FAR Deck 2

Question 1

Put options

Answer 1

— Right to sell the stock to a given party

— Expect stock will decline in value

— Exercise if FMC of stock < Strike price

                  Strike price : predetermined price

*A put option is purchased to limit any potential losses or for speculative purposes when the investor belives the stock may decline in value.

Question 2

Call options

Answer 2

— Right to buy the stock from a given party

— Expect stock will increase in value

— Exercise if FMV of stock > strike price

              *Strike price : predetermined price*

Question 3

Interest rate risk

Answer 3

Interest rate risk is the risk of exchanging a lower interest rate for a higher rate.

Question 4

Credit risk

Answer 4

The risk that the counterparty might default on the agreement.

Question 5

Interest rate swaps

Answer 5

An interest rate swap is derivative contract that allows two parties to exchange a stream of variable IR payments with fixed-rate payment.

It allows companies to hedge exposure to changes in IR.

A company can use an IR swap as a cash flow hedge to convert its variable financing to convert its variable-rate financing into a fixed rate.

Question 6

Simplifed Hedge Accounting

Answer 6

— The variable rate on the debt and the variable rate on the Interest rate swap must be lined to the same index.

— The IR swaps FV must be close or equal to zero

— The notional amount must be less than or equal to the debt’s principal balance.

Question 7

5 Step Revenue Recognition Proces

Answer 7

1. Identify contracts with customers
2. Identify separate performance obligations

3, Determine total consideration

4. Allocate total consideration
5. Recognize revenue when or as performance obligations are satisfied

Question 8

Reclassifications (transfers) of debt securities

Answer 8

Trasfer to trading &raquo_space;> Revalued @ FMV &raquo_space;> recognized in earnings

Transfer from trading &raquo_space;» Revalued @ FMV &raquo_space;»> already been recognized in earnings and do not need to be reversed

From AFS to HTM&raquo_space;» Revalued @ FMV &raquo_space;» Recognized in OCI; transferred to AOCI and amortized over remaining life

From HTM to trading&raquo_space;» Revalued @ FMV &raquo_space;» Recognized in OCI

Question 9

Fair Value characteristics

Answer 9

MOST

M : Market-based measure

O : Orderly transaction at a specific measurement date

S : Sale of asset or transfer of liability (i.e. exit price)

T : Three levels of input called the fair value hierarchy
Level 1 - observable inputs (quoted prices) in active markets of identifical items
Level 2 - for similar items
Level 3 - unobserable assumptions to determine FV

Question 10

Construction in progress (CIP)
Also called Costs and profits

Contract price and % to completed calculations

Answer 10

Total contract profit = Contract price - Total estimated costs

% to Complete = Costs incurred to date / Total estiminated costs

Question 11

Changes to current and quick ratios

Answer 11

If quick assets and current liabilities increases by the same amount:
If ratio > 1, the ratio will decrease
If ratio is < 1, the ratio will increase

If quick assets and current liabilities decreases by the same amount:

Question 12

Changes to current and quick ratios

Answer 12

If quick assets and current liabilities increases by the same amount:
If ratio > 1, the ratio will decrease
If ratio is < 1, the ratio will increase

If quick assets and current liabilities decreases by the same amount:
If ratio is > 1, the ratio will increase
If ratio is < 1, the ratio will decrease

Question 13

Dividends per share payout ratio

Answer 13

Dividents per share / Earnings per share

*Measues dividents distributed per share

Question 14

Earnings per share

Answer 14

Net income - Preferred dividends / Weighted-average common shares outstanding

*Measures net income earned per share

Question 15

Bond Premium amortzation formula

Answer 15

Equals the cash interest payment (face vaue x stated rate) less the interest income recorded (carrying value (CV) x effective interest rate).

Question 16

Forward exchange contracts

Answer 16

Forward exchange contracts are used when an entity agreees to exchange one currency for another at a specific exchange rate on a specific date in the future.

They are valued using forward rates (i.e. expected future exchange rates).

Gains and losses on forwards used as fair value hedges are recorded in the income statement.

Unrealized forward gains and losses from cash flow hedges are recorded in other comprehensive income.

Gains and losses on forwards used for speculation are recorded in the income statement.

Question 17

What are the 3 types of currencies?

Answer 17

1. Transactional currency : the currency used in a specific transaction.
2. Functional currency : the currency with the greatest economic impact on the company (usually the subsidiary’s local currency).
3. Reporting currency : the currency used for the financial statements (usually the parents local currency).

• ** When these currencies differ, it is necessary to convert them from recording and reporting of accounting information. The transactional currency must first be converted to the functional currency (ie. remeasurement). Remeasurmenet gains and losses are recognized on the income statement.

The functional currency must then be converted to the reporting currency (translation). Translation gains and losses are recognized as other comprehensve income (OCI) on the consolidated balance sheet.

Question 18

Financial statement translation process

Answer 18

Step 1: Translate income statement items (provides translated net ncome)

      - - Revenue and expenses : Weighted average rate
      - - Gains/losses on fixed assets : Transaction date rate

Step 2: Translate balance sheet items

      - - Asset & Liabilities : Rate on balance sheet date 
      - - Capital accounts : Historical rates

Step 3: Roll forward retained earnings

       -- Translated net income is closed to retained earnings : No exchange 
       rate used
       --- Dividends translated : rate on devidend date
       ---- Result is current periods ending retained earnings  : no exchange 
       rate used

Step 4: Recognize translation adjustement in other comprehensive income
No activity and no exchange rate used

Question 19

What happens when the spot rate increases or decreases?

Answer 19

If the spot rate decreases, a foreign currency gain is recorded.

If the spot rate increase, a foreign currencny loss is recorded.

Question 20

Foreign currency gains and losses

Answer 20

Transaction date : record receivables and payables at exchange rate

• If exchange rate increases : receivables have an exchange gain and payablaes have an exchange loss
• If exchange rate decreases : receivables have an exchange loss and payables an exchange gain.

Settlement date and year end adjust for change in exchange rate

Question 21

Remeasure VS Translate foreign currency

Answer 21

A transaction that occurs in a currency other than the entitys functional currency is REMEASURED to match the transactional cash flows with currency rate changes as if the transaction had occured in the functional currency.

If the entitys functional currency is different from its REPORTING currency, reporting date account balances are TRANSLATED from the functional currency into the reporting currency.

BOTH remeasurement and translation procedures are required when the U.S. dollar is not the functional currency.

1. Remeasurement is used first to convert the transactional currency to the functional currency. Remeasurment gains and losses are reported in the income statement.
2. The functional currency is then converted to the reporting currency (i.e. translation). Translation gains and losses are recognized as accumulated other comprehensive income (ACOI) on the consolidated balance sheet.

Question 22

Exchange rate loss and gain

Answer 22

The exchange rate goes increases or is a gain, when the dollar amount decreases.
(i.e 1.25 to 1.15)

The exchange rate goes down or is a loss, when the dolla when the dollar amount increases.
(i.e. $1.25 to $1.35)

Question 23

Retained earnings

Answer 23

Retained earnings is the accumulated earnings since inception of the income that have not been paid out to shareholders in the form of a dividend.

At the end of each accounting year, net income is closed into retained earnings.

Retained earnings is periodically reduced for dividends.

Question 24

Times interest earned ratio

Answer 24

Earnings before interest and taxes (EBIT) / Interest exepnse

Question 25

Asset Valuation Account

Answer 25

If the FV is LOWER than the original cost (due to market conditions) the difference is CREDITED to AFS securities unrealized losses, a contra account to the investment.

If the FV is GREATER than the original cost, AFS securities-unrealized gains, an adjunct account (to the investment) is DEBITED