Derivative & Hedging - 19

Question 1

What is the difference between a foreign currency transaction & translation?

Answer 1

FC Transaction - An A/P or A/R established where the money paid or received must undergo a FC conversion

FC Translation - Entire FS demoninated in a FC which must be converted to US dollars

Question 2

What two disclosures are required for FC transactions?

Answer 2

1. Aggregate gain/loss from FC transactions included in the entities NI
2. Significant changes subsequent to the date of the FS

Question 3

What are examples of Financial Instruments?

Answer 3

Cash
Account/Noted Receivable
Account/Notes Payable
Bonds
Common Stock
Preferred Stock
Stock Options
FC Forward Contracts 
Futures Contracts

Question 4

What are the three types of hedges?

Answer 4

1. Fair Value Hedge
2. Cash Flow Hedge
3. Foreign Currency Hedge

Question 5

What is a Fair Value hedge?

Answer 5

A hedge on the exposure to changes in the FV of a recognized asset or liability or unrecognized firm commitment

Question 6

What is a Cash Flow hedge?

Answer 6

A hedge of the exposure to variability in the cash flows of a recognized asset or liability or a forecasted transaction (Purchase Order)

Question 7

What is a Foreign Currency hedge?

Answer 7

A hedge of the foreign currency exposure of an unrecognized firm commitment, an AFS security, a forecasted transaction, or a net investment asset in a foreign operation

Question 8

What are the two reasons to have a derivative?

Answer 8

1. To Hedge (offset g/l of operation)

2. For speculation (basically gambling as you are hedging against the market moving against you)

Question 9

What three things must be present in a derivative instrument?

Answer 9

1. An underlying - what causes the risk - any financial or physical variable that has either observable or objectively verifiable changes
2. A notional amount - the number of units
3. A Settlement amount -

Question 10

What is excluded from derivative?

Answer 10

Normal purchases
Equity Securities (Common Stock)
Debt Securities
Leases
Mortgage Backed Securities
Employee Stock Options
Royalty Agreements and other contracts tied to sales volumes
Variable Annuity Contracts
Adjustable Rate Loans
Guaranteed Investment Contracts
Non-exchanged traded companies tied to physical variables
Derivatives that serve as impediments to sales accounting

Question 11

What is included in being a derivative?

Answer 11

Call & Put Options
Futures Contracts
Interest Rate Swaps
Currency Swaps
Swaptions
Credit Indexed Contracts
Interest Rate Caps/Floor/Collars

Question 12

What is an example of an embedded derivative?

Answer 12

Convertible Bond Payable - because the stock options are embedded in the bond

Question 13

What is bifurcation?

Answer 13

Splitting an embedded derivative from it’s host and accounted for in the derivate way

Question 14

What three criteria are used to determine if bifurcation must occur?

Answer 14

1. The embedded derivative meets the definition of a derivative
2. The hybrid instrument is not regularly recorded at Fair Value
3. The economic characteristics & risks of the embedded derivative instrument are not clearly and closely related

Question 15

Must bifurcation be used if the three criteria are met?

Answer 15

No - it is an election by the holder. If bifurcation is not elected, the entire instrument is valued at fair value

Question 16

What are the two primary criteria that must be met in order for a derivative instrument to qualify as a hedging instrument?

Answer 16

1. Sufficient documentation at the beginning of the process

2. The hedge must be highly effective

Question 17

For an unrecognized firm commitment to qualify as a hedged item, it must:

Answer 17

1. Be binding on both parties
2. Be specific with respect to all significant terms
3. Contain a nonperformance clause that makes performance probably

Question 18

What specific criteria must be met in order to qualify as a cash flow hedge?

Answer 18

The hedging instrument must be linked

Question 19

Where to effective and ineffective portions get reported?

Answer 19

Fair Value Hedges - I

Cash Flow Hedge - Effective - OCI; Ineffective - I

Question 20

What are four areas of FC Hedges and how are they treated?

Answer 20

1. Unrecognized Firm Commitment - FV Hedge
2. AFS Securities - FV Hedge
3. FC Denominated Forecasted Transactions - Cash Flow Hedge
4. Net Investment in Foreign Operations - Cash Flow Hedge

Question 21

Disclosures related to financial instruments, both derivatives and non-derivative, that are used as hedging instruments, must include?

Answer 21

1. Objectives & the strategies for achieving them
2. Context to understand the instrument
3. risk management policies
   4 List of hedged instruments

Question 22

What are the characteristics of a derivative?

Answer 22

1. One or more underlyings or notional amounts
2. No or small initial net investment
3. Terms that require or permit a net settlement

Question 23

When is credit risk required to be disclosed?

Answer 23

When it exists

Question 24

Does credit risk disclosure require the names of the parties involved?

Answer 24

No