Figure 5 illustrates the instruments of the former illustration (debt and shares) as well as the issuers of deposit securities, i.e. the central bank and the private sector banks. It also indicates the three interbank markets, which we cover in the text on money creation).
The central bank in most countries is the sole issuer of notes and coins. It may seem strange to call these deposit securities, but they are: the public and banks that hold these have made a deposit with the central bank.
Figure 5: financial instruments / securities (excluding Pis)
BOX 6: EXAMPLE OF CENTRAL BANK SECURITY
The central bank is usually the sole banker to government, and these deposits are not negotiable; hence the term NNCD applies here (non-negotiable certificates of deposit). The central bank also takes deposits from other sources; this differs from country to country but usually includes the foreign sector and certain other government entities; the term NNCD applies here also.
Many central banks also issue their own securities (central bank securities - CBS) and many terms apply here: Reserve Bank of Malawi bills, South African Reserve Bank debentures, Bank of Botswana certificates, Bank of Ghana bills, and so on. These are short-term securities and therefore fall into the money market. They are issued solely for monetary policy implementation purposes. Because they are akin to term deposits, and for the sake of simplicity, we refer to these CBS as deposits (NCDs). An example is presented in Box 6.
The private banking sector issues two types of deposit certificates (securities): NNCDs and NCDs. The majority are NNCDs and most are of short term duration, making them money market instruments.
BOX 7: EXAMPLE OF NCD
NNCDs come in various forms, such as call deposits, fixed deposits, notice deposits, savings deposits and so on. NNCDs usually pay interest periodically, while NCDs are usually of the interest add-on form, i.e. an amount is deposited and interest is added to give a maturity value, payable at the end of the deposit period. An example of a NCD is presented in Box 7. NNCDs make up the vast majority of banks' deposits.
Instruments of investment vehicles
A reminder of the investment vehicles:
• Contractual intermediaries:
- Retirement funds.
• Collective investment schemes:
- Securities unit trusts (SUTs).
- Property unit trusts (PUTs).
- Exchange traded funds (ETFs).
• Alternative investments:
- Hedge funds (HFs).
- Private equity funds (PEFs).
Figure 6 completes the picture: all the previous securities as well as the instruments of the investment vehicles, which we call participate on interns (PIs).
Figure 6: financial instruments / securities
The instruments of the investment vehicles fall into a separate category because they are fundamentally different to those outlined above, and because they do not fit into the debt, share or deposit markets. All of them are also non-negotiable (with some exceptions). They invest in the instruments covered above (debt, shares, deposits and others such as property) and issue investment-type instruments suited to the specified needs of investors.
Insurers issue various types of polices, but only endowment policies and annuities are pure investment vehicles. The instruments they issue to the investor can be referred to as PIs. Retirement funds also issue PIs (also called membership interests). SUTs And PUTs issue units which are akin to PIs. ETFs issue PIs, as do the HFs and the PEFs (although these may be termed differently in some countries).
Figure 7: derivative instruments / markets
In addition to the debt, deposit, share and PI securities, there are a number of other related financial instruments that are called derivatives. The name arises from the fact that these instruments are derived from debt and share instruments, which mean that they cannot exist on their own, and they derive their value from the underlying debt and share instruments.
It must be added that there are also other derivative instruments that are derived not from debt instruments but from commodities (soft, such as grain, and hard, such as metals). In addition there are derivatives that are not derived from debt, shares or from commodities, such as weather derivatives; they are also financial instruments.
The wide array of derivatives can be quite confusing: futures, swaps, options, swaptions, forward rate agreements, forwards, caps and floors, repos, weather derivatives, credit derivatives, etc. Sorting them out in a logical sense is a challenge. Our attempt is presented in Figure 7. Derivatives are found in all markets.
Essentially, forwards and futures are contracts to buy or sell an asset (commodity, financial instrument or index) on a specified date in the future at a price determined upfront. An option is the same, except that the buy or sell is optional and the date is on the contract expiry date or before. Swaps are contracts to exchange cash flows on specified dates in the future, based on a notional amount.
Financial instruments are issued by ultimate borrowers and financial intermediaries. There are five categories: debt instruments (short-term and long-term), share instruments (ordinary and preference shares), deposit instruments (NNCDs and NCDs), the PIs of investment vehicles, and derivative market instruments.