Like direct investments, portfolio investments are a form of international capital flows, which is reflected in the balance of payments.
Portfolio investment is a group of balance of payments items showing the relationship between residents and non-residents in connection with the sale of financial instruments that do not give the right to control the object of investment.
From the point of view of the balance of payments, portfolio investments are of two main types:
securities providing participation in capital (equity securities) – shares, shares, ADRs (American depositary receipts – receipts for foreign shares deposited in US banks) confirming participation in the capital of enterprises; debt obligations (debt securities) – bonds, money market instruments and financial derivatives that confirm the creditor’s right to recover debt from the debtor.
Bonds, unsecured debt and other debt obligations, as a rule, give their owners an unconditional right to receive some cash income, the amount of which is either fixed by the contract or changes in accordance with its terms. Unlike securities that provide participation in capital, interest payments on debt obligations do not depend on the level of the debtor’s current income. The concept of bonds also includes non-voting preferred shares, convertible bonds, providing for the possibility of converting them into shares, negotiable certificates of deposit with a payment term of more than a year; double-currency bonds; bonds with a zero coupon and a deep discount, initially placed at a price lower than repayment and not providing for regular interest payments; bonds with a floating interest rate; indexed securities, interest payments for which are tied to any price index, exchange rate or price of a particular product; as well as securities secured by a particular type of collateral (gold, currency, real estate, etc.).
Money market instruments usually also give their owners the right to receive a fixed amount of money on time. The main sign of money market instruments is that they are usually sold and bought in organized markets at a price lower than the repayment price. The difference between them depends on the market interest rate and on the maturities. In addition, the state can regulate the volume and composition of such securities in order to manage liquidity, maintain the exchange rate or finance the budget deficit. Treasury bills, securities of private enterprises and banks, bank acceptances, negotiable certificates of deposit, short-term debt obligations with bank support (note issuance facilities, NIFs) are considered to be money market instruments. The latter include short-term liabilities issued by the borrower on his own behalf on the basis of an agreement with the bank on his obligation to place the entire issue of such securities or to buy an undelivered part. Thus, this mechanism is a form of revolving loan, and securities are called euronota or debt receipt.
Securities are considered financial derivatives, the terms of circulation and the prices of which are tied to primary securities or macroeconomic indicators (treasury bills, foreign currency, interest rate, price indices) either for certain exchange goods (gold, sugar, coffee, etc.). However, financial derivatives may apply on the market and have an independent market value that is independent of the value of primary assets. Therefore, despite the fact that the derivatives are somehow tied to the primary financial instruments, within the financial account of the balance of payments, transactions with derivatives are allocated to an independent group and their accounting is carried out separately from the accounting of the underlying primary securities. Among the most typical derivatives, transactions with which are recorded in the balance of payments, the following:
Option (option) – a contract giving the buyer the option to buy (option “call”) or sell (option “put”) a certain amount of financial instruments or goods at a predetermined price within a certain period of time. Among the most common options are currency, interest, commodity, stock options, options with exchange indices, etc. The option buyer pays the seller a bonus, and the seller agrees to buy / sell the agreed amount of financial instruments or goods with which the option is associated, or at the request of the buyer to provide him with appropriate monetary compensation. The premium consists of the price of the acquired financial asset and service charges; Warrant (warrant) – form of option, giving the right to its holder to buy from the seller of a certain number of shares and bonds on specially agreed terms for a certain period of time. Varrant can be sold separately from the security in connection with which it is issued, and have an independent market value. One of the varieties of warrants is a currency warrant, the value of which is defined as the amount of one currency that will be needed in order to buy a fixed amount of another currency by the time the term of the warrant expires; Swap (swap) is an agreement under which participants exchange payments on the same amount of debt on pre-agreed terms. Interest swaps provide for the exchange of interest payments in various forms, for example, fixed on a floating interest rate, a fixed rate in one currency on a floating rate in another, etc. Currency swaps involve the exchange of cash amounts expressed in different currencies (for example, deposits between central banks), followed by a reverse exchange of payments and interest payments; Futures is an agreement providing for the exchange of a real asset, owned by one of the parties, for a financial asset belonging to the other party, or the exchange of two financial assets within the time period specified in the agreement and at a predetermined rate. Futures are interest, currency and commodity, there are futures for stocks and stock indexes; Forward is an agreement concluded with the aim of insuring against losses in case of changes in interest rates, within which the parties agree on a interest rate on a certain contingent amount of debt that must be paid on time. If the actual interest rate on the market exceeds that established in the contract, the seller of the contract pays compensation to the buyer and vice versa.
In the balance of payments, interest payments for all derivatives are recorded in the current account, and payments of the principal amounts are recorded in the financial account. Registration of securities transactions occurs at market prices. But any changes in market value that have taken place during the period while these instruments belonged to the owners – as a result of changes in the exchange rate, relative prices, etc. – are not taken into account. The difference between the market value of assets at the beginning and at the end of the period may reflect transactions made during the reporting period, or changes in asset prices at that time.