In today’s modern financial world, credit instruments play a vital role in facilitating transactions and providing financial flexibility. These instruments enable lenders and borrowers to establish credit relationships, allowing individuals and businesses to manage their cash flows effectively. In this article, we will explore the different types of credit instruments and their significance in various financial transactions.
What are Credit Instruments?
Credit instruments refer to various financial contracts that allow individuals, businesses, and governments to borrow or lend money. These instruments provide a legal framework for the repayment of borrowed funds, along with any interest or fees charged. In essence, credit instruments are IOUs that specify the terms, conditions, and obligations of the borrowing and lending parties.
The Main Types of Credit Instruments
1. Loans
Loans are one of the most common types of credit instruments used by individuals and businesses. In a loan agreement, the lender provides a specific amount of money to the borrower, who promises to repay the principal amount along with interest within a predetermined timeframe. Loans can be secured, meaning they are backed by collateral, or unsecured, relying solely on the borrower’s creditworthiness.
2. Bonds
Bonds are debt securities issued by corporations, municipalities, and governments to raise capital. When an investor purchases a bond, they are essentially lending money to the issuer for a fixed period of time. The issuer promises to repay the principal amount upon maturity and pays periodic interest known as coupon payments to the bondholder. Bonds are commonly used by entities to finance long-term projects or manage short-term cash flows.
3. Letters of Credit
A letter of credit (LOC) is a credit instrument often used in international trade transactions. It serves as a guarantee from a bank to a seller that the buyer will make the payment upon fulfillment of certain conditions. The bank undertakes the payment obligation in case the buyer fails to fulfill their contractual obligations. Letters of credit reduce risk and provide assurance to the parties involved in cross-border trade.
4. Credit Cards
Credit cards are revolving credit instruments that allow cardholders to borrow funds from a financial institution up to a predetermined credit limit. Cardholders can make purchases or withdraw cash against the available credit line. The borrowed amount must be repaid within a specific period to avoid interest charges. Credit cards offer convenience and flexibility but require responsible usage to avoid accumulating high debt.
5. Mortgages
Mortgages are credit instruments specifically designed for real estate transactions. Typically, individuals borrow money from a lender to purchase a property, and the property itself serves as collateral for the loan. The borrower makes regular mortgage payments to repay the principal along with interest over an agreed-upon period. Mortgages provide individuals with the opportunity to own homes while spreading the cost over an extended period.
Conclusion
Credit instruments are fundamental to the functioning of modern economies, as they provide individuals, businesses, and governments with the means to borrow and lend money. Whether it’s a loan, bond, letter of credit, credit card, or mortgage, each type of credit instrument serves a specific purpose and carries its own set of terms and conditions. By understanding the different types of credit instruments, individuals and businesses can make informed financial decisions and effectively manage their cash flows.
There are following two types of credit instruments.
Kinds of Instruments
Negotiable Non-negotiable
Instruments Instruments
- NEGOTIABLE INSTRUMENTS:
These are such credit instruments whose rights can be transferred to any other person. The rights of these instruments may be transferred by endorsement or delivery (e.g.) cheque, promissory note, bills of exchange and bank draft etc.
- NON-NEGOTIABLE INSTRUMENTS:
These are such instruments whose rights cannot be transferred to any other person, (e.g.) Banker’s letters of credit, money order and postal order etc.
NEGOTIABLE INSTRUMENTS & ITS CHARACTERISTICS
INTRODUCTION:
The word “negotiable ” means “transferable ” from one person to another in return for consideration and the word “instrument” means “a written document ” by which a right is created in favour of some person. So the term “Negotiable Instrument” means a written document transferable by delivery.
[CHAPTER-13] NEGOTIABLE INSTRUMENTS (I)277
DEFINITION:
“A negotiable instrument means a promissory note, bill of exchange or cheque either to order or to bearer”.
(Sec. 13 of Negotiable Instrument Act)
The Act expressly recognizes only three negotiable instruments i.e.,
- Promissory Note.
- Bill of Exchange, and
[CHARACTERISTICS!
A negotiable instrument must possess the following characteristics:
- T ransferability:
Negotiable means transferable and negotiable instrument can be transferred by endorsement or mere delivery. When a negotiable instrument is transferred from one person to another, the ownership of such instrument also passes.
- Title of Transferee:
The transferee should take reasonable steps to examine the title of transferor even then the title of transferor proves defective no burden falls on the transferee.
- Entitled to Receive Payment:
When a negotiable instrument is transferred then the transferee gets the right or entitled to receive the payment from the debtor.
- Sue in his Own Name:
If a debtor defaults then the transferee can recover the amount by filing a suit against debtor in his own name.
- Nature:
Negotiable instrument is unconditional and only contains the order or promise for the payment of money on demand or at a fixed future date.
CHEQUE
INTRODUCTION:
A cheque (French word) was originated in the 1st century BC and then evolved under various imperial financial systems of the Persians, Arabs, Mongols and the Chinese. The cheque was known by many names in history such as prescription, Akas and check. Edmond Wareupp draws the earliest known handwritten cheque on Thomas Effowlds (a goldsmith) in
thefavour of Samuel Howard in August 1675. It is believed that cheques m printed form were issued between 1749 to 1759 for the first time. In China the cheque was introduced in 1807 A.D. Italy, Spain, France and England played important role in the development of cheque. Now, evci commercial bank prints cheques itself in particular colour and size an<l issues it to accountholder in form of chequebook for the withdrawal <»l money from bank.
DEFINITIONS:
- “Cheque is a bill of Exchange drawn on a specified bank and not
expressed to be payable otherwise than on demand”.
(Sec. 6 of Negotiable Instrument Act 18811 (ii) A cheque is an unconditional order in writing, drawn on u specified bank, signed by drawer, directing the bank to pay him on demand a certain sum of money or to a certain person.
(Dr. Hartj (Hi) Acheque is a written order by which the customer requires hi\ bank to repay the money which has been deposited with him or in other words, a cheque is a document which is used to withdraw money from the bank.
(Comprehensively} Main Points of Definition
- An unconditional order in writing.
- Given to a specified bank.
- For the payment of money on demand.
To the depositor or certain person.