Financial Instruments

Question 1

Types of Hedges carried out using Derivatives

Answer 1

• FV Hedge
• Cash flow hedge
• Foreign currency hedge

Question 2

Financial Instrument Assets

Answer 2

• Cash & cash equivalents
• Accounts Receivable
• Investments in debt & equity
• Interest in partnerships
• Option contracts with favorable terms
• Future’s & forward contracts with favorable terms
• Swap contacts with favorable terms

Question 3

Financial Instrument Liabilities

Answer 3

• Accounts payable
• Notes & Bonds payable
• Option contract with unfavorable terms
• Future’s & forward contracts with unfavorable terms
• Swap contracts with unfavorable terms

Question 4

When derivatives are use for speculative purposes

Answer 4

Intent is not to hedge an existing position but rather to make a profit

Question 5

Financial Instrument Disclosure

Answer 5

• Significant concentrations and the maximum amount is risk and measured at gross FV
• FV disclosure can be in body of financial statements or in the notes
• If FV disclosure is not practicable describe why and include info relevant to estimating FV

Question 6

Characteristics of a Derivative

Answer 6

• Has an underlying and a notional amount or a payment provision
• Requires no or very small investment
• Permits or requires settlement in cash, instead of delivery of the underlying

Question 7

Underlying - Specified price or rate

Answer 7

• Stock price
• Commodity price
• Foreign currency exchange rate

Question 8

Notional Amount - Specified unit of measure

Answer 8

• Shares of stock
• Pounds or bushels of a commodity
• Number of foreign currency units

Question 9

Examples of derivatives

Answer 9

• Option contract: a right to buy or sell
• Futures contract: obligation to buy or sell in the future at a price set now through a clearhouse or exchange
• Forward contract: obligation to buy or sell in the future at a price set now directly between contracting parties
• Swap contact: exchange in cashflow stream usually associated with interest or debt; fixed interest payments for variable rate payments

Question 10

Recognition & Measurement of Derivatives

Answer 10

• Either recognized as asset(contractual right) or liability (contractual obligation)
• Measured at FV
• change in FV results in gain or loss in earnings unless meets specific criteria or hedging

Question 11

Embedded Derivatives

Answer 11

• Can be embedded in a “host” contract like debt instruments, equity instruments and leases
• If embedded derivative meets definition of a derivative then may need to bifurcate

Question 12

Perfect Hedge

Answer 12

No risk of future gain or loss

Question 13

Intrinsic Value of Call Option

Answer 13

Difference between the exercise(strike) price and the market price.

Question 14

Hedges of foreign currency risks can be the hedge of

Answer 14

Can be either the risk to fair value in the foreign currency or the risk to cash flows in the foreign currency

Question 15

Derivative instrument purposes

Answer 15

• Hedging purposes

- Speculative purposes

Question 16

Derivative instruments can be used only to hedge FV or or cash flow

Answer 16

Both

Question 17

Which one of the following is an item for which risk associated with the item cannot be hedged for accounting purposes?

Answer 17

The fair value of an investment accounted for using the equity method of accounting is specifically excluded as being eligible to be hedged for accounting purposes under U.S. GAAP

Question 18

FV Hedges

Answer 18

Compare change in FV of hedged items and change in value of contract

Question 19

FV ineffectiveness

Answer 19

Difference in the change in value of hedged item and contract

Question 20

Firm Commitment

Answer 20

Occurs when an entity has a contractual obligation or contractual right, but no transaction has been recorded

Question 21

In a cash flow hedge, the item being hedged is measured using

Answer 21

Measured using the present value of expected cash inflows or cash outflows

Question 22

Cash Flow hedge

Answer 22

Hedge of an exposure to variability (changes) in the cash flow associated with a (recognized) asset, liability, or a forecasted transaction due to a particular risk. A cash flow hedge converts a floating price to a fixed price.

Question 23

Forecasted transaction

Answer 23

A forecasted transaction is a planned or expected transaction which has not yet been recognized, but which is subject to the risk of changes in related cash flow. As such, the cash flow (inflow or outflow) associated with forecasted transactions can be hedged.

Question 24

Foreign Currency Hedges

Answer 24

• Forecasted transaction denominated in a foreign currency: cash flow hedge
• Firm Commitment denominated in a foreign currency: Fair value
• ## Investment if AFS: FV hedge

Question 25

When derivatives are used for cash flow or FV where are they recorded

Answer 25

• Cash flow: Accumulated Comprehensive Income

- FV: Income Statement

Question 26

Gain or loss in earnings or AOCI

Answer 26

Must be disclosed

Question 27

Notional Amount and IFRS

Answer 27

IFRS doesn’t recognize the notion

Question 28

The process of bifurcation

Answer 28

Bifurcation is the process of separating an embedded derivative from its host contract