Financial derivatives (F.34)

5.65 Definition:

The sub-category financial derivatives (F.34) consists of all transactions in financial derivatives (AF.34) that is financial assets based on or derived from a different underlying instrument. The underlying instrument is usually another financial asset, but may also be a commodity or an index.

5.66 Financial derivatives are also referred to as secondary instruments and since risk avoidance is frequently a motivation for their creation, they are also referred to as hedging instruments. Only those secondary instruments, which have a market value because they are tradable or can be offset on the market, are financial assets in the system and are classified in the sub-category AF.34 (see paragraph 5.05.).

5.67 Sub-category AF.34 includes:

1. options, tradable and over-the-counter (OTC). Options are contingent assets which give their holders the right, but not the obligation, to purchase from (in the case of a call option) or to sell to (in the case of a put option) the issuer of the option (the option writer) financial or non-financial assets (the underlying instrument) at a predetermined price (the strike price) within a given time span (American option) or on a given date (European option). The purchaser of the option pays a premium (the option price) for the commitment of the option writer to sell or to purchase the specified amount of the underlying asset or to provide, on demand of the purchaser, appropriate remuneration. By convention, that commitment is treated as a liability of the option writer because the option price represents the current cost to the option writer of buying out his contingent liability;
2. warrants. They are a form of tradable options, which give their holders the right to purchase from the issuer of the warrant (usually a corporation) a certain number of shares or bonds under specified conditions for a designated period of time. There are also currency warrants, the value of which is based on the amount of one currency required to purchase another currency at or before the expiration date of the warrant and cross-currency warrants tied to third currencies. By convention, the issuer of the warrant is considered to have incurred a liability representing the current cost of buying out the issuer's contingent liability;
3. futures, but only if they have a market value because they are tradable or can be offset. Futures are commitments to deliver, or to take delivery of, a specified quantity of a standard grade of a commodity, foreign exchange, or a security at a fixed price and for a specified delivery date or period. Futures may also be based on an index rather than a specific financial or non-financial asset;
4. swaps, but only if they have a market value because they are tradable or can be offset. Swaps are contractual arrangements between two parties who agree to exchange, over time and according to predetermined rules, streams of payment of the same amount of indebtedness. The most prevalent varieties are interest rate swaps, foreign exchange swaps and currency swaps (also named cross-currency interest swaps). Interest rate swaps involve an exchange of interest payments of different character, such as fixed rate for floating rate, two different floating rates, fixed rate in one currency and floating rate in another, etc. Foreign exchange swaps (including all forward contracts) are transactions in foreign currencies at a rate of exchange stated in advance. Currency swaps involve an exchange of specified amounts of two different currencies with subsequent repayments, which include both interest and repayment flows, over time according to predetermined rules. None of the resulting payments is considered as property income in the system and all settlements are to be recorded in the financial account;
5. forward rate agreements (FRAs), but only if they have a market value because they are tradable or can be offset. FRAs are contractual arrangements in which two parties, in order to protect themselves against interest rate changes, agree on an interest to be paid, at a settlement date, based on a notional amount of principal that is never exchanged. The payments are related to the difference between the agreement rate and the prevailing market rate at the time of settlement. These payments are not considered as property income in the system but are to be recorded under the item financial derivatives.