Definition
A negotiable instrument is a legally binding document that guarantees the payment of a specified amount of money either on demand or at a set future date. Examples include checks, promissory notes, and bills of exchange. They are transferable by endorsement or delivery, allowing the holder in due course to claim the amount specified therein.
Key Takeaways
- A Negotiable Instrument refers to a legal document guaranteeing the payment of a specific amount of money, either on demand, or at a set time, with the payer named on the document.
- Checks, promissory notes, bill of exchange, bank drafts, and certificates of deposit are commonly used types of negotiable instruments. These instruments can be transferred from one person to another.
- They are transferable by delivery or by endorsement and delivery. Upon transfer, the holder in due course obtains a good title to the instrument. However, it’s crucial to note, if the instrument is dishonored, the holder has a right to sue all those whom he endorses.
Importance
Negotiable Instruments play a critical role in the finance world due to their flexibility, transferability, and their function as a reliable promise to pay a certain amount to the bearer or to a specified person.
They facilitate trade and commerce by providing a secure and trustworthy payment system.
These instruments, such as checks, promissory notes, and bills of exchange, are essentially a contract in tangible form that guarantees payment to the holder by a specified date, thereby reducing risk.
Their ability to be endorsed to different parties makes them a practical financial tool, enabling easy transactions and creating liquidity for businesses and individuals alike.
Hence, negotiable instruments are an essential part of contemporary finance.
Explanation
Negotiable Instruments serve a crucial purpose in the sphere of financial transactions, essentially functioning as a ‘substitute for money’ and acting as a tool for the payment of money. They are written contracts that promise a specified amount of money to a specified person, thus facilitating trade and commerce by eliminating the need to deal with hard cash. Examples include checks, drafts, promissory notes, and certificates of deposit.
The key feature of a negotiable instrument is its transferability; it can be transferred from one person (the original payee or holder) to another (the new payee or holder), and the person who ends up with the instrument has the right to claim the money promised by it. Negotiable Instruments are mainly used for conducting commercial or financial transactions. The ease of transport, the legal protection they confer, and the trust they inspire among traders are critical reasons why they have been relied upon for centuries to settle transactions.
For example, using checks, a type of negotiable instrument, a person can pay for goods and services without having to carry around large sums of cash. Instead, they write the check for the agreed-upon amount, and the receiver can then either cash it in or, via endorsement, pass it onto someone else. Thus, negotiable instruments continue to serve as an efficient, secure means of executing transactions.
Examples of Negotiable Instruments
Checks: Perhaps the most common example of a negotiable instrument, a check is a written document which an individual can use to order the bank to pay a particular amount to the person named or to the bearer of the instrument.
Promissory Notes: These are a type of negotiable instrument where one person promises to pay another person a certain sum of money at a specific future date or on demand. A common example would be a student loan where the student promises to pay back the loan to the educational institution or bank at a certain date in the future.
Bills of Exchange: They are like a sophisticated version of a check. A bill of exchange is an unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or at a fixed or determinable future time a sum certain in money to order or to bearer. It’s common practice international trade, where an exporter sells goods on credit to a foreign importer.
Frequently Asked Questions about Negotiable Instruments
What is a Negotiable Instrument?
A Negotiable Instrument is a document guaranteeing the payment of a specific amount of money, either on demand, or at a set time, with the payer named on the document.
What are the types of Negotiable Instruments?
There are several types of Negotiable Instruments. The most common ones include checks, promissory notes, and banknotes (also known as a bill or a draft). Bills of exchange and drafts require the payer to pay the amount to a third party.
Why are Negotiable Instruments important?
Negotiable Instruments serve various purposes in the financial world. They are often used in business transactions to make payments, as a credit instrument, and as a means to transfer funds. It provides certainty and predictability in commercial transactions.
What is the process of Negotiation in Negotiable Instruments?
Negotiation typically involves the transfer of possession of the negotiable instrument to a new party who becomes the holder. If an instrument is ‘to order’ it gets negotiated by endorsement and delivery, and if an instrument is ‘bearer’ it negotiates by delivery.
What are the conditions for an instrument to be negotiable?
The instrument must be in writing and signed by the maker or drawer. It should contain an unconditional promise or order to pay a certain sum of money and no other promise, order, obligation, or power given by the maker or drawer. The payment should be on demand or at a definite time. The instrument does not cease to be negotiable if it is post-dated or ante-dated.
Related Entrepreneurship Terms
- Promissory Note
- Bill of Exchange
- Cheque
- Bearer Bond
- Bank Draft
Sources for More Information
- Investopedia : A comprehensive resource with information about virtually every financial topic imaginable. For topics on negotiable instruments, use their internal search function.
- The Balance : A personal finance website with a focus on practical advice. It also includes informational articles on a wide range of finance topics.
- Legal Information Institute – Cornell Law School : An extremely useful resource for understanding the legal aspects of negotiable instruments and other financial matters.
- JSTOR : A digital library for scholars, researchers, and students. JSTOR provides access to thousands of academic papers and articles and is a good resource for in-depth study on the topic of negotiable instruments.
