Investments

Question 1

What is meant by the term derivative?

Answer 1

A derivative is a financial instrument or other contract whose value is derived (hence, the name derivative) from its relationship to something else known as the underlying. The underlying can be another financial instrument, a physical commodity, currency, etc.

Question 2

What is meant by the term hedge?

Answer 2

A hedge is a defensive strategy designed to protect against the risk of adverse price or interest rate movements to achieve a state of balance.

Question 3

What is usually considered to be the best evidence of fair value for a financial instrument that is measured at fair value?

Answer 3

Quoted market prices obtained from financial publications, national exchanges, or NASDAQ.

Question 4

What else should the auditor do if estimates of fair value for financial instruments are obtained from third-party sources (such as broker-dealers)?

Answer 4

The auditor should obtain an understanding of the methods they used.

Question 5

What is the auditor’s basic responsibility if estimates of fair value for financial instruments are based on management’s valuation model?

Answer 5

The auditor should obtain sufficient appropriate audit evidence about the fair value based on that model.

Question 6

What considerations might be helpful to the auditor in determining whether a decline in fair value for a financial instrument is other than temporary

Answer 6

1. )How much (and how long) the fair value is below the carrying value
2. )Whether the financial condition of the issuer has deteriorated
3. )Whether a rating agency has downgraded the security
4. )Whether dividends have been reduced or eliminated (or interest payments not made)
5. )Whether the entity recorded losses on the security after the period-end

Question 7

What audit procedures might an auditor perform to evaluate an investment in securities that is based on cost?

Answer 7

The auditor might inspect the documentation of the purchase price, confirm the existence of the security with the appropriate outside parties, and test the amortization of any premium or discount.

Question 8

What audit procedures might an auditor perform to evaluate an investment in securities that is based on the investee’s financial results?

Answer 8

The auditor would normally read the audited financial statements of the investee.