FINANCIAL DERIVATIVES

A SUPPLEMENT TO THE FIFTH EDITION (1993) OF THE

BALANCE OF PAYMENTS MANUAL

INTERNATIONAL MONETARY FUND

Library of Congress Cataloging-in-Publication Data

Financial derivatives, a supplement to the Balance of payments manual,5th ed., 1993 — Washington, DC: International Monetary Fund, 2000.50p.

Companion volume to Balance of payments manual, 5th ed.ISBN 1-55775-941-3

1. Balance of payments — Handbooks, manuals, etc.2. International finance. I. International Monetary Fund.HG3881.5.I58 I55 2000

Price: US$21.00

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Preface

This document comprises a new chapter onfinancial derivatives and modifications to theexisting material on financial derivatives in thefifth edition of the Balance of Payments Manual(BPM5).

In response to large-scale changes occurringin recent decades in the size and nature offinancial derivative markets, theSystem of National Accounts 1993 (1993 SNA)and the BPM5 presented new standards for thetreatment of such derivatives. After the 1993SNA and the BPM5 were published, markets forfinancial derivatives evolved to an even greaterextent, and national statisticians requestedclarification and amplification of the publishedstandards.

These inquiries led to the creation of theInformal Group on the Measurement ofFinancial Derivatives. This informal group, theIMF Committee on Balance of PaymentsStatistics (the Committee), and the group ofexperts working on the draft of the IMFManual on Monetary and Financial Statisticsproduced discussion papers that were widelydistributed and commented upon in theinternational statistical community.

The process of discussion and commentaryconfirmed the view that financial derivativesshould be treated as financial assets. Trans-actions in financial derivatives, in general,should be reported as separate transactionsrather than as integral parts of the values ofunderlying transactions or as integral parts ofthe values of financial assets to whichderivatives may be linked as hedges. Theprocess also led to two significant changes inprevious statistical standards. One was thechange to a less restrictive view towards the

classification of financial derivatives within theSNA asset boundary. This change permittedthe inclusion of more over-the-counter(or non-exchange-traded) instruments. Asecond, related change was the recognitionof interest rate swaps and forward rate agree-ments as financial assets and the recordingof net cash settlement payments resultingfrom these contracts as financial transactionsrather than investment income flows. Inaddition, it was agreed that a new functionalcategory, financial derivatives, would becreated for the balance of payments and anew instrument, financial derivatives,for the national accounts. These changeswere adopted by the Committee and theInter-Secretariat Working Group on NationalAccounts (ISWGNA) at their October 1997meetings. In November 1997, the IMF StatisticsDepartment released The Statistical Treatmentof Financial Derivatives.

The ISWGNA and the Committee then askedthat the IMF Statistics Department useThe Statistical Treatment of FinancialDerivatives as a base to prepare—for inclusionin the 1993 SNA and the BPM5—text containinga definitive description of financial derivativesand recommended treatments for them. Aversion suitable for each publication wasprepared, but the wording of the two versions isidentical in many instances. The BPM5 version,although subject to further review regarding theclassification of financial derivatives as directinvestment and reserve assets, was consideredand adopted at the October 1998 meeting of theCommittee.

At its October 1999 meeting, the Committeemade a provisional decision to include financialderivatives in both of these functional categories

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and to record such derivatives as separateitems. This treatment is consistent with thatdescribed, in the October 1999 release of theprovisional IMF Operational Guidelines onthe Data Template for International Reservesand Foreign Currency Liquidity, for financialderivatives classified as reserve assets. Thisguideline will be reviewed in late 2000 or early2001. The continued classification of financialderivatives within direct investment and reserveassets depends on the results of the review andon country experience in implementing therecommendations with regard to derivativesclassified in direct investment.

The text that follows comprises two parts:a new, additional chapter for the BPM5 and anamendment to material in the existing BPM5.

The new chapter presents information on thefunctional category of financial derivatives.The underlying features of financial derivativesand treatments appropriate for specificderivatives are described. The amendment tothe BPM5 shows, by means of shading andstrikeout, clarifications and changes to thepublished manual. Only modified paragraphsand tables are shown—in the same order aschapters and paragraphs are shown in the 1993text. The release of this addendum andamendment to the BPM5 was coordinated withfinalization of the parallel revision to the 1993SNA. (The process of dissemination andadoption for the latter revision was morelengthy.) The revised 1993 SNA was adopted bythe United Nations Statistical Commission inFebruary 2000.

Carol S. CarsonDirectorStatistics Department

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Contents

Preface page 3

PART I. ADDITIONS TO THE FIFTH EDITION (1993) OF THE BALANCE OF PAYMENTS MANUAL

XXV. Financial Derivatives page 9

Concept and Coverage page 9; ¶¶1–8

Forwards page 11; ¶¶9–10

Options page 11; ¶11

Recording of Financial Derivative Transactions and Positions page 12; ¶14

Valuation of positions page 12; ¶¶15–16

Payments at inception page 12; ¶¶17–19

Sales of derivatives in secondary markets page 13; ¶20

Settlement payments page 13; ¶21

Margins page 14; ¶¶22–26

Treatment of Selected Financial Derivatives page 14

Specific interest-rate contracts page 14; ¶27

Specific foreign currency contracts page 15; ¶¶28–29

Credit Derivatives page 16; ¶¶30–31

Selected Supplementary Information page 16; ¶32

PART II. AMENDMENTS TO THE FIFTH EDITION (1993) OF THE

BALANCE OF PAYMENTS MANUAL

VIII. Classification and Standard Components page 19; ¶¶176–178a

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Contents (continued)

Standard Components of the Balance of Payments page 21

XIII. Other Services page 27; ¶258

XIV. Income page 28; ¶¶ 274, 280

XVI. Structure and Characteristics of the Capitaland Financial Account page 29; ¶¶ 308, 315, 318, 324, 330, 332–333, 339

XVIII. Direct Investment page 33; ¶¶ 369, 370a, 372, 375

XIX. Portfolio Investment page 35; ¶¶385, 387, 389–390, 392–393, 395,398, 401–408

XX. Other Investment page 39; ¶¶411–413, 421–23

XXI. Reserve Assets page 40; ¶¶424, 442a

XXIII. International Investment Position page 41; ¶¶464–465, 468–470,473a

Standard Components of the International Investment Position page 43

Appendix I. Relationship of the Rest of the World Account to the Balance ofPayments Accounts and the International Investment Position page 48; ¶511

Appendix II. A Note on Sectors page 49; ¶¶512

Appendix V. Selected Issues in Balance of Payments Analysis page 50; ¶556

PART I OF FINANCIAL DERIVATIVES

ADDITIONS TO THE FIFTH EDITION (1993) OF THE

BALANCE OF PAYMENTS MANUAL

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XXV. Financial Derivatives

Concept and Coverage

FD 1. A financial derivative contract is afinancial instrument that is linked to anotherspecific financial instrument or indicator orcommodity and through which specificfinancial risks (such as interest rate risk,foreign exchange risk, equity and commodityprice risks, credit risk, etc.) can, in theirown right, be traded in financial markets.Transactions in financial derivatives aretreated as separate transactions rather than asintegral parts of the values of the underlyingtransactions to which they are linked. Thevalue of a financial derivative derives fromthe price of an underlying item such as anasset or index. No principal amount thatmust be repaid is advanced, and no invest-ment income accrues. Financial derivativesare used for a number of purposes—riskmanagement, hedging, arbitrage betweenmarkets, and speculation, for example.

FD 2. Financial derivatives enable partiesto trade specific financial risks to otherentities that are more willing, or bettersuited, to take or manage these risks and thattypically, but not always, do so withouttrading in primary assets or commodities.The risk embodied in a derivative contractcan be traded either by trading the contractitself, as with options, or by creating a newcontract embodying risk characteristics thatmatch, in a countervailing manner, those ofthe existing contract. The latter practice,which is termed offsetability1, occurs in

1Offsetability should not be confused with an offset,which is the legal right of a debtor to net its claimsagainst the same counterparty. It is recommendedthat positions be recorded on a gross basis wheneverpossible.

forward markets. Offsetability means that itis often possible to eliminate the risk associ-ated with a derivative by creating a new but“reverse” contract having characteristics thatcountervail the risk of the first derivative.Buying the new derivative is the functionalequivalent of selling the first derivativebecause the result is the elimination of risk.The ability to countervail the risk in themarket is therefore considered the equi-valent of tradability in demonstrating value.The outlay that would be required to replacethe existing derivative contract represents itsvalue; actual offsetting is not required todemonstrate value.

FD 3. There are two broad types offinancial derivatives. In a forward contract,which is unconditional, two counterpartiesagree to exchange a specified quantity of anunderlying item (real or financial) at anagreed-upon price (the strike price) on aspecified date. In an option contract, thepurchaser acquires from the seller a right tobuy or sell, (depending on whether theoption is a call or a put) a specifiedunderlying item at a strike price on orbefore a specified date. Unlike debtinstruments, financial derivatives do notaccrue investment income; nor are principalamounts advanced that must be repaid.

FD 4. The value of a financial derivativederives from the price of the underlying item(the reference price). Because a future refer-ence price is not known beforehand, thevalue of a financial derivative at maturitycan only be anticipated or estimated. Areference price may be related to acommodity, a financial instrument, aninterest rate, an exchange rate, another

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derivative, a spread between two prices, oran index or basket of prices. An observablereference price for the underlying item isessential for calculating the value of anyfinancial derivative. If there is no observableprevailing market price for the underlyingitem, it cannot be regarded as a financialasset. Transactions in financial derivativesare treated as separate transactions ratherthan as integral parts of the values of theunderlying transactions to which they arelinked. Embedded derivatives, however, arenot identified and valued separately fromprimary instruments. (See paragraph FD 6.)

FD 5. Financial derivative contracts areusually settled by net payments of cash.Exchange-traded contracts, such as commodityfutures, are often settled before maturity. Cashsettlement is a logical consequence of the use offinancial derivatives to trade risks independ-ently of the ownership of underlying items.However, some financial derivative contracts,particularly those involving foreign currency,are settled by deliveries of the underlying items.

FD 6. For balance of payments purposes,the following types of financial instrumentsare NOT FINANCIAL DERIVATIVES.

•A FIXED PRICE CONTRACT FOR GOODS AND

SERVICES is not a financial derivativeunless the contract is standardized so thatthe market risk therein can be traded infinancial markets in its own right.

•INSURANCE is not a financial derivative.Insurance contracts provide individualinstitutional units with financial protectionagainst the consequences of the occurrenceof specified events. (In many instances, thevalue of this financial protection cannot beexpressed in terms of market prices.)Insurance is a form of financial inter-mediation through which funds are collectedfrom policyholders and invested in financialor other assets. These assets are held astechnical reserves to meet future claims

arising from the occurrence of eventsspecified in insurance policies. That is,insurance is used to manage event riskprimarily by the pooling, not the trading,of risk.

•CONTINGENCIES, such as guarantees andletters of credit, are not financial derivatives.The principal characteristic of a contingencyis that one or more conditions must befulfilled before a financial transaction takesplace. Contingencies are typically notinstruments that facilitate the trading ofspecific financial risks.

•An EMBEDDED DERIVATIVE (a derivativefeature that is inserted in a standard financialinstrument and is inseparable from theinstrument) is not considered a financialderivative for balance of payments purposes.If a primary instrument such as a security orloan contains an embedded derivative, theinstrument is valued and classified accordingto its primary characteristics—even thoughthe value of that security or loan may welldiffer from the values of comparablesecurities and loans because of the embeddedderivative. Examples are bonds that areconvertible into shares and securities withoptions for repayment of principal incurrencies that differ from those in which thesecurities were issued.

FD 7. In addition, TIMING DELAYS that arise inthe normal course of business and may entailexposure to price movements do not, for balanceof payments purposes, give rise to transactionsand positions in financial derivatives. Timingdelays include normal settlement periods forspot transactions in financial markets.

FD 8. Financial derivatives that can be valuedseparately from the underlying items to whichthey are linked are included—whether or notthey are traded on an exchange—in the financialaccount of the balance of payments and in theinternational investment position.

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Forwards

FD 9. In a forward contract, the counter-parties agree to exchange, on a specified date, aspecified quantity of an underlying item (real orfinancial) at an agreed-upon contract price (thestrike price). This class of financial derivativesincludes futures and swaps. Futures are forwardcontracts traded on organized exchanges.Futures and other forward contracts aretypically, but not always, settled by payments ofcash or provision of other financial instrumentsrather than by actual deliveries of underlyingitems. Futures are valued and traded separatelyfrom underlying items. If a forward contract is aswap contract, the counterparties exchange, inaccordance with pre-arranged terms, cash flowsbased on the reference prices of the underlyingitems. Forward rate agreements and forwardforeign exchange contracts are common types offorward contracts. Interest-rate and crosscurrency interest-rate swaps are common typesof swap contracts. (See paragraphs FD 27 andFD 28 for further discussion.)

FD 10. At the inception of a forward contract,risk exposures of equal market value areexchanged. Both parties are potential debtors,but a debtor/creditor relationship can beestablished only after the contract goes intoeffect. Thus, at inception, a contract normallyhas zero value. However, as the price of theunderlying item changes during the life of theforward contract, the market value of eachparty’s risk exposure will differ from the marketvalue of zero at the inception of the contract.When a change in the price of the underlyingitem occurs, an asset (creditor) position iscreated for one party, and a liability(debtor)position is created for the other. Thedebtor/creditor relationship may change, in bothmagnitude and direction, during the life of aforward contract.

Options

FD 11. The purchaser of an option contractpays a premium to the writer of the option. In

return, the buyer acquires the right but not theobligation to buy (call option) or sell (putoption) a specified underlying item (real orfinancial) at an agreed-upon contract price (thestrike price) on or before a specified date. Amajor difference between forward and optioncontracts is that either party to a forwardcontract is a potential debtor, whereas the buyerof an option acquires an asset, and the optionwriter incurs a liability. However, an optionmay expire without worth; it is exercised only ifsettling the contract is advantageous to thebuyer. The option buyer may make gains ofunlimited size, and the option writer mayexperience losses of unlimited size.

FD 12. Options are written on a wide varietyof underlying items—such as equities,commodities, currencies, and interest rates(including caps, collars, and floors).2 Optionsare also written on futures, swaps (known asswaptions), caps (known as captions), and otherinstruments.

FD 13. In organized markets, option contractsare usually settled in cash, but some types ofoption contracts are normally settled bypurchases of underlying assets. For instance, awarrant is a financial contract that gives theholder the right to buy, under specified terms, acertain number or amount of the underlyingasset (such as equity shares). If a warrant isexercised, the underlying asset is usually deliv-ered. Warrants can be traded separately from theunderlying assets to which they are linked.

Recording of Financial DerivativeTransactions and Positions

FD 14. The statistical treatment of financialderivatives for the balance of payments and theinternational investment position requirescompilers and statisticians to

2A cap imposes an upper limit; a floor sets a lower limit;and a collar maintains upper and lower bounds onfloating-rate interest payments or receipts.

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•recognize the exchange of claims andobligations at the inception of a derivativecontract as a true financial transaction creatingasset and liability positions that normallyhave, at inception, zero value if the instrumentis a forward and value equal to the premium ifthe instrument is an option

•treat any changes in the values of derivativesas holding gains or losses

•record secondary market transactions inmarketable derivatives, such as options, asfinancial transactions

•record any payments made at settlements astransactions in financial derivative assets orliabilities (That is, no income arises fromsettlements of financial derivatives.)3

•record, in the international investmentposition, outstanding values of financialderivatives at market prices.

Valuation of positions

FD 15. A key characteristic of most derivativecontracts is that the counterparties makecommitments to transact, in the future and atagreed-upon prices, in underlying items. Thepresent value (or market price) of a financialderivative is derived from the differencebetween the agreed-upon contract price of anunderlying item and the prevailing market price(or the market price expected to prevail),appropriately discounted, of that item. Foroptions, whether they are traded on an exchangeor not, the prices are directly observable becauseoption purchasers acquire assets (the rights tobuy or sell specified underlying items) and the

3 Financial derivative transactions may take place directly

between two parties or through intermediaries. In thelatter case, there may be implicit or explicit servicecharges. Distinguishing an implicit service change is notusually possible. Therefore, it is recommended that netsettlement payments for derivative contracts be recordedas financial transactions. When possible, service chargesshould be recorded separately.

prices of those assets must be established. Theprice of an option depends on the potential pricevolatility of the underlying instrument, the timeto maturity, interest rates, and the differencebetween the strike price and the market price ofthe underlying item. The value of a swapcontract based on a notional principal amount isderived from the difference, appropriatelydiscounted, between expected gross receipts andgross payments.

FD 16. Financial derivatives are valued atmarket prices prevailing on balance sheetrecording dates. Price changes occurringbetween recording dates are classified asrevaluation gains or losses. If market price dataare unavailable, other fair value methods (suchas option models or discounted present values)may be used to value derivatives.

Payments at inception

FD 17. The purchaser of an option pays apremium to the seller. The full price of thepremium is recorded, by the buyer, as theacquisition of a financial asset and, by the seller,as the incurrence of a liability. Sometimes apremium is paid after the inception of aderivative contract. Then the value of thepremium payment is recorded by the optionpurchaser as an asset that was financed by aloan from the option writer at the time thederivative was purchased.

FD 18. The creation of a forward contractdoes not normally require the recording of atransaction in a financial derivative because riskexposures of equal value are usually beingexchanged. That is, there is zero exposure andzero value for both sides.

FD 19. Commissions and fees paid—at incep-tion or during the lives of derivatives—to banks,brokers, and dealers are classified as paymentsfor services. These payments are rendered forservices provided within current periods and areindependent of asset and liability relationshipscreated by the derivatives.

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Sales of derivatives in secondary markets

FD 20. Sales of derivatives in secondarymarkets—whether the markets are exchanges orover-the-counter—are valued at market pricesand recorded in the financial account astransactions in financial derivatives.

Settlement payments

FD 21. Net settlement payments are financialtransactions that are similar to transactions atthe maturities of other financial instruments. Atsettlement, either a cash payment is made, or anunderlying item is delivered.

•When a financial derivative is settled incash, a transaction equal to the cash value ofthe settlement is recorded for the derivative.No transaction in the underlying item isrecorded. In most instances, when a cashsettlement payment is received, a reductionin a financial derivative asset (a credit) isrecorded. When a cash settlement paymentis made, a reduction of a financial derivativeliability (a debit) is recorded. However, insome circumstances, this practice does nothold. When a contract (such as an interestrate swap) calls for ongoing settlement anda cash settlement is received, there is anincrease in a financial derivative liability (acredit) if, at the time of the settlement pay-ment, the contract is in a liability position.The reverse also applies; that is, when acontract calls for ongoing settlement, a cashpayment is recorded as an increase in anasset (a debit) if, at the time of the settle-ment, the contract is in an asset position. Ifcompilers are unable to implement thisapproach because of market practice, it isrecommended that all cash settlementreceipts be recorded as reductions infinancial assets and all cash settlement pay-ments be recorded as decreases in liabilities.

•When an underlying instrument isdelivered, two transactions occur and bothare recorded. The transaction in the

underlying item is recorded at the marketprice prevailing on the day of thetransaction. The transaction in the derivativeis recorded as the difference, multiplied bythe quantity, between the prevailing marketprice for the underlying item and the strikeprice specified in the derivative contract.

•When more than one contract is settled—incash, at the same time, and with the samecounterparty—some of the contracts beingsettled are in asset positions and some are inliability positions. In this situation, it isrecommended that the transactions berecorded on a gross basis ; that is, the trans-actions in assets are recorded separatelyfrom those in liabilities and are therebyrecorded as separate credit and debit flows.Recording the transactions on a gross basisis preferred to recording them on a net basis;that is, after the sum of the liability flows issubtracted from the sum of the asset flows,the resulting debit or credit is recorded as asingle amount.4 However, for practicalreasons, there may be no alternative to netrecording.

Margins

FD 22. Margins are payments of cash ordeposits of collateral that cover actual orpotential obligations incurred through financialderivatives—especially futures or exchange-traded options. The required provision ofmargin reflects market concern over counter-party risk and is standard in financial derivativemarkets

FD 23. Repayable margin consists of cash orother collateral deposited to protect a counter-party against default risk. Ownership of themargin remains with the unit that deposited it.Although its use may be restricted, a margin isclassified as repayable if the depositor retains

4 However, the net basis is recommended for transactionsin financial derivatives classified as reserve assets.

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the risks and rewards of ownership—such asthe receipt of income or exposure to holdinggains and losses. At settlement, a repayablemargin (or the amount of repayable margin inexcess of any liability owed on the derivative)is returned to the depositor. In organizedmarkets, repayable margin is sometimes knownas initial margin.

FD 24. Repayable margin payments of cashare transactions in deposits, not transactions infinancial derivatives. A depositor has a claim onan exchange, brokerage, or other institutionholding the deposit. Some countries may preferto classify repayable margin deposits withinother accounts receivable/payable in order toreserve the term deposits for monetary aggre-gates. When a repayable margin deposit is madein a non-cash asset (such as securities), notransaction is recorded because no change inownership has occurred. The entity (the issuerof the security) on which the depositor has aclaim is unchanged.

FD 25. The payment of nonrepayable marginis a transaction in a derivative; the payment ismade to reduce a financial liability createdthrough a derivative. In organized exchanges,nonrepayable margin (sometimes known asvariation margin) is paid daily to meet liabilitiesrecorded as a consequence of the daily markingof derivatives to market value. The entity thatpays nonrepayable margin no longer retainsownership of the margin or has the right to therisks and rewards of ownership. A payment ofnonrepayable margin is recorded as a reductionin financial derivative liability (a debit); thecontra-entry is a reduction (probably in currencyand deposits) in a financial asset (a credit). Thereceipt of nonrepayable margin is recorded as areduction in a financial derivative asset (acredit); the contra-entry is an increase (probablyin currency and deposits) in a financial asset(a debit).

FD 26. Arrangements for margining can becomplex, and procedures differ amongcountries. In some countries, repayable and

nonrepayable margins are recorded in a singleaccount, and it may be difficult to distinguishbetween the two types. The actual institutionalarrangements (such as the identities of unitsmaking payments and types of instrument used)must be reviewed. The key test is whether themargin is repayable or whether payment of themargin represents an effective transfer ofownership between counterparties to thefinancial derivative contract.

Treatment of Selected FinancialDerivatives

Specific interest-rate contracts

FD 27. An interest-rate swap contract consistsof a contract to exchange, in one currency andduring a specified period of time, cash flowsrelated to interest payments or receipts on anotional amount of principal that is neverexchanged. Such swaps are often settled throughnet cash payments from one of the counter-parties to another. A forward rate agreement(FRA) is a contract in which the counterpartiesagree on an interest rate to be paid, at aspecified settlement date, on a notional amountof principal that is never exchanged. FRAs aresettled by net cash payments; that is, thedifference between the rate agreed upon and theprevailing market rate at the time of settlementis recorded as a transaction in the balance ofpayments. The buyer of an FRA receivespayment from the seller if the prevailing rateexceeds the rate agreed upon. The sellerreceives payment from the buyer if the prevail-ing rate is lower than the rate agreed upon. Theexistence of active financial markets in thesecontracts results in holding gains and losses.The creation of interest rate swaps and FRAcontracts normally requires no entries in thefinancial account because there are noexchanges of value at the inception of thesecontracts. Net cash settlement payments forinterest-rate swaps and FRAs are classified inthe financial account as transactions in financialderivatives. Interest-rate swaps usually

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involve ongoing settlements during the lives ofthe contracts; FRAs are usually settled atcontract maturity.

Specific foreign currency contracts

FD 28. A foreign exchange swap contractconsists of a spot sale/purchase of currenciesand a simultaneous commitment to a forwardpurchase/sale of the same currencies. A forwardforeign exchange contract consists of acommitment to transact, at a designated futuredate and agreed-upon exchange rate, in aspecified amount of specified foreign currencies.A cross currency interest-rate swap contract(also known as a currency swap) consists ofan exchange of cash flows related to interestpayments and, at the end of the contract, anexchange of principal amounts in specifiedcurrencies at a specified exchange rate. Theremay also be an exchange of principal at thebeginning of the contract. In that case,subsequent repayments that comprise bothinterest and amortization of principal may bemade over time and according to pre-arrangedterms. Streams of interest payments resultingfrom swap arrangements are recorded in thefinancial account as transactions in financialderivatives, and repayments of principal arerecorded in relation to relevant instruments.

FD 29. For foreign currency financialderivative contracts, it is necessary todistinguish between a transaction in a derivativecontract and the requirement to deliver andreceive underlying principal associated with thecontract.

•In contrast to the creation of other forwardcontracts, the creation of a foreign currencyfinancial derivative contract does notnormally lead to the recording, in thefinancial account, of a transaction infinancial derivatives. Any initial sale orpurchase of currency is a transaction that isrecorded, at the exchange rate agreed uponby the counterparties, in the otherinvestment category of the financial account.

•The exchange rate for the forward sale orpurchase of currencies through a foreigncurrency derivative contract is agreed uponby the counterparties when the terms of thecontract are established. The derivativecontract acquires value as the prevailingmarket exchange rate differs from theexchange rate agreed upon in the contract.

•At the time of settlement, the differencebetween the values (which are measured inthe unit of account and at the prevailingexchange rate) of the currencies exchangedare allocated to a transaction in a financialderivative. In other words, if the value of thecurrency received exceeds that of thecurrency paid, a reduction in a financialderivative asset (a credit) is recorded. Thecontra-debit entry is an increase in anotherasset (probably other investment—assets,currency and deposits) classified in thefinancial account. When the value of thecurrency received is less than that of thecurrency paid, the opposite applies. Thatis, a reduction in a financial derivativeliability (a debit) is recorded. The contra-credit entry is a reduction in another item(probably other investment—assets,currency and deposits) classified in thefinancial account.

Credit Derivatives

FD 30. The financial derivatives described inprevious sections are related to market risk,which pertains to changes in the market pricesof securities and commodities and to changes ininterest and exchange rates. Other types offinancial derivatives are used primarily to tradecredit risk. These credit derivatives, which aredesigned for trading in loan and security defaultrisk, can be either forward or option contracts.Like other financial derivatives, creditderivative contracts are frequently drawn upaccording to standard legal agreements thatspecify procedures for the provision of margin,which serves as a basis for market valuation.

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FD 31. There are a number of common typesof credit derivatives. A total return swapconsists of swapping of cash flows and capitalgains and losses related to the liability of alower-rated creditor for cash flows related to aguaranteed interest rate, such as an interbankrate, plus a margin. A spread option is acontract with value derived from an interest ratespread between higher quality credit and lowerquality credit. For example, if the spreadnarrows sufficiently, the option holder benefitsfrom exercising the option. A credit defaultswap consists of swapping, usually on anongoing basis, the risk premium inherent in aninterest rate on a bond or a loan in return for acash payment that is made in the event ofdefault by the debtor. Some credit default swapcontracts require that one party make only a

single payment to the other in order to befinancially protected against the risk of acatastrophe befalling the creditor. Referenceprices for these single-premium contracts, whichare more properly classified as forms ofinsurance rather than financial derivatives, maynot be readily available.

Selected Supplementary Information

FD 32. Because financial derivatives arerisk-transferring instruments, there may beinterest—from analytical and policymakingpoints of view—in presenting transactions andpositions in financial derivatives by type(option and forward) and by category of risk(foreign exchange, interest-rate, and other).

PART II OF FINANCIAL DERIVATIVES

AMENDMENTS TO THE FIFTH EDITION (1993) OF THE

BALANCE OF PAYMENTS MANUAL

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Classification and Standard Components

VIII. of the Balance of Payments

[. . .]

Capital and Financial Account

[. . .]

Financial account (2.B)

176. The classification of standard compon-ents in the financial account is based on thesecriteria:

All components are classified according totype of investment or by functionalsubdivision (direct investment, portfolioinvestment, financial derivatives, otherinvestment, reserve assets).

For the category of direct investment, thereare directional distinctions (abroad or in thereporting economy) and—for the equitycapital, and other capital, and financialderivative components within thiscategory—asset or liability distinctions.

For the categories of portfolio investment,financial derivatives, and other investment,there are the customary asset/liabilitydistinctions.

Particularly significant for portfolioinvestment and other investment is thedistinction by type of instrument (equity ordebt securities, trade credits, loans, currencyand deposits, other assets or liabilities). Inthis Manual, traditional and new moneymarket and other financial instruments andderivatives are included in portfolioinvestment.

For portfolio investment, financialderivatives, and other investment, there aredistinctions by sector of the domesticcreditor for assets and by sector of thedomestic debtor for liabilities. Thesedistinctions serve to facilitate links withthe income accounts, the internationalinvestment position, the SNA, and otherstatistical systems.

The traditional distinction, which is basedon original contractual maturity of morethan one year or one year or less, betweenlong- and short-term assets and liabilitiesapplies only to other investment. In recentyears, the significance of this distinction hasclearly diminished for many domestic andinternational transactions. Consequently, thelong- and short-term distinction is accordedless importance in the 1993 SNA and in thefifth edition of the Manual than previously.However, because the maturity factorremains important for specificpurposes—analysis of external debt, forexample—it is retained, in the fifth editionof the Manual, for other investment.

177. Direct investment—reflecting the lastinginterest of a resident entity in one economy(direct investor) in an entity resident in anothereconomy (direct investment enterprise)—coversall transactions between direct investors anddirect investment enterprises. That is, directinvestment covers the initial transaction betweenthe two and all subsequent transactions betweenthem and among affiliated enterprises, bothincorporated and unincorporated. Directinvestment transactions occurring abroad and inthe reporting economy are subclassified intoequity capital, reinvested earnings, and other

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capital (intercompany transactions), andfinancial derivatives. For equity capital, andother capital, and financial derivatives, claimson and liabilities to affiliated enterprises and todirect investors are distinguished. Transactionsbetween affiliated banks and between otheraffiliated financial intermediaries are limited toequity and permanent debt capital. (Seeparagraph 372.)

178. Portfolio investment covers transactionsin equity securities and debt securities; the latterare subsectored subclassified into bonds andnotes and money market instruments. andfinancial derivatives (such as options) when thederivatives generate financial claims andliabilities. Various new financial instruments,other than financial derivatives, are covered

under appropriate instrument classifications.Transactions covered under direct investmentand reserve assets are excluded.

New paragraph

178a. The financial derivative category coversfinancial instruments that are linked to otherspecific financial instruments, indicators, orcommodities and through which specificfinancial risks (such as interest rate risk, foreignexchange risk, equity and commodity pricerisks, credit risk, etc.) can, in their own right, betraded in financial markets. Transactions infinancial derivatives should be treated asseparate transactions rather than as integral partsof the values of the underlying transactions towhich they are linked.

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Standard Components of the Balance of PaymentsCredit Debit

1. Current Account

A. Goods and services

a. Goods1 General merchandise2. Goods for processing3 Repairs on goods4 Goods procured in ports by carriers5. Nonmonetary gold

5.1 Held as a store of value5.2 Other

b. Services1. Transportation

1.1 Sea transport1.1.1 Passenger1.1.2 Freight1.1 .3 Other

1.2 Air transport1.2.1 Passenger1.2.2 Freight1.2.3 Other

1.3 Other transport1.3.1 Passenger1.3.2 Freight1.3..3 Other

2. Travel2.1 Business2.2 Personal*

3. Communications services4. Construction services5. Insurance services**6. Financial services7. Computer and information services8. Royalties and license fees9. Other business services

9.1 Merchanting and other trade-related services9.2 Operational leasing services9.3 Miscellaneous business, professional, and technical services*

* See Selected Supplementary Information table for components.** Memorandum items: 5.1 Gross premiums

5.2 Gross claims

22

Standard Components of the Balance of PaymentsCredit Debit

10. Personal, cultural, and recreational services10.1 Audiovisual and related services10.2 Other personal, cultural, and recreational services

11. Government services, n.i.e.

B. Income

1. Compensation of employees

2. Investment income

2.1 Direct investment2.1.1 Income on equity

2.1.1.1 Dividends and distributed branch profits**2.1.1.2 Reinvested earnings and undistributed branch profits**

2.1.2 Income on debt (interest)2.2 Portfolio investment

2.2.1 Income on equity (dividends)2.2.2 Income on debt (interest)

2.2.2.1 Bonds and notes2.2.2.2 Money market instruments and financial derivatives

2.3 Other investment

C. Current transfers

1. General government2. Other sectors

2.1 Workers' remittances2.2 Other transfers

2. Capital and Financial Account

A. Capital account

1. Capital transfers

1.1 General government1.1.1 Debt forgiveness1.1.2 Other

* See Selected Supplementary Information table for components.** If distributed branch profits are not identified, all branch profits are considered to be distributed.

23

Standard Components of the Balance of PaymentsCredit Debit

1.2 Other sectors1.2.1 Migrants' transfers1.2.2 Debt forgiveness1.2.3 Other

2. Acquisition/disposal of nonproduced, nonfinancial assets

B. Financial account

1. Direct investment1.1 Abroad

1.1.1 Equity capital1.1.1.1 Claims on affiliated enterprises1.1.1.2 Liabilities to affiliated enterprises

1.1.2 Reinvested earnings1.1.3 Other capital

1.1.3.1 Claims on affiliated enterprises1.1.3.2 Liabilities to affiliated enterprises

1.1.4 Financial derivatives1.1.4.1 Claims on affiliated enterprises1.1.4.2 Liabilities to affiliated enterprises

1.2 In reporting economy1.2.1 Equity capital

1.2.1.1 Claims on direct investors1.2.1.2 Liabilities to direct investors

1.2.2 Reinvested earnings1.2.3 Other capital

1.2.3.1 Claims on direct investors1.2.3.2 Liabilities to direct investors

1.2.4 Financial derivatives1.2.4.1 Claims on direct investors1.2.4.2 Liabilities to direct investors

2. Portfolio investment

2.1 Assets2.1.1 Equity securities

2.1.1.1 Monetary authorities2.1.1.2 General government2.1.1.3 Banks2.1.1.4 Other sectors

2.1.2 Debt securities2.1.2.1 Bonds and notes

2.1.2.1.1 Monetary authorities2.1.2.1.2 General government

24

Standard Components of the Balance of PaymentsCredit Debit

2.1.2.1.3 Banks2.1.2.1.4 Other sectors

2.1.2.2 Money market instruments2.1.2.2.1 Monetary authorities2.1.2.2.2 General government2.1.2.2.3 Banks2.1.2.2.4 Other sectors

2.1.2.3 Financial derivatives2.1.2.3.1 Monetary authorities2.1.2.3.2 General Government2.1.2.3.3 Banks2.1.2.3.4 Other sectors

2.2 Liabilities2.2.1 Equity securities

2.2.1.1 Banks2.2.1.2. Other sectors

2.2.2 Debt securities2.2.2.1 Bonds and notes

2.2.2.1.1 Monetary authorities2.2.2.1.2 General government2.2.2.1.3 Banks2.2.2.1.4 Other sectors

2.2.2.2 Money market instruments2.2.2.2.1 Monetary authorities2.2.2.2.2 General government2.2.2.2.3 Banks2.2.2.2.4 Other sectors

2.2.2.3 Financial derivatives2.2.2.3.1 Banks2.2.2.3.2 Other sectors

3. Financial Derivatives3.1 Assets

3.1.1 Monetary authorities3.1 2 General government3.1.3 Banks3.1.4 Other sectors

3.2 Liabilities3.2.1 Monetary authorities3.2.2 General government3.2.3 Banks3.2.4 Other sectors

4. 3 Other investment

4. 3.1 Assets

25

Standard Components of the Balance of PaymentsCredit Debit

4. 3.1.1 Trade credits4. 3.1.1.1 General government

4. 3.1.1.1.1 Long-term4. 3.1.1.1.2 Short-term

4. 3.1.1.2 Other sectors4. 3.1.1.2.1 Long-term4. 3.1.1.2.2. Short-term

4. 3.1.2 Loans4. 3.1.2.1 Monetary authorities

4. 3.1.2.1.1 Long-term4. 3.1.2.1.2 Short-term

4. 3.1.2.2 General government4. 3.1.2.2.1 Long-term4. 3.1.2.2.2 Short-term

4. 3.1.2.3 Banks4. 3.1.2.3.1 Long-term4. 3.1.2.3.2 Short -term

4. 3.1.2.4 Other sectors4. 3.1.2.4.1 Long-term4. 3.1.2.4.2 Short-term

4. 3.1.3 Currency and deposits4. 3.1.3.1 Monetary authorities4. 3.1.3.2 General government4. 3.1.3.3 Banks4. 3.1.3.4 Other sectors

4. 3.1.4 Other assets4. 3.1.4.1 Monetary authorities

4 3.1.4.1.1 Long-term4 3.1.4.1.2 Short-term

4. 3.1.4.2 General government4 3.1.4.2.1 Long-term4 3.1.4.2.2 Short-term

4. 3.1.4.3 Banks4. 3.1.4.3.1 Long-term4. 3.1.4.3.2 Short-term

4. 3.1.4.4 Other sectors4. 3.1.4.4.1 Long-term4. 3.1.4.4.2 Short-term

4. 3.2 Liabilities4. 3.2.1 Trade credits

4. 3.2.1.1 General government4. 3.2.1.1.1 Long-term4. 3.2.1.1.2 Short-term

4. 3.2.1.2 Other sectors4. 3.2.1.2.1 Long-term4. 3.2.1.2.2 Short-term

26

Standard Components of the Balance of PaymentsCredit Debit

4. 3.2.2 Loans4. 3.2.2.1 Monetary authorities

4. 3.2.2.1.1 Use of Fund credit and loans from the Fund4. 3.2.2.1.2 Other long-term4. 3.2.2.1.3 Short-term

4. 3.2.2.2 General government4. 3.2.2.2.1 Long-term4. 3.2.2.2.2 Short-term

4. 3.2.2.3 Banks4 3.2.2.3.1 Long-term4 3.2.2.3.2 Short -term

4. 3.2.2.4 Other sectors4.3.2.2.4.1 Long-term4.3.2.2.4.2 Short-term

4. 3.2.3 Currency and deposits4. 3.2.3.1 Monetary authorities4. 3.2.3.2 Banks

4. 3.2.4 Other liabilities4. 3.2.4.1 Monetary authorities

4. 3.2.4.1.1 Long-term4. 3.2.4.1.2 Short-term

4. 3.2.4.2 General government4. 3.2.4.2.1 Long-term4. 3.2.4.2.2 Short-term

4. 3.2.4.3 Banks4. 3.2.4.3.1 Long-term4. 3.2.4.3.2 Short -term

4. 3.2.4.4 Other sectors4. 3.2.4.4.1 Long-term4. 3.2.4.4.2 Short-term

5. 4 Reserve assets5. 4.1 Monetary gold5. 4.2 Special drawing rights5. 4.3 Foreign exchange

5. 4.4.1 Currency and deposits5. 4.4.1.1 With monetary authorities5. 4.4.1.2. With banks

5. 4.4.2 Securities5. 4.4.2.1. Equities5. 4.4.2.2 Bonds and notes5. 4.4.2.3 Money market instruments and financial derivatives

5.4.3 Financial derivatives5. 4.5 Other claims

27

XIII. Other Services

[. . .]

Definitions

[. . .]

258. Financial services cover financialintermediary and auxiliary services (exceptthose of insurance enterprises and pensionfunds) conducted between residents andnonresidents. Included are intermediary servicefees, such as those associated with letters ofcredit, bankers' acceptances, lines of credit,financial leasing, and foreign exchangetransactions. (For the latter, the spread betweenthe midpoint rate and the buying/selling rate isthe service charge.) Also included arecommissions and other fees related totransactions in securities—brokerage,placements of issues, underwritings, andredemptions; and arrangements of swaps,options, and other hedging instruments;

commissions and fees paid for the arrangementof financial derivative contracts; commissions ofcommodity futures traders; and services relatedto asset management services, financial marketoperational and regulatory services, securitycustody services, etc. 6b Service charges onpurchases of International Monetary Fundresources are included among an economy'sfinancial service payments, as are charges(similar to commitment fees) associated withundrawn balances under stand-by or extendedarrangements with the IMF.

6bFinancial derivative transactions may take place directly

between two parties or through intermediaries. In thelatter case, there may be implicit or explicit servicecharges. It is not usually possible to distinguish implicitservice charges. Therefore, it is recommended that netsettlement payments of derivative contracts be recordedas financial transactions. However, when possible, servicecharge components should be recorded separately.

28

XIV. Income

[. . .]

Definition and Classification

[. . .]

274. Investment income (property income in theSNA) covers income derived from a residententity's ownership of foreign financial assetsearned on the provision of nonproduced capital.Such provision is usually evidenced by theownership of foreign financial assets. Financialderivative assets do not represent the provisionof finance capital; their value derives fromchanges in the prices of factors used to constructderivative contracts. Therefore, no investmentincome is earned on financial derivatives. Themost common types of investment income areincome on equity (dividends) and income ondebt (interest). Dividends, including stockdividends, are the distributed earnings allocatedto shares and other forms of participation in theequity of incorporated private enterprises,cooperatives, and public corporations.Dividends represent income that is payablewithout a binding agreement betweenthe creditor and the debtor. Among other typesof income on equity are (i) earnings of branchesand other unincorporated direct investmententerprises and (ii) direct investors' shares ofearnings of incorporated direct investmententerprises. (The latter type of earnings, whichare not formally distributed, are earnings otherthan dividends.) Shares of reinvested earningsattributed to direct investors are proportionate tothe participation of the direct investors in theequity of the enterprise. Also, in principle,

income is imputed to households from netequity in life insurance reserves and pensionfunds and included indistinguishably underwithin other investment. Interest, includingdiscounts in lieu of interest, comprises incomeon loans and debt securities (i.e., bank deposits,bills, bonds, notes, and trade advances). Netinterest flows arising from interest rate swapsalso are included (See paragraph 406). Interestis payable in accordance with a bindingagreement between the creditor and the debtor.

[. . . ]

Portfolio investment income

280. Portfolio investment income comprisesincome transactions between residents andnonresidents and is derived from holdings ofshares, bonds, notes, and money marketinstruments and associated with financialderivatives. This category is subdivided intoincome on equity (dividends) and income ondebt (interest). See Chapter 19 for details onnew financial instruments and treatment offinancial derivatives, such as options. includedin portfolio investment. The financial instrumentclassification scheme for portfolio investmentincome is consistent with that in the financialaccount and with that in the internationalinvestment position. Subsectoring into domesticinstitutional sectors (monetary authorities,general government, banks, and other) is shownunder Selected Supplementary Information.(See the table at the end of Chapter 8.) A varietyof other supplementary disaggregations byforeign sector, etc. may be desirable for specificanalytical purposes.

29

Structure and Characteristics

XVI. of the Capital and Financial Account

Coverage

[. . .]

308. The standard components of both thecurrent account and the capital and financialaccount are discussed in Chapter 8. Coverage ofthe capital and financial account is described inparagraphs 172 through 181, and theclassification of components appears at the endof the chapter. Capital and financial accounttransactions presented in this Manual are thesame as those reflected in the capital andfinancial accounts of the SNA externalaccumulation accounts. However, in the balanceof payments, the primary basis for classificationof the financial account is functional category(i.e., direct investment, portfolio investment,financial derivatives, other investment, andreserve assets) while the SNA classification isprimarily by type of instrument: monetary gold,currency and deposits, loans, etc. (See Chapter 3for details of the relationship between the twosets of accounts.) The structure of the capitaland financial account also is generallycompatible with other statistical systems of theIMF and is consistent with the classification ofrelated income components of the currentaccount and with the international investmentposition.

[. . .]

Financial Account

Coverage

[. . .]

315. However, options and other Financialderivatives are included among financial items;in accordance with the treatment of these itemsin the SNA. These instruments this treatment isconsistent with the SNA treatment of financialderivatives. There are active financial marketsin these instruments, and they can be valued byreference to the market prices of the derivativesthemselves or to the market prices of thecommitments real or financial items underlyingthe derivatives. Thus, Both parties to aderivative contract recognize a financialinstrument asset; one party recognizes a liabilityand the other recognizes a claim. Alternatively,this value could be viewed as the amount oneparty must pay to the other party in order toextinguish the contract. As a result, derivativessatisfy the definition (see paragraph 314) offoreign financial assets and liabilities. A fulldiscussion of financial derivatives instrumentsappears in Chapter 19 the chapter devoted tothat subject.

[. . .]

Transactions in assets

[. . .]

318. To establish whether a transactioninvolving a foreign asset is a transactionbetween a resident and a nonresident, thecompiler must know the identities of bothparties. The information available ontransferable claims constituting foreign assets

30

may not, however, permit identification of thetwo parties to the transaction. That is, acompiler may not be able to ascertain whether aresident, who acquired or relinquished atransferable claim on a nonresident, conductedthe transaction with another resident or with anonresident, or whether a nonresident dealt withanother nonresident or with a resident. Thus, arecommendation that the balance of paymentsbe confined solely to asset transactions betweenresidents and nonresidents would be difficult orimpossible to implement. Also, the introduction,in the Manual, of a domestic sectoral break-down for the portfolio investment, financialderivative, and other investment components ofthe financial account makes it necessary torecord certain transactions between residentsectors within the economy—although suchtransactions cancel each other for the totaleconomy. As a result, recorded transactions mayinclude not only those that involve assets andliabilities and take place between residents andnonresidents but also those that involvetransferable assets of economies and take placebetween two residents and, to a lesser extent,transactions that take place betweennonresidents. (See paragraph 334.)

[. . .]Net recording

324. Two or more changes in a specific asset,or changes in two or more different assetsclassified in the same standard component, areconsolidated in a single entry. This entry reflectsthe net effect of all the increases and decreasesthat occur during the recording period inholdings of that type of asset. For example,purchases (by nonresidents) of securities issuedby resident enterprises of an economy areconsolidated with sales (by nonresidents) ofsuch securities, and the net change is recordedfor that item. Net decreases in claims or otherassets and net increases in liabilities arerecorded as credits; net increases in assets andnet decreases in liabilities are recorded as debits.

There is one exception: it is recommended thattransactions in financial derivatives classified asreserve assets be recorded only as a singleamount; that is, after the change in liabilities isdeducted from the change in assets. It is recog-nized that, in practice, this approach may be theonly means by which transactions in financialderivatives classified in other categories (directinvestment and financial derivatives) can berecorded.

[. . .]

Functional types of investment

330. Four Five broad categories of investment,each of which is dealt with in a subsequentchapter, are distinguished.

Direct investment

The direct investor seeks a significant voice inthe management of an enterprise operatingoutside his or her resident economy. To achievethis position, the investor must almostinvariably provide a certain, often substantial,amount of the equity capital of the enterprise.The direct investor may also decide to supplyother capital to further enterprise operations.Because of the direct investor’s special relation-ship to the enterprise, his motives in supplyingcapital will be somewhat different from those ofother investors. Thus, the capital supplied by adirect investor will probably exhibit charac-teristic behavior. Direct investment is classifiedprimarily on a directional basis—resident directinvestment abroad and nonresident investmentin the reporting economy—and is subdividedinto equity capital, reinvested earnings, andother capital and financial derivatives. Equitycapital and other capital, in turn, are subdividedinto asset and liability transactions. (Relatedincome, however, is shown on a net basis in thecurrent account.)

31

Portfolio investment

Cross-border investment in equity and debtsecurities (other than direct investment) isboth quantitatively and analytically significant.Such cross-border investment thereforewarrants separate recording and coverage,particularly in view of the trend towards freeinternational movement of capital and thegrowth of new financial instruments and newmarket participants. Coverage of this categoryis expanded to reflect these developments andto include money market debt instruments andfinancial derivatives, as well as longer-termdebt and equity securities.

Financial Derivatives

The number and the importance of transactions(particularly those taking place outsideorganized markets) in options and forwards(including swaps) have increased in recentyears. The treatment of financial derivativesas a separate functional category reflects theirincreased importance, as well as thedifferences between financial derivatives andother types of financial instruments. Withfinancial derivatives, no capital is advanced orrepaid; nor is any interest accrued. In the firstand second printings of the BPM5, data onfinancial derivatives were formerly classifiedwithin a subcategory of portfolio investment.Compilers may continue with this approachif activity in financial derivatives is toolimited to justify presenting data on theseinstruments in a separate functional category,but compilers should separately classify dataif activity in financial derivatives is significant.

Other investment

This residual group comprises many differentkinds of investments. In practice, it is notfeasible to draw any further functionaldistinctions among the various types because

the reasons underlying the flows are toonumerous and varied. Other breakdowns aretherefore used to distinguish behavioraldifferences among components of this category(i.e., trade credits, loans, currency and deposits,use of Fund credit, loans from the Fund, etc.).

Reserve assets

These are foreign financial assets available to,and controlled by, the monetary authorities forfinancing or regulating payments imbalances orfor other purposes. Reserve assets consist ofmonetary gold, SDRs, reserve position in theFund, foreign exchange, and other claims.Changes in the holdings of reserves may reflectpayments imbalances or responses to them,official exchange market intervention toinfluence the exchange rate, and/or other actionsor influences.

[. . .]

Type of instrument

332. For portfolio investment, the type ofinstrument is the primary classification (i.e.,equity and debt securities). Debt securities aresubdivided into bonds and notes and moneymarket instruments. and financial derivatives.Although the sectoral subdivision for portfolioinvestment is secondary, there is no implicationthat, in certain instances, it may not be of equalinterest to the compiling economy. The sameholds true for financial derivatives and otherinvestment.

Domestic sector

333. For assets, the institutional sector of thedomestic (resident) creditor and, for liabilities,that of the domestic debtor often are factors thatinfluence transactions in financial items. Thesectoring also improves links with the IMF and

32

other statistical systems, including the SNA.This Manual distinguishes four sectors—monetary authorities, general government,banks, and other sectors—for both portfolioinvestment, financial derivatives, and otherinvestment.8

[. . .]

Long- and short-term investment[. . .]

8 See Appendix 2.

339. In the categories of direct investment,portfolio investment, financial derivatives,and reserve assets, long- and short-terminvestments are not formally distinguished.For direct investment, such a distinction is notmade because it is essentially determined byarbitrary enterprise decisions and because of thefact that there is no meaningful analyticdistinction between the two maturities forintercompany flows. For portfolio investment,financial derivatives, and reserve assets, formalmaturity is not likely to be a significant factoraffecting the behavior of components in thesecategories.

33

XVIII. Direct Investment

[. . .]

Direct Investment Capital

[. . .]

369. The components of direct investmentcapital transactions, which—as noted inparagraph 330—are recorded on a directionalbasis (i.e., resident direct investment abroad andnonresident direct investment in the recordingeconomy), are equity capital, reinvestedearnings, and other capital associated withvarious intercompany debt transactions, andfinancial derivatives. Equity capital comprisesequity in branches, all shares in subsidiaries andassociates (except nonparticipating, preferredshares that are treated as debt securities andincluded under direct investment-othercapital—see paragraph 370), and other capitalcontributions. Reinvested earnings consist of thedirect investor’s share (in proportion to directequity participation) of earnings not distributedas dividends by subsidiaries or associates andearnings of branches not remitted to the directinvestor. If such earnings are not identified, allbranch earnings are considered, by convention,to be distributed. Because undistributed(reinvested) earnings result in additions todirect investors’ equity in subsidiaries andbranches, these earnings are included as directinvestment capital transactions in amounts equalto (and with opposite sign) the correspondingentries recorded under direct investmentincome. (See paragraphs 278, 288, and 321.)

[. . .]

New paragraph

370a. The subcategory of direct investment–financial derivatives covers financial derivativetransactions between directors and directinvestment enterprises unless the transactionsare part of the usual banking transactionsdescribed in paragraph 372.

[. . .]

372. The recording of intercompanytransactions that (1) take place betweenaffiliated banks (depository institutions) andaffiliated financial intermediaries (e.g., securitydealers) or SPEs serving solely as financialintermediaries and (2) are recorded as directinvestment capital transactions is limited tothose transactions associated with permanentdebt (loan capital representing a permanentinterest) and equity (share capital) investmentor, in the case of branches, to transactionsassociated with fixed assets. Deposits and otherclaims and liabilities (including financialderivatives) related to the usual bankingtransactions of depository institutions andclaims and liabilities of other financialintermediaries are classified, as appropriate,within the categories of portfolio investment,financial derivatives, or other investment. Thestock of foreign assets and liabilities of banksand other financial intermediaries (internationalinvestment position) should be treated in aparallel manner.

[. . .]

34

Extent of Net Recording

375. Direct investment is often referred to asan asset for the economy of the direct investorand as a liability for the economy in which thedirect investment enterprise operates. Actually,investor and enterprise have claims on, orliabilities to, each other—although the investorcould be expected to have net foreign claimsand the enterprise to have net foreign liabilities.It is recommended in the Manual that directinvestment transactions in equity capital, andother capital (intercompany debt), and financialderivatives be recorded for assets (claims) andliabilities. Thus, in addition to a net

investment transaction for each of thesecomponents, separate entries are made forthe change in claims of direct investors on,and the change in liabilities to affiliatedenterprises. These entries are made underdirect investment-abroad and vice versa fordirect investment-in reporting economy. Forrecording direct investment in the internationalinvestment position, the same entries are made.See the table presenting the standardcomponents of the international investmentposition at the end of Chapter 23. However, asnoted in Chapter 23, the related direct invest-ment income on equity and debt is shown on anet basis for each direction.

35

XIX. Portfolio Investment

Coverage

385. Portfolio investment includes in additionto equity securities and debt securities in theform of bonds and notes and money marketinstruments. and financial derivatives such asoptions. Excluded are any of the aforementionedinstruments included in the categories of directinvestment and reserve assets. The expandedcoverage in transactions reflects changes ininternational financial markets in recent yearsand includes the introduction of many newfinancial instruments within the framework ofcontinuous innovation.[. . .]

Classification and Definitions

387. The categories of financial instrumentsclassified and defined in the Manual aregenerally consistent with those in the SNA. Themajor components of portfolio investment,which are classified under assets and liabilities,are equity securities and debt securities. Bothare usually traded (or tradable) in organized andother financial markets. Debt securities aresubdivided into bonds and notes and moneymarket instruments. and financial derivatives,including varieties of new financial instruments.[. . .]

389. Debt securities cover (i) bonds,debentures, notes, etc. and (ii) money market ornegotiable debt instruments. and (iii) financialderivatives or secondary instruments, such asoptions, that usually do not extend to actualdelivery and are utilized for hedging of risks,investment, and trading purposes.

390. Bonds, debentures, notes, etc. usuallygive the holder the unconditional right to a fixedmoney income or contractually determined

variable money income. (Payment of interest isnot dependent upon the earnings of the debtor.)With the exception of perpetual bonds, bondsand debentures also provide the holder with theunconditional right to a fixed sum as arepayment of principal on a specified date ordates. Included are nonparticipating preferredstocks or shares; convertible bonds; and bondswith optional maturity dates—the latest ofwhich is more than one year after issue. 9 Thiscategory also includes negotiable certificates ofdeposit with maturities of more than one year;dual currency bonds; zero coupon and otherdeep discounted bonds; floating rate bonds;indexed bonds; and asset-backed securities, suchas collateralized mortgage obligations (CMOs)and participation certificates. (Mortgages are notclassified as bonds but are included underloans.)

[. . .]

392. Certain financial instruments give theholder the qualified right to receive an economicbenefit in the form of cash, a primary financialinstrument, etc. at some future date. Theseinstruments are referred to as derivatives orsecondary instruments in that they are linked toeither specific financial instruments orindicators (foreign currencies, governmentbonds, share price indices, interest rates, etc.) orto particular commodities (gold, sugar, coffee,etc.) that may be purchased or sold at a futuredate. Derivatives also may be linked to a future

9 The conversion (into equities) option may be considereda tradable derivative (i.e., an asset separate from theunderlying security). See paragraph 392. Separation of thevalue of a transaction into the value of the bond and thevalue of the option may be effected by reference totransactions in similar bonds traded without options.

36

exchange, according to a contractualarrangement, of one asset for another. Theinstrument, which is a contract, may be tradableand have a market value. When that is the case,the characteristics of the instrument as acontingent asset or liability (not to be recordedin the balance of payments or in SNA sectoralbalance sheets) change and give rise totreatment of the instrument as an actualfinancial asset or liability in the financialaccount. Among derivative instruments areoptions (on currencies, interest rates,commodities, indices, etc.), traded financialfutures, warrants, and arrangements such ascurrency and interest rate swaps.

393. Transactions in derivatives are treated asseparate (mainly financial) transactions ratherthan being included as integral parts ofunderlying transactions to which they may belinked as hedges. There are several reasons forthis treatment, which is consistent with that inthe SNA. The counter party to a derivativetransaction will be a different transactor than thetransactor for the underlying transaction beinghedged. Also, the two parties to the derivativetransaction may have different motives—hedging, dealing in the instrument involved, oracquiring the derivative as an investment. Evenif both parties are hedging, the hedging may beassociated with different financial or otherassets. If derivative transactions were includedas integral parts of underlying transactions, suchtreatment would lead to asymmetries ofmeasurement in the balance of paymentsaccounts. For example, the counter party to aderivative contract that hedges an underlyingposition with a resident may also be a resident.In such an instance, the inclusion of thederivative as part of the underlying transactionwould result in the incorrect inclusion oftransactions in the balance of payments.

Selected Recording Issues

395. The expanded coverage, which includestraditional and new money market andderivative instruments and innovative long-term

securities, of portfolio investment raises issuesconcerning the recording of balance ofpayments entries associated with theseinstruments. Such issues are discussed, forselected instruments, in subsequent paragraphs.

[. . .]

398. Among money market and derivativeinstruments and arrangements, the treatments ofshort-term notes issued under NIFs, options,warrants, swaps, traded financial futures, andforward rate agreements are noted subsequently.

[. . .]

401. Options are contracts that give thepurchaser of the option the right, but not theobligation, to buy (a call option) or to sell (a putoption) a particular financial instrument orcommodity at a predetermined price (strikeprice) within a specific time span or on aspecified date. Some leading types of optionsare those on foreign currencies, interest rates,equities, commodities, specified indexes, etc.The buyer of the option pays a premium (theoption price) to the seller (writer or issuer) forthe latter's commitment to sell or purchase thespecified amount of the underlying instrumentor commodity or to provide, on demand of thebuyer, appropriate remuneration. Byconvention, in this Manual and in the SNA, thatcommitment is treated as a liability of the sellerand represents the current cost to the seller ofbuying out his contingent liability.

402. Conceptually, the payment of thepremium referred to previously includes twoelements: the purchase price of a financial assetand a service charge. In practice, it often is notpossible to identify the service elementseparately. If the latter can be distinguished, itshould be entered under financial services. Ifnot, it is recommended that the full premium berecorded in the balance of payments as theacquisition of a financial asset by the buyer andas an incurrence of a liability by the seller.Subsequent trading (sales) of options is

37

recorded in the financial account, as is theexercise or purchase/sale of the underlyingfinancial instrument. If an option actuallyproceeds to delivery, which is not the usualcase, the acquisition or sale of the underlyingasset (real or financial) is recorded at theprevailing market price in the appropriatebalance of payments component. Offsetting thatentry is the actual amount payable or receivable;the difference between that amount and theprevailing market price is reflected in an entrythat extinguishes the option contract. If anoption contract is closed out prior to delivery,the actual amount payable or receivable is offsetby the entry extinguishing the option contract.When initial margin payments and subsequentincreases or decreases are payable by the partiesto options, the payments should be recorded asboth assets and liabilities in the financialaccount under other investment, currency anddeposits in the financial account. Payments into,and withdrawals from, these accountssometimes may be reflected in transactions inthe traded options to which the accounts relateand, if so, are recorded under optiontransactions in the financial account.

403. Warrants (a particular form of option) aretradable instruments giving the holder the rightto buy from the issuer of the warrant (usually acorporation) a certain number of shares or bondsunder specified conditions for a designatedperiod of time. Warrants can be traded apartfrom the underlying securities to which thewarrants are linked and thus have a marketvalue. The treatment of warrants is the same asthat for other options, and the issuer of thewarrant is considered, by convention, to haveincurred a liability, which is the counterpart ofthe asset held by the buyer and reflects thecurrent cost of buying out the issuer's contingentliability.

404. Another variety of tradable warrant(usually issued by investment intermediaries) isa currency warrant, the value of which is basedon the amount of one currency required topurchase another currency at or before the

expiration date of the warrant. Currencywarrants and cross-currency warrants withpayments denominated in third currenciesshould be treated in a similar manner to otherwarrants.

405. A swap is a contractual arrangementinvolving two parties who agree to exchange,over time and according to predetermined rules,streams of payment on the same amount ofindebtedness. The two most prevalent varietiesof swaps are interest rate swaps and currencyswaps. An interest rate swap involves anexchange of interest payments of differentcharacter (e.g., fixed rate and floating rate, twodifferent floating rates, fixed rate in onecurrency and floating rate in another, etc.). Acurrency swap involves an exchange ofspecified amounts denominated in two differentcurrencies and subsequent repayments reflectingprincipal and/or interest. (Central bank currencyswap arrangements usually undertaken forexchange rate policy purposes and involving thetemporary exchange of deposits as of aparticular date and the reversal of thetransaction at a future date are referred to inparagraph 434.)

406. Balance of payments entries for streamsof interest payments associated with swaptransactions are recorded, on a net basis, in thecurrent account, and streams of principalrepayments are recorded in the financialaccount. Although neither party to a swaparrangement is considered to be the provider ofa service to the other, any payment to a thirdparty involved in arranging the swap is recordedunder financial services.

407. A futures contract is an agreementbetween two parties to exchange a real asset fora financial asset, or to exchange, on a specifieddate at a predetermined rate, two financialassets. Traded financial futures, including thosefor interest rates, currencies, commodities,equities, or other indices, are recorded in thefinancial account in a manner similar to therecording of options. Transactions associated

38

with nontraded financial futures are likely tooccur infrequently and are recorded under theother assets or other liabilities components ofother investment.

408. A forward rate agreement (FRA) is anarrangement according to which two partiesagree on an interest rate to be paid, on aspecified settlement date, on a notional amountof principal that is never exchanged. At thattime, the settlement payment (i.e., the differencebetween the rate agreed upon and the prevailing

market rate at the time of settlement) isrecorded as a transaction in the balance ofpayments. The buyer of the FRA receivespayment from the seller if the prevailing rateexceeds the rate agreed upon; the seller receivespayment from the buyer if the prevailing rate islower than the rate agreed upon. Thesepayments are recorded as interest income in thecurrent account of the balance payments.Because there is only a notional (not an actual)underlying asset, there are no entries in thefinancial account.

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XX. Other Investment

Coverage

411. Other investment is a residual categorythat includes all financial transactions notcovered in direct investment, portfolioinvestment, financial derivatives, or reserveassets (discussed in Chapter 21).

Classification

412. As is the case with portfolio investment,assets and liabilities for other investment areclassified primarily on an instrument basis. Thesectors of domestic creditor or debtor—thesecondary basis for the classification—aremonetary authorities, general government,banks, and other sectors. (For the definitions ofsectors, see Appendix 2.) In contrast to those fordirect investment, and portfolio investment, andfinancial derivatives, the maturity distinction(long- or short-term) for other investment is athird-level basis of classification.

413. The instrument subclassification for otherinvestment (as is that for portfolio investment) isclosely linked to the SNA categories forfinancial assets. (See Chapter 3.) While therelative importance of types of investmentdiffers considerably among economies, thetypes reflect most of the financial instrumentsand channels utilized for the acquisition ofassets and incurrence of liabilities—other thanfor direct investment, portfolio investment,financial derivatives, and reserve assets. Theinstrument classification comprises tradecredits, loans (including the use of Fund creditand loans from the Fund), currency and deposits(both transferable and other), and other assetsand liabilities (for example, miscellaneousaccounts receivable and payable).

Definitions and Recording[. . .]421. Deposits comprise both transferable andother deposits. Transferable deposits consist ofdeposits that are exchangeable on demand at parwithout restriction or penalty, freely transferableby check or giro order, and otherwise commonlyused to make payments. Deposits may bedenominated in domestic or foreign currencies.With the exclusion of transferable deposits,other deposits include comprise all claims,including repayable margins for financialderivatives, that reflect evidence of deposit.Typical examples are non-transferable savingsdeposits, time deposits; and shares (evidence ofdeposit),which are legally or practically redeem-able on demand or on short notice, in savingsand loan associations, credit unions, buildingsocieties, etc.

422. Other assets and liabilities cover anyitems other than loans and currency anddeposits. For example, capital subscriptions tointernational nonmonetary organizations areclassified under this category within thissubcomponent, as are miscellaneous accountsreceivable and payable. In countries whererepayable margins for financial derivatives arenot classified as deposits, the repayable marginsshould be recorded as other assets and liabilities.

423. As noted in paragraph 372, transactions(other than those associated with permanentdebt and equity investment) of banks and otherfinancial intermediaries in a direct investmentrelationships are included in portfolio invest-ment, financial derivatives, or other investment.Thus, loans and deposits of such institutions areincluded, as described in paragraphs 415 and421, within those components.

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XXI. Reserve Assets

Concept and Coverage

424. Reserve assets, the fourth fifth majorfunctional category of the financial account, isan important component of balance of paymentsstatistics and an essential element in the analysisof an economy’s external position. Reserveassets consist of those external assets that arereadily available to and controlled by monetaryauthorities for direct financing of paymentimbalances, for indirectly regulating themagnitude of such imbalances throughintervention in exchange markets to affect thecurrency exchange rate, and/or for otherpurposes. (See paragraphs 425 and 432.) Thecategory of reserve assets, as defined in thisManual, comprises monetary gold, SDRs,reserve position in the Fund, foreign exchangeassets (consisting of currency and deposits, andsecurities, and financial derivatives), and otherclaims. (See paragraph 443.) Securities that donot satisfy the requirements of reserve assets areincluded in direct investment and portfolioinvestment.

[. . .]

Classification

[. . .]

New paragraph

442a. Transactions in financial derivatives (forexample, forwards, futures, swaps, and options)that take place with nonresidents should berecorded in reserve assets only if suchtransactions pertain to the management ofreserve assets, are integral to the valuation ofsuch assets, and are controlled by monetaryauthorities. In addition, such financialderivatives must be highly liquid and settlementpayments must be made in foreign currency.Unlike transactions in all other items, financialderivative transactions in reserve assets shouldbe recorded after transactions in liabilitypositions are subtracted from transactions inasset positions. This method of recording willsometimes result in negative net asset positions.

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XXIII. International Investment Position

[. . . ]

Classification

464. Classification of the internationalinvestment position (and of changes to the IIP)has two dimensions. (See the table at the end ofthis chapter.) In the rows of the table, theprimary distinction is between assets andliabilities; the difference between the tworepresents the net position. Fully consistent withthe balance of payments financial account, thefirst IIP subclassification is by function. Assetsare divided into direct investment, portfolioinvestment, financial derivatives, otherinvestment, and reserve assets; liabilities aredivided the same way (except for reserveassets).

465. Within the functional categories and inconcordance with the income component of thecurrent account and with the financial accountin the balance of payments, direct investment issubdivided into equity capital plus reinvestedearnings, and other capital (intercompany debt),and financial derivatives. Claims on, andliabilities to, affiliated enterprises are shownseparately. Portfolio investment is classifiedprimarily by instrument—equity securities anddebt securities and financial derivatives—andsecondarily by appropriate sectors. Financialderivatives are classified by sector. Otherinvestment also is classified first by instrumentand then by sector. Included are Other invest-ment covers trade credits, loans, currency anddeposits, and other assets and liabilities (such ascapital subscriptions to international, nonmon-etary organizations and miscellaneous accountsreceivable and payable). Reserve assets arelargely interchangeable from a functionalstandpoint. (See paragraphs 437 through 443.)

[. . .]

Valuation of Components

[. . .]

468. Portfolio investment (equity securitiesand debt securities and financial derivatives) isvalued at current market prices at theappropriate reference dates. For equities that arelisted in organized markets or are readilytradable, the value of outstanding stocks shouldbe based on actual prices. The value of equitiesthat are not quoted on stock exchanges orotherwise traded regularly should be estimatedby using the prices of quoted shares that arecomparable as to past, current, and prospectiveearnings and dividends. Alternatively, the netasset values of enterprises to which the equitiesrelate could be used to estimate market values ifthe balance sheets of the enterprises areavailable on a current value basis. For debtsecurities that are listed in organized markets orare readily tradable, the outstanding value ofstocks also should be determined on the basis ofcurrent market prices. For debt securities thatare not readily tradable, the net present value ofthe expected stream of future payments/receiptsassociated with the securities could be used toestimate market value. (The net present value ofany future receipt is equal to the value of thatreceipt when discounted at an appropriateinterest rate.)

469. Financial derivatives are valued, for theinternational investment position, at marketprices current on appropriate reference dates. Itis recommended that gross asset and grossliability data be compiled by summing,

42

respectively, the values of all individualcontracts in asset positions and the values of allindividual contracts in liability positions. 13a Ifmarket prices data are unavailable, other fairvalue methods, such as option models ordiscounted present values, may be used to valuefinancial derivatives. Principles for valuation offinancial derivatives in the investment positionare, in some respects, less definitive than forother portfolio investment instruments. Thereare ongoing efforts by national and internationalaccounting bodies to define standards for themeasurement and recording of derivatives.Thus, in the Manual, a thorough treatment ofderivative valuation is not attempted—particularly in view of continued innovations inthis area. Rather, brief valuation guidelines thatare consistent with those in the SNA andapplicable to a number of existing derivativesare presented subsequently.

470. Traded options, warrants, and tradedfinancial futures, all of which are treated asfinancial assets, are included in the position atmarket values on the appropriate accountingdates. For an option, the market value recordedis either the current value of the option—that is,the prevailing market rate price—or the amountof the premium paid as a proxy. The counterpartliability is attributable, by convention, to thewriter of the option and is valued at the currentvalue cost of buying out the rights of the optionholder. For a warrant, the counterpart liability ofthe issuer is the current value of buying outoutlay required to buy out the exercise rights of

13a There is one exception, which pertains to reserveassets, to this recommendation. See paragraph 473a.

the holder. A contract for a currency swapA forward is recorded at market value; whenpayments are effected, the value of the asset andassociated liability is amortized andsubsequently reflected in the position on theappropriate accounting date. The market valueof a forward contract can switch from an assetposition to a liability position (and vice versa)between reporting dates. The switch is a resultof movement in the price of the underlyingitem(s) from which the value of the forward isderived. All price changes, including those thatresult in such switches of position, are treated asrevaluations. When a switch in position occurs(and there are no settlement payments), themarket value of the gross asset/liability positionat the close of the previous accounting period isrevalued to zero, and the gross liability/assetposition is revalued from zero to the marketvalue at the end of the present accountingperiod.

[. . .]

New paragraph

473a. The net marked-to-market values offinancial derivative contracts (forwards, futures,swaps and options, for example) withnonresidents should be recorded in reserveassets only if the derivative contracts pertain tothe management of reserve assets, are integral tothe valuation of such assets, and are controlledby the monetary authorities. In addition, suchderivative contracts must be highly liquid, andsettlement thereof must be executed in foreigncurrency. Unlike all other items recorded in theposition, financial derivatives—if reported asreserve assets—should be recorded after liabil-ity positions are deducted from asset positions,even if the result is a negative net asset position.

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Standard Components of the International Investment Position

Changes in Position Reflecting

Position at Exchange Other PositionBeginning Trans- Price Rate Adjust- at Endof Year actions Changes Changes ments of Year

A. Assets

1. Direct investment abroad*

1.1 Equity capital and reinvested earnings1.1.1 Claims on affiliated enterprises1.1.2 Liabilities to affiliated enterprises

1.2 Other capital1.2.1 Claims on affiliated enterprises1.2.2 Liabilities to affiliated enterprises

1.3 Financial derivatives1.3.1 Claims on affiliated enterprises1.3.2. Liabilities to affiliated enterprises

2. Portfolio investment

2.1 Equity securities2.1.1 Monetary authorities2.1.2 General government2.1.3 Banks2.1.4 Other sectors

2.2 Debt securities2.2.1 Bonds and notes

2.2.1.1 Monetary authorities2.2.1.2 General government2.2.1.3 Banks2.2.1.4 Other sectors

2.2.2 Money market instruments2.2.2.1 Monetary authorities2.2.2.2 General government2.2.2.3 Banks2.2.2.4 Other sectors

2.2.3 Financial derivatives2.2.3.1 Monetary authorities2.2.3.2 General government2.2.3.3 Banks2.2.3.4 Other sectors

*Because direct investment is classified primarily on a directional basis—abroad under the heading Assets and, in thereporting economy, under the heading Liabilities—claim/liability breakdowns disaggregations are shown for the componentsof each, although these sub-items do not strictly conform to the overall headings of Assets and Liabilities.

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Standard Components of the International Investment Position

Changes in Position Reflecting

Position at Exchange Other PositionBeginning Trans- Price Rate Adjust- at Endof Year actions Changes Changes ments of Year

3. Financial Derivatives

3.1. Monetary authorities3.2 General government3.3 Banks3.4 Other sectors

4. 3. Other investment

4. 3.1 Trade credits4. 3.1.1 General government

4. 3.1.1.1 Long-term4. 3. 1.1.2 Short-term

4. 3. 1.2 Other sectors4. 3. 1.2.1 Long-term4. 3. 1.2.2 Short-term

4. 3. 2 Loans4. 3.2.1 Monetary authorities

4. 3.2.1.1 Long-term4. 3.2.1.2 Short-term

4. 3.2.2 General government4. 3. 2.2.1 Long-term4. 3. 2.2.2 Short-term

4. 3. 2.3 Banks4. 3.2.3.1 Long-term4. 3. 2.3.2 Short -term

4. 3.2.4 Other sectors4. 3. 2.4.1 Long-term4. 3. 2.4.2 Short-term

4. 3. 3 Currency and deposits4. 3.3.1 Monetary authorities4. 3.3.2 General government4. 3.3.3 Banks4. 3.3.4 Other sectors

4. 3. 4 Other assets4. 3. 4.1 Monetary authorities

4. 3. 4.1.1 Long-term4. 3. 4.1.2 Short-term

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Standard Components of the International Investment Position

Changes in Position Reflecting

Position at Exchange Other PositionBeginning Trans- Price Rate Adjust- at Endof Year actions Changes Changes ments of Year

4. 3. 4.2 General government4. 3. 4.2.1 Long-term4. 3. 4.2.2 Short-term

4. 3. 4.3 Banks4. 3.4.3.1 Long-term4. 3.4.3.2 Short-term

4. 3.4.4 Other sectors4. 3.4.4.1 Long-term4. 3.4.4.2 Short-term

5. 4. Reserve assets

5. 4. 1 Monetary gold5. 4. 2 Special drawing rights5. 4. 3 Reserve position in the Fund5. 4. 4 Foreign exchange

5. 4. 4.1 Currency and deposits5. 4. 4.1.1 With monetary authorities5. 4. 4.1.2 With banks

5. 4. 4.2 Securities5. 4. 4.2.1 Equities5. 4. 4.2.2 Bonds and notes5. 4. 4.2.3 Money market instruments and financial derivatives

5.4.3 Financial derivatives (net)5. 4. 5 Other claims

B. Liabilities

1. Direct investment in reporting economy*

1.1 Equity capital and reinvested earnings1.1.1 Claims on direct investors1.1.2 Liabilities to direct investors

1.2 Other capital1.2.1 Claims on direct investors1.2.2 Liabilities to direct investors

1.3 Financial derivatives1.3.1 Claims on direct investors1.3.2 Liabilities to direct investors

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Standard Components of the International Investment Position

Changes in Position Reflecting

Position at Exchange Other PositionBeginning Trans- Price Rate Adjust- at Endof Year actions Changes Changes ments of Year

2. Portfolio investment

2.1 Equity securities2.1.1 Banks2.1.1 Other sectors

2.2 Debt securities2.2.1 Bonds and notes

2.2.1.1 Monetary authorities2.2.1.2 General government2.2.1.3 Banks2.2.1.4 Other sectors

2.2.2 Money market instruments2.2.2.1 Monetary authorities2.2.2.2 General government2.2.2.3 Banks2.2.2.4 Other sectors

2.2.3 Financial derivatives2.2.3.1 Monetary authorities

2.2.3.2 General government2.2.3.3 Banks2.2.3.4 Other sectors

3. Financial Derivatives

3.1. Monetary authorities3.2 General government3.3 Banks3.4 Other sectors

4. 3 Other investment

4. 3.1 Trade credits4. 3.1.1 General government

4. 3.1.1.1 Long-term4. 3.1.1.2 Short-term

*Because direct investment is classified primarily on a directional basis—abroad under the heading Assets and, in thereporting economy, under the heading Liabilities—claim/liability breakdowns disaggregations are shown for the componentsof each, although these sub-items do not strictly conform to the overall headings of Assets and Liabilities.

47

Standard Components of the International Investment Position

Changes in Position Reflecting

Position at Exchange Other PositionBeginning Trans- Price Rate Adjust- at Endof Year actions Changes Changes ments of Year

4. 3.1.2 Other sectors4. 3.1.2.1 Long-term4. 3.1.2.2 Short-term

4. 3.2 Loans4. 3.2.1 Monetary authorities

4. 3.2.1.1 Use of Fund credit and loans from the Fund4. 3.2.1.2 Other long-term4. 3.2.1.3 Short-term

4. 3.2.2 General government4. 3.2.2.1 Long-term4. 3.2.2.2 Short-term

4. 3.2.3 Banks4. 3.2.3.1 Long-term4. 3.2.3.2 Short-term

4. 3.2.4 Other sectors4. 3.2.4.1 Long-term4. 3.2.4.2 Short-term

4. 3.3 Currency and deposits4. 3.3.1 Monetary authorities4. 3.3.2 Banks

4. 3.4 Other liabilities4. 3.4.1 Monetary authorities

4. 3.4.1.1 Long-term4. 3.4.1.2 Short-term

4. 3.4.2 General government4. 3.4.2.1 Long-term4. 3.4.2.2 Short-term

4. 3.4.3 Banks4. 3.4.3.1 Long-term4. 3.4.3.2 Short-term

4. 3.4.4 Other sectors4. 3.4.4.1 Long-term4. 3.4.4.2 Short-term

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Appendix I. Relationship of the Rest of the World Account to theBalance of Payments Accounts and the International Investment Position

[. . .]

Conversion Procedures

[. . .]

Classification and Linkages

[. . .]

511. Coverage of account V.III.2, the SNAfinancial account, is identical with that of thefinancial account of the capital and financialaccount in the balance of payments, althoughthe level of detail is different. (See Table 4 atthe end of this appendix.) In the SNA, financialassets are classified primarily by type of instru-ment. In the balance of payments, financialitems are classified primarily by function: direct

investment, portfolio investment, financialderivatives, other investment (including loans),and reserve assets. In addition to categoriesidentifying types of financial instruments(insurance technical reserves being anexception), the balance of payments contains anabbreviated breakdown disaggregation by sector(monetary authorities, general government,banks, and other sectors) to provide links withother bodies of economic and financial statisticssuch as money and banking, governmentfinance, international banking, and externaldebt. Furthermore, to conform with the SNA, theManual states that entries in the financialaccount of the balance of payments arerecorded, in principle, on a net basis (increasesless decreases in assets or liabilities). However,gross recording is included as supplementaryinformation (for example, in the case ofdrawings and repayments on long-term loans).

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Appendix II. A Note on Sectors

512. As presented in the Manual, thesectorization of the balance of paymentsportfolio investment, financial derivativesand other investment accounts and relatedcomponents of the international investmentposition strengthens the links between the

international accounts, the SNA, and IMFstatistical systems such as money andbanking, government finance, and inter-national banking. In addition, the sectorizationenhances the analytic usefulness of theaccounts.

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Appendix V. Selected Issues in Balance of Payments Analysis

[. . .]

General Framework

[. . .]

556. In addition to current transactions(i.e., those involving the exchange of goods,the provision of services, and the receipt andpayment of income and transfers), the flow offinancial transactions (i.e., those involvingchanges in financial claims on, and liabilitiesto, the rest of the world) must be analyzed. Asnoted in chapters 8 and 16, these transactionshave two main components: (i) narrowlydefined financial transactions in directinvestment, portfolio investment, financialderivatives, and other investment (including

trade credits, loans, and deposits) and(ii) transactions in reserve assets. There aredirect linkages between these components of acountry’s international transactions. Forexample, imports of goods are often financedby nonresident suppliers so that an increase inimports will typically be matched by a financialinflow. At the expiration of the financingperiod, the payment to the nonresident supplierwill involve either a drawdown of foreign assets(e.g., foreign deposits held by domestic banks)or the replacement of the liability to thenonresident supplier by another liability tononresidents. There are also close connectionsbetween many financial account transactions.For example, the proceeds from the sale ofbonds in foreign capital markets (a financialinflow) may be temporarily invested abroad inshort-term assets (a financial outflow).