Clintonstan pays the bank 100 units each year for providing the facility. In the first year, no notes are issued under the facility. At the beginning of the second year, 1000 three-month notes with face values of 100 units each are issued. Of these, 700 notes are sold to residents of Algornia, and the underwriting bank purchases the other 300 notes. The notes are issued for 95 units each and there are no coupon payments. At the end of the three months, the notes are rolled over. This time, all 1000 notes are sold, with the issue price remaining at 95 units, to residents of Algornia. After the end of the second three months, the notes are redeemed and no further notes are issued under the facility. The following entries are shown in Clintonstan’s balance of payments:
Entries for this item would normally be shown on a net basis in the balance of payments. Gross entries are shown in this example for illustrative purposes only.
| Year 1 | Credit | Debit | ||
|---|---|---|---|---|
| Financial services (Coonawarra) | 100 | |||
| Reserve assets (or other appropriate financial account item) | 100 | |||
| Year 2 | Credit | Debit | ||
| Financial services (Coonawarra) | 100 | |||
| Portfolio investment income-interest | ||||
| First set of notes (Coonawarra) | 1,500 | |||
| (Algornia) | 3,500 | |||
| Second set of notes (Algornia) | 5,000 | |||
| Portfolio investment-money market instruments* | ||||
| First set of notes (issue) | ||||
| Coonawarra | 28,500 | |||
| Algornia | 66,500 | |||
| First set of notes (accrual of interest) | ||||
| Coonawarra | 1,500 | |||
| Algornia | 3,500 | |||
| First set of notes (redemption) | ||||
| Coonawarra | 30,000 | |||
| Algornia | 70,000 | |||
| Second set of notes (issue) | ||||
| Algornia | 95,000 | |||
| Second set of notes (accrual of interest) | ||||
| Algornia | 5,000 | |||
| Second set of notes (redemption) | ||||
| Algornia | 100,000 | |||
| Reserve assets (or other appropriate financial account item) | ||||
| Fee | 100 | |||
| First set of notes (net) | 5,000 | |||
| Second set of notes (net) | 5,000 | |||
| Year 3 | Credit | Debit | ||
| Financial services (Coonawarra) | 100 | |||
| Reserve assets (or other appropriate financial account item) | 100 | |||
Entries for this item would normally be shown on a net basis in the balance of payments. Gross entries are shown in this example for illustrative purposes only.
| Year 1 | Credit | Debit | ||
|---|---|---|---|---|
| Financial services (Coonawarra) | 100 | |||
| Reserve assets (or other appropriate financial account item) | 100 | |||
| Year 2 | Credit | Debit | ||
| Financial services (Coonawarra) | 100 | |||
| Portfolio investment income-interest | ||||
| First set of notes (Coonawarra) | 1,500 | |||
| (Algornia) | 3,500 | |||
| Second set of notes (Algornia) | 5,000 | |||
| Portfolio investment-money market instruments* | ||||
| First set of notes (issue) | ||||
| Coonawarra | 28,500 | |||
| Algornia | 66,500 | |||
| First set of notes (accrual of interest) | ||||
| Coonawarra | 1,500 | |||
| Algornia | 3,500 | |||
| First set of notes (redemption) | ||||
| Coonawarra | 30,000 | |||
| Algornia | 70,000 | |||
| Second set of notes (issue) | ||||
| Algornia | 95,000 | |||
| Second set of notes (accrual of interest) | ||||
| Algornia | 5,000 | |||
| Second set of notes (redemption) | ||||
| Algornia | 100,000 | |||
| Reserve assets (or other appropriate financial account item) | ||||
| Fee | 100 | |||
| First set of notes (net) | 5,000 | |||
| Second set of notes (net) | 5,000 | |||
| Year 3 | Credit | Debit | ||
| Financial services (Coonawarra) | 100 | |||
| Reserve assets (or other appropriate financial account item) | 100 | |||
Entries for this item would normally be shown on a net basis in the balance of payments. Gross entries are shown in this example for illustrative purposes only.
The only entries in the first and third years relate to the fee payable to the bank in Coonawarra for arranging and underwriting the NIF facility. In the second year, the Coonawarra bank’s acquisition of notes that could not be sold to Algornia is shown as an investment by Coonawarra in Clintonstan. The interest income payable on the notes represents the difference between the issue price (95 units) and the amount payable on redemption (100 units). This accrued interest, which is part of the amount paid at redemption, is “reinvested” in the notes.
Option Terminology
Option Terminology
| Call option—an option that gives the holder the right, but not the obligation, to buy an underlying asset |
| Put option—an option that gives the holder the right, but not the obligation, to sell an underlying asset |
| Strike price—the price, stated in the option contract, at which transactions, if any, in the underlying asset take place |
| Expiration date—the final date for exercise of an option |
| European option—an option that can be exercised only on the expiration date |
| American option—an option that can be exercised at any time up to and including the expiration date |
| Writer—the party that issues the option; that is, the debtor |
| Premium—the initial cash paid |
| Margin—an amount paid by the writer to a broker or some other financial intermediary as security against the writer’s future obligations |
| In-the-money—an option that has a strike price that is less than the prevailing market price for the underlying asset |
| Out-of-the-money—an option that has a strike price that is greater than the prevailing market price for the underlying asset |
| Black-Scholes model—a mathematical formula used to value options |
Option Terminology
| Call option—an option that gives the holder the right, but not the obligation, to buy an underlying asset |
| Put option—an option that gives the holder the right, but not the obligation, to sell an underlying asset |
| Strike price—the price, stated in the option contract, at which transactions, if any, in the underlying asset take place |
| Expiration date—the final date for exercise of an option |
| European option—an option that can be exercised only on the expiration date |
| American option—an option that can be exercised at any time up to and including the expiration date |
| Writer—the party that issues the option; that is, the debtor |
| Premium—the initial cash paid |
| Margin—an amount paid by the writer to a broker or some other financial intermediary as security against the writer’s future obligations |
| In-the-money—an option that has a strike price that is less than the prevailing market price for the underlying asset |
| Out-of-the-money—an option that has a strike price that is greater than the prevailing market price for the underlying asset |
| Black-Scholes model—a mathematical formula used to value options |
Financial Derivatives
Options and Warrants
572. Options are financial instruments that provide one party (the holder) with the right, but not the obligation, to buy (call option) or sell (put option) a specified financial or real asset for a predetermined price (the strike price) from another party (the option writer).24 If the option holder exercises his or her right, then he or she is said to exercise the option. Exercise can take either of two forms: (1) actual delivery of the underlying asset for the strike price or (2) a cash settlement based on the difference between the prevailing market price of the underlying asset and the strike price. Table 10.1 provides an overview of the terminology associated with options, and table 10.2 shows factors that determine the values of options.
Factors Determining the Values of Options
Factors Determining the Values of Options
| Factor 1—the difference between the strike price (A) and the value of the underlying asset (B) For call options, if A > B, the bigger the difference, the less an option is worth. (An option can never have a negative value.) If B > A, the bigger the difference, the more an option is worth. For put options, the reverse is true. |
| Factor 2—the current interest rate The higher the interest rate, the less an option is worth. |
| Factor 3—the price volatility of the underlying asset The more volatile the price, the more an option is worth. |
| Factor 4—the time remaining to expiration The closer an option is to expiration, the less it is worth. |
Factors Determining the Values of Options
| Factor 1—the difference between the strike price (A) and the value of the underlying asset (B) For call options, if A > B, the bigger the difference, the less an option is worth. (An option can never have a negative value.) If B > A, the bigger the difference, the more an option is worth. For put options, the reverse is true. |
| Factor 2—the current interest rate The higher the interest rate, the less an option is worth. |
| Factor 3—the price volatility of the underlying asset The more volatile the price, the more an option is worth. |
| Factor 4—the time remaining to expiration The closer an option is to expiration, the less it is worth. |
573. If the option holder and option writer are residents of different countries, the creation and exercise of option contracts constitute transactions that are recorded in the BOP statements of the relevant countries. Also, the trading of options between residents of different countries results in BOP transactions for the countries concerned.
574. The following example illustrates the treatment of options in the balance of payments. A resident of Pokolbin writes a three-month call option on 10 shares in an enterprise located in Cromania; the strike price is $15 per share. The option is purchased from the writer by a resident of Coonawarra for $20. The following transactions would be recorded in the balance of payments of Pokolbin:
| Credit | Debit | ||
|---|---|---|---|
| Portfolio investment—liabilities | |||
| Financial derivatives | 20 | ||
| Reserve assets (or other appropriate financial account item) | 20 | ||
| Credit | Debit | ||
|---|---|---|---|
| Portfolio investment—liabilities | |||
| Financial derivatives | 20 | ||
| Reserve assets (or other appropriate financial account item) | 20 | ||
575. After three months, the price of shares in the enterprise in Cromania rises to $18 per share, and the option holder in Coonawarra decides to exercise the option. The resident of Coonawarra acquires ownership of 10 shares, with a market value of $180, in the enterprise located in Cromania. However, only $150 (10 x $15) is actually paid. The remaining $30 represents the extinguishment of the option contract at the time of exercise. The following transactions would be recorded in the balance of payments of Pokolbin:25
| Credit | Debit | ||
|---|---|---|---|
| Portfolio investment—assets | |||
| Equities | 180 | ||
| Portfolio investment—liabilities | |||
| Financial derivatives | 30 | ||
| Reserve assets (or other appropriate financial account item) | 150 | ||
| Credit | Debit | ||
|---|---|---|---|
| Portfolio investment—assets | |||
| Equities | 180 | ||
| Portfolio investment—liabilities | |||
| Financial derivatives | 30 | ||
| Reserve assets (or other appropriate financial account item) | 150 | ||
In this example, the underlying asset is delivered when the option is exercised. However, the option holder in Coonawarra could, instead, have accepted a cash settlement of $30, in which case the following entries would be recorded in the balance of payments of Pokolbin:
| Credit | Debit | ||
|---|---|---|---|
| Portfolio investment—liabilities | |||
| Financial derivatives | 30 | ||
| Reserve assets (or other appropriate financial account item) | 30 | ||
| Credit | Debit | ||
|---|---|---|---|
| Portfolio investment—liabilities | |||
| Financial derivatives | 30 | ||
| Reserve assets (or other appropriate financial account item) | 30 | ||
576. Table 10.3 shows the common transactions and how such transactions are recorded, in association with options, in the balance of payments.
Common Transactions Associated with Options
Common Transactions Associated with Options
| Issue of an option— In the balance of payments of the option writer’s country, credit portfolio investment-liabilities-options and debit the financial instrument (e.g., currency) acquired in exchange. In the balance of payments of the option holder’s country, debit portfolio investment-assets-options and credit the financial instrument (e.g., currency) provided in exchange. |
| Sale of option from one holder to another—In the balance of payments of the option seller’s country, credit portfolio investment-assets-options and debit the financial instrument (e.g., currency) acquired in exchange. In the balance of payments of the option buyer’s country, debit portfolio investment-assets-options and credit the financial instrument (e.g., currency) provided in exchange. |
| Exercise of a call option; delivery of underlying asset—In the balance of payments of the option writer’s country, debit (1) portfolio investment- liabilities-options (at a value representing the difference between the strike price and the prevailing market price of the underlying asset) and (2) the financial instrument (e.g., currency) acquired; credit the underlying asset that is given up (at a value representing the prevailing market price for that asset). In the balance of payments of the option holder’s country, credit (1) portfolio investment-assets-options (at a value representing the difference between the strike price and the prevailing market price of the underlying asset) and (2) the financial instrument (e.g., currency) provided; debit the underlying asset received (at a value representing the prevailing market price for that asset). |
| Exercise of a put option; delivery of underlying asset—In the balance of payments of the option writer’s country, debit (1) portfolio investment- liabilities-options (at a value representing the difference between the strike price and the prevailing market price of the underlying asset) and (2) the underlying asset received (at a value representing the prevailing market price for that asset); credit the financial instrument provided in exchange. In the balance of payments of the option holder’s country, credit (1) portfolio investment-assets-options (valued as the difference between the strike price and the prevailing market price of the underlying asset) and the underlying asset sold (valued at the prevailing market price for that asset); debit the financial instrument received in exchange. |
| Exercise of an option; settlement in cash—In the balance of payments of the option writer’s country, debit portfolio investment-liabilities-options and credit the financial instrument (e.g., currency) paid to the holder. In the balance of payments of the option holder’s country, credit portfolio investment-assets-options and debit the financial instrument (e.g., currency) received from the option writer. |
| Option expires without being exercised—No BOP transactions are recorded. |
Common Transactions Associated with Options
| Issue of an option— In the balance of payments of the option writer’s country, credit portfolio investment-liabilities-options and debit the financial instrument (e.g., currency) acquired in exchange. In the balance of payments of the option holder’s country, debit portfolio investment-assets-options and credit the financial instrument (e.g., currency) provided in exchange. |
| Sale of option from one holder to another—In the balance of payments of the option seller’s country, credit portfolio investment-assets-options and debit the financial instrument (e.g., currency) acquired in exchange. In the balance of payments of the option buyer’s country, debit portfolio investment-assets-options and credit the financial instrument (e.g., currency) provided in exchange. |
| Exercise of a call option; delivery of underlying asset—In the balance of payments of the option writer’s country, debit (1) portfolio investment- liabilities-options (at a value representing the difference between the strike price and the prevailing market price of the underlying asset) and (2) the financial instrument (e.g., currency) acquired; credit the underlying asset that is given up (at a value representing the prevailing market price for that asset). In the balance of payments of the option holder’s country, credit (1) portfolio investment-assets-options (at a value representing the difference between the strike price and the prevailing market price of the underlying asset) and (2) the financial instrument (e.g., currency) provided; debit the underlying asset received (at a value representing the prevailing market price for that asset). |
| Exercise of a put option; delivery of underlying asset—In the balance of payments of the option writer’s country, debit (1) portfolio investment- liabilities-options (at a value representing the difference between the strike price and the prevailing market price of the underlying asset) and (2) the underlying asset received (at a value representing the prevailing market price for that asset); credit the financial instrument provided in exchange. In the balance of payments of the option holder’s country, credit (1) portfolio investment-assets-options (valued as the difference between the strike price and the prevailing market price of the underlying asset) and the underlying asset sold (valued at the prevailing market price for that asset); debit the financial instrument received in exchange. |
| Exercise of an option; settlement in cash—In the balance of payments of the option writer’s country, debit portfolio investment-liabilities-options and credit the financial instrument (e.g., currency) paid to the holder. In the balance of payments of the option holder’s country, credit portfolio investment-assets-options and debit the financial instrument (e.g., currency) received from the option writer. |
| Option expires without being exercised—No BOP transactions are recorded. |
577. An international transactions reporting system (ITRS) or enterprise surveys (ES) could be used to collect, for the balance of payments, information on transactions involving options. However, if an ITRS is used, particular care should be taken to ensure correct recording of transactions that result in delivery of the underlying asset. Unless supplementary information is sought, an ITRS respondent would probably (1) record the transaction in the underlying asset at the option strike price rather than at the market value at the time of transaction and (2) fail to record the extinguishment of the option contract.
Other Derivatives
578. Derivatives other than options typically involve contracts in which two parties agree to exchange specified assets, either real or financial, at some future point or points in time. Such contracts are either (1) tradable or (2) settled, on a net basis, for cash rather than an actual exchange of the underlying assets. Such derivatives are considered financial instruments and include forward foreign exchange contracts, futures, and currency swaps. If transactions in these instruments involve residents of different countries, the transactions are recorded in the BOP financial account.26 Transactions that are recorded in relation to derivative instruments include any trading in the contracts and the net value of settlements made. It may also be necessary to record transactions associated with the establishment of derivative contracts. Frequently, however, two parties will enter into a derivative contract but neither will make any payment to the other. In these cases, the value of the transaction establishing the contract is nil, and no entry is actually required in the balance of payments.
579. Fees paid to financial intermediaries (such as banks and brokers) to establish derivative contracts do not represent transactions in derivatives per se. These fees are classified as financial services and recorded in the services component of the current account. Likewise, margin payments provided by one party to another as security against future obligations do not represent transactions in derivatives. These margin payments are reflected in the currency and deposits item in the other investment component of the financial account.
580. Two more examples provide illustration of the treatment of derivatives in the balance of payments. A resident of Namdarb purchases a tradable futures contract from a broker in Clintonstan for 100 units and pays brokerage fees of 12 units. The resident of Namdarb is also asked to make a margin payment of 250 units to the broker as security against adverse market movements. The following transactions are recorded in the balance of payments of Namdarb:
| Credit | Debit | |||
|---|---|---|---|---|
| Current account | ||||
| Financial services | 12 | |||
| Financial account | ||||
| Portfolio investment—liabilities | ||||
| Financial derivatives | 100 | |||
| Other investment—assets | ||||
| Currency and deposits | 362 | 250 | ||
| Credit | Debit | |||
|---|---|---|---|---|
| Current account | ||||
| Financial services | 12 | |||
| Financial account | ||||
| Portfolio investment—liabilities | ||||
| Financial derivatives | 100 | |||
| Other investment—assets | ||||
| Currency and deposits | 362 | 250 | ||
581. When the futures contract expires after three months, the market has moved against the resident of Namdarb, and he is required to pay 180 units as settlement. This settlement is deducted from the margin payment previously made, and the balance of 70 units is returned to the resident of Namdarb. The following transactions are recorded in the balance of payments of Namdarb:
| Credit | Debit | |||
|---|---|---|---|---|
| Financial account | ||||
| Portfolio investment—assets | ||||
| Financial derivatives | 180 | |||
| Other investment—assets | ||||
| Currency and deposits | 250 | 70 | ||
| Credit | Debit | |||
|---|---|---|---|---|
| Financial account | ||||
| Portfolio investment—assets | ||||
| Financial derivatives | 180 | |||
| Other investment—assets | ||||
| Currency and deposits | 250 | 70 | ||
In this example, the financial derivative contract has “flipped”—as a result of adverse market movements—from being an asset to being a liability for the resident of Namdarb. Such “flipping” can occur with derivative contracts other than options. Movements in prices of underlying assets cause such movements in value and are reflected in the price change component of the reconciliation statement between stocks and flows.
582. In the second example, an enterprise in Daniherland enters into a currency swap with an enterprise in Hughesavia. No money changes hands at the start of the contract. In six months, because of favorable movements in exchange rates, the enterprise in Daniherland receives a net settlement of 80 units from the swap partner in Hughesavia. The following transactions are recorded in the balance of payments of Daniherland:
| Credit | Debit | |||
|---|---|---|---|---|
| Financial account | ||||
| Portfolio investment—assets | ||||
| Financial derivatives | 80 | |||
| Other investment—assets | ||||
| Currency and deposits | 80 | |||
| Credit | Debit | |||
|---|---|---|---|---|
| Financial account | ||||
| Portfolio investment—assets | ||||
| Financial derivatives | 80 | |||
| Other investment—assets | ||||
| Currency and deposits | 80 | |||
583. One or both parties to a derivative contract may enter into the contract to hedge against adverse movements in some other position. For example, an enterprise borrowing in U.S. dollars but preferring liabilities in Japanese yen may enter into a currency swap in which the enterprise receives U.S. dollars for Japanese yen. In BOP recording, transactions in derivative contracts are recorded separately from any transactions involving the position being hedged. Otherwise, asymmetries could arise in the recording of BOP transactions, and distortions could occur in the analysis of BOP items. If compilers wish to provide users with information on the impact of hedges, such data could be shown in satellite tables.