Types of Financial Instrument

1. Cash Instruments

Cash instruments are financial instruments with values directly influenced by the condition of the markets. Within cash instruments, there are two types; securities and deposits, and loans.

Securities: A security is a financial instrument that has monetary value and is traded on the stock market. When purchased or traded, a security represents ownership of a part of a publicly-traded company on the stock exchange.

Deposits and Loans: Both deposits and loans are considered cash instruments because they represent monetary assets that have some sort of contractual agreement between parties.

2. Derivative Instruments

Derivative instruments are financial instruments that have values determined from underlying assets, such as resources, currency, bonds, stocks, and stock indexes.

The five most common examples of derivatives instruments are synthetic agreements, forwards, futures, options, and swaps. This is discussed in more detail below.

Synthetic Agreement for Foreign Exchange (SAFE): A SAFE occurs in the over-the-counter (OTC) market and is an agreement that guarantees a specified exchange rate during an agreed period of time.

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Forward: A forward is a contract between two parties that involves customizable derivatives in which the exchange occurs at the end of the contract at a specific price.

Future: A future is a derivative transaction that provides the exchange of derivatives on a determined future date at a predetermined exchange rate.

Options: An option is an agreement between two parties in which the seller grants the buyer the right to purchase or sell a certain number of derivatives at a predetermined price for a specific period of time.

Interest Rate Swap: An interest rate swap is a derivative agreement between two parties that involves the swapping of interest rates where each party agrees to pay other interest rates on their loans in different currencies.

3. Foreign Exchange Instruments

Foreign exchange instruments are financial instruments that are represented on the foreign market and primarily consist of currency agreements and derivatives.

In terms of currency agreements, they can be broken into three categories.

Spot: A currency agreement in which the actual exchange of currency is no later than the second working day after the original date of the agreement. It is termed “spot” because the currency exchange is done “on the spot” (limited timeframe).

Outright Forwards: A currency agreement in which the actual exchange of currency is done “forwardly” and before the actual date of the agreed requirement. It is beneficial in cases of fluctuating exchange rates that change often.

Currency Swap: A currency swap refers to the act of simultaneously buying and selling currencies with different specified value dates.

How SBLC works

The process of obtaining an SBLC is similar to a loan application process. The process starts when the buyer applies for an SBLC at a commercial bank. The bank will perform its due diligence on the buyer to assess its creditworthiness, based on past credit history and the most recent credit report. If the buyer’s creditworthiness is in question, the bank may require the buyer to provide an asset or the funds on deposit as collateral before approval.

​The level of collateral will depend on the risk involved, the strength of the business, and the amount secured by the SBLC. The buyer will also be required to furnish the bank with information about the seller, shipping documents required for payment, the beneficiary’s bank, and the period when the SBLC is valid.

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After review of the documentation, the commercial bank will provide an SBLC to the buyer. The bank will charge a service fee of 1% to 10% for each year when the financial instrument remains valid. If the buyer meets its obligations in the contract before the due date, the bank will terminate the SBLC without a further charge to the buyer.

If the buyer fails to meet the terms of the contract due to various reasons, such as bankruptcy, cash flow crunch, dishonesty, etc., the seller is required to present all the required documentation listed in the SBLC to the buyer’s bank within a specified period, and the bank will make the payment due to the seller’s bank.