5.01- Financial Instruments and Derivatives Flashcards
What are the three types of FINANCIAL INSTRUMENTS?
- Cash
- Ownership interests in equity
- Derivative contracts that create a right or obligation
How should investments in marketable securities and all derivatives be valued?
Fair market value
How should notes and loans receivable or payable be valued?
Amortized cost
What are the three reason entities acquire DERIVATIVES?
- Investments
- Arbitage
- Hedging
What is ARBITAGE?
The ability to take advantage of price differentials.
potential profitability without the risk
What is a HEDGE?
A derivative that reduces or eliminates the risk of price fluctuation.
When using a derivative as an investment, what is the primary goal? What is the biggest risk?
- To Gain money
- Losing money
What is the primary goal of a HEDGE?
To make sure you do not gain or lose money. (no risk!)
Are DERIVATIVES assets or liabilities?
They can be either!
What are DERIVATIVES reported at?
Fair value
Where are unrealized gains and losses generally recognized for DERIVATIVES? What is the exception?
- Income
- Cash flow hedges are recognized in OCI
What are the three CHARACTERISTICS of DERIVATIVES?
(NUNS)
- No net investment
- Underlying and Notional amounts
- net Settlement
Why are derivatives considered to have “no net settlement”
There is no real investment being made, since losses are being swapped with gains and gains are being swapped with losses.
What is the NOTIONAL AMOUNT?
The number of units.
What is the UNDERLYING AMOUNT?
The factor that affects the derivatives value.
