Lecture 4 - Financial Intruments Flashcards
Financial Intruments
IFRS 9
Financial Intruments
Definition
a Financial Intruments (FI) is defined as “a contract that gives rise to a financial asset of one enterprise and a financial liability or equity of another”
Financial Instruments
2 step classification of financial assets
Financial Instruments
Step 1: Contractual CF Characteristics and SPPI
Cash flows are solely payments of principal and interests (SPPI)
- principal is the FV of the financial asset at initial recognition, which may change over the life of a financial instrument
- interest is the consideration for the time value of money
Example: A bond with stated maturity data, variable market interest rate, variable interest capped.
NOT: options, future, swaps, dividends, convertible bonds, returns linked to performance or commodity price
Financial Instruments
Step 2: Types of Business Models
Holding assets in order to collect contractual CFs
- collect payments over the life
- typically involve lower frequuency and value of sales
- e.g. Bank Loan Portfolio: A bank holds a portfolio of loans and collects interest and principal payments over the life of the loans, without the intention of selling them.
Both collecting contractual CFs and selling FA
- Sale integral to achieve the objective of the business model
- typically involve greater frequency and values of sales
- e.g. Debt Securities Portfolio: An investment firm holds a portfolio of debt securities. The firm collects interest payments but also sells securities when market conditions are favorable to achieve the business objective.
Other
- Neither held to collect not held to collect and sale
- collection of contractual CFs incidental to the objective of the business model
- e.g. Equity Investments for Trading: A hedge fund invests in equities purely for trading purposes. The objective is to buy and sell securities to profit from short-term price fluctuations, rather than holding to collect contractual cash flows.
Financial Instruments
Measurement of Financial Assets
Financial Instruments
Classification of Financial Liabilities
FI Impairment
Measurment of ECLs (Part 1)
Credit Loss = the difference between all contractual CFs and all the CFs an entity expects to receive (i.e. cash shortfalls), discounted at the original effective interest rate.
Fi Impairment
Measurement of ECLs (Part 2)
ECL are probability-weighted estimate of credit losses over the expected life of the FI
- Max. period is the max. contractual period of exposure to risk
- Include CFs expected from collateral and other credit enhancements that are part of contractual terms
Fi Impairment
ECL Formula
EL = PD * EAD * LGD
PD = Prob. Default
EAD = Exposure at Default (debtor’s amount outstanding)
LGD = Loss Given Default (1-Recovery Rate)
–> EL is highly sensitive to input parameters!
Hedge Accounting
Definition
The objective of HA is to represent in the FS the effect of an entity’s risk managmeent activities that use FI to manage exposures arising from particular risks that could affect P/L or OCI
Hedge Accounting
Hedging Intruments
Hedge Accounting
Hedged Items
Hedge Accounting
3 types of Hedged Relationships
Hedge Accounting
Accouting for Hedges
Hedge Accounting
Qualifying Criteria (3 to be met)
Hedge Accounting
Deep Dive into the 3 Criteria
Hedge Accounting
Hedge Effectiveness Requirements
