Hedge Derivities

Question 0

The general criteria for a hedging instrument are that

Answer 0

Sufficient documentation must be provided at the beginning of the process and the hedge must be “highly effective” throughout its life

Question 1

Hedge accounting is permitted

4 types

Answer 1

1 unrecognized firm commitments
2 available for sale securities
3 foreign currency denominated hedge forecasted transactions
4 net investments in foreign operations

Question 2

Fair value hedge is a hedge

Answer 2

Of the exposure to change in the fair value of a recognized asset or liability or firm commitment.

Question 3

Fair value hedge gains and losses are recognized

Answer 3

In the current earnings.

Question 4

Foreign currency transactions include

Answer 4

Unrecognized firm commitment
Available for sale security
Foreign currency denominated transaction
Net investment in foreign operations

Question 5

A derivative has three characteristics

Answer 5

1 there is an underlying or notional amount
2 there is little or not initial net investment
3 it’s term requires or permits net settlement

Question 6

Perfect hedge characteristic

Answer 6

No possibility of future gain or loss

The purpose of Hedge is to reduce exposure to a particular type of risk. A perfect hedge would remove all the risk - remove the possibility of any future gain or loss

Question 7

At the money

Answer 7

An at the money option is one in which the price of the underling is equal to the strike or exercise price

Question 8

Bifurcation

Answer 8

The process of separating an embedded derivative from it’s host contract. This process is necessary so that hybrid instruments can be separated into their component parts, each being accounted for using The appropriate valuation technique

Question 9

Call option

Answer 9

An American call option provides the holder the right to acquire and underlying at an exercise or strike price anytime during the option term. A premium is paid by the holder for the right to benefit from the appreciation in the underlying

Question 10

Derivative instruments 3 characteristics

Answer 10

1 one or more underlying and one or more notional amounts
2 no initial net investment or a smaller net investment than required for contracts expected to have a similar response to market changes
3 terms that require or permit
A net settlement
B net settlement by means outside the contract
C delivery of an asset that results in a position substantially the same as net settlement

Question 11

Discount or premium on a forward contract

Answer 11

The foreign currency amount of the contract multiplied by the difference between the contracted forward rare and the spot Tate at the date of inception of the contrast

Question 12

Embedded derivative

Answer 12

A feature in a financial instrument or other contract which if the feature stood alone would meet the definition of a derivative

Question 13

Fair value

Answer 13

Defined as the amount at which an asset or liability could be bought or settled in an arm’s length transaction- measured by reference to market prices or estimated by net present value of future cash flows options pricking models or by other techniques

Question 14

Financial instrument

Answer 14

Financial instruments include cash 
accounts notes receivable 
accounts notes payable 
bonds 
common stock 
Preferred stock
Stock options 
Foreign currency forward contracts
Future contracts 
Various financial swaps

Question 15

Firm commitment

Answer 15

An agreement with and unrelated party, binding on both, usually legally enforceable, specifying all significant terms and including a disincentive for nonperformance sufficient to make performance likely

Question 16

Foretasted transaction

Answer 16

A transaction expected to occur for which there is no firm commitment and thus which gives the entity no present rights or obligations. Foretasted transactions can be hedged and special hedge accounting can be applied

Question 17

foreign currency transactions

Answer 17

transactions whose terms are denominated in a currency other than the entity’s functional currency

Question 18

Forward contract

Answer 18

a forward contract is an agreement between two parties to buy and sell a specific quantity of a commodity, foreign currency, or financial instrument at an agreed upon price with deliver and or settlement at a designated future date.

Question 19

Forward exchange contract

Answer 19

an agreement to exchange at a specified future date currencies of different countries at a specified rate

Question 20

Futures Contract

Answer 20

A futures contract is a forward based contract to make or take delivery of a designated financial instrument, foreign currency , or commodity during a designated period, at a specified price or yield.

Question 21

In the money

Answer 21

a call option is in the money if the prices of the underlying is greater than the strike or exercise price of the underlying

Question 22

Initial net investment

Answer 22

a derivative instrument is one where the initial net investment is zero or is less than the notional amount.

Question 23

Intrinsic value

Answer 23

with regard to call (put) options, it is the larger of zero or the spread between the stock (exercise) price and the exercise (stock) price

Question 24

LIBOR

Answer 24

London Interbank Offer Rate. A widely used measure of average interest rates a a point in time

Question 25

Notional Amount

Answer 25

The notional amount (or payment provision) is the referenced associated asset or liability.  A notional amount is commonly a number of units such as shares of stock
principal amount
face value
stated value
basis points
 barrels of oil

Question 26

Out of the money

Answer 26

A call option is out of the money if the strike or exercise price is greater than the price of the underlying. A put option is out of the money if the price of the underlying is greater than the strike or exercise price.

Question 27

Put Option

Answer 27

An american put option provides the holder the right to sell the underlying at an exercise or strike price anytime during the option term A gain accrues to the holder as the market price of the underlying falls below the strike price

Question 28

Swap

Answer 28

A swap is a forward based contract or agreement generally between two counter parties to exchange streams of cash flows over a specified period in time

Question 29

Swaption

Answer 29

A swaption is an option on a swap that provides the holder with the right to enter into a swap at a specified future date at specified terms or extend or terminate the life of an existing swap.

Question 30

Time value

Answer 30

the difference between an option’s price and its intrinsic value

Question 31

Transaction gain or loss

Answer 31

Transaction gains or losses result from a change in exchange rates between the functional currency and the currency in which a foreign currency transaction is denominated

Question 32

Underlyings

Answer 32

An underlying is commonly a specified price or rate such as a stock price, interest rate, currency rate, commodity price or related index.