Foreign Currency, Derivative Instruments and Hedgin

Question 1

Foreign currency transactions

Answer 1

Purchases A/P
Sales A/R
Currency exchanging hands is not US Dollars

Question 2

Foreign Currency Disclosures - ASC 830

Answer 2

1. Aggregate transation gain(loss) that is included in the entity’s NI
2. Significant rate changes subsequent to the date of the financial statements including effects on unsettled foreign currency transactions. As of the B/S date you have to remeasure the payables and receivables according to the exchange rate for any particular foreign currency.

Question 3

Monetary Unit Assumption

Answer 3

All F/S have to be in terms of the U.S. Dollar.

Question 4

Spot rate

Answer 4

Exchange rate “on the spot”

Exchange rate as of the B/S date

Question 5

When the foreign currency transaction rate applies

Answer 5

When money exchanging hands is not in US Dollars.

When there’s a sale and there’s a title of transfer. Not when an order is placed.

Question 6

Derivative Instruments

Answer 6

Derive their value as a financial instrument from something outside the instrument itself.
3 characteristics must be present for a financial instrument or other contract to be considered a derivative
1. one or more Underlying
2. one or more Notional
3. Settlement amount

The financial instrument or other contract requires no initial net investment or an inital net invest that is smaller than would be required (it’s cheap)

The terms of financial instrument or other contract do one of the following in regard to settlement:

1. Require or permit net settlement
2. Provide for the delivery of an asset

Question 7

How to measure Derivatives

Answer 7

Fair value

Question 8

Derivatives uses

Answer 8

1. Speculation

2 Hedging

Question 9

Derivatives for Speculation

Answer 9

Unrealized holding gains and losses are reported in income from continuing operations. plus other revs and gains or minus other exps and losses

Question 10

Fair Value Hedge

Answer 10

Hedge of the exposure to changes in the fair value of a) recognized asset or liability, or b) an unrecognized firm commitment (PO or contract).
Unreal gains and losses - Income from Cont’d ops. Plus other revs gains, Minus other exps and losses

Question 11

Cash Flow Hedge

Answer 11

A hedge of the exposure to variability in the cash flows of a) a recognized asset or liability, or b) a forecasted transaction (haven’t ordered anything)

Unreal gains and losses (effective portion) - Other comprehensive Income

Question 12

Foreign Currency Hedge

Answer 12

A hedge of foreign currency exposure of a) an uncrecognized firm commitment (PO), b) avail-for-sale security (both of these are treated as a Fair value hedge), c) a forecasted transaction, or d) a net investment in a foreign operation (both of these are treated as Cash Flow hedges)

Question 13

How to treat a Derivative instrument that does not qualify under any of the three categories

Answer 13

The gains and losses must be reported and recognized in current earnings. Income from Continuing Ops

Question 14

Underlying

Answer 14

Any financial or physical variable that has either observable changes or objectively varifiable changes (commodity prices, interest rates, exchange rate..) the thing that changes that causes the risk

Question 15

Notional amounts

Answer 15

the “number of currency or other units” specified in the financial instrument or other contract. (bushels of wheat, shares of stock)

Question 16

Settlement amount

Answer 16

of financial instruments or other contracts is calculated using the underlying(s) and notional amount(s) in some combination
as simple as multiplying the fair value of a stock times a speicified number of shares

Question 17

Bifurcation

Answer 17

The process of seperating an embedded derivative from its host contract. This process is necessary so that hybrid instruments can be seperated into their component part, each being accounted for using the appropriate valuation techniques

Question 18

Criteria to determine if Bifurcation must occur

Answer 18

All three must be met

1. The embedded derivative meets the definition of a derivative
2. The hybrid instrument is not regularly recorded at fair value, with changes reported in current earnings.
3. The economic characteristics and risks of the embedded derivative instrument are not “clearly and closely related” to the economic characteristics and risks of the host contract.
   ex. Convertible debt (investor’s point of view) investment in a bond and stock option

Question 19

How to value Bifurcations

Answer 19

Holder of a hybrid instrument normally requiring bifurcation can make the election not to bifurcate the instrument, instead the entire instrument is valued at fair value.
Unrealized gains/losses are reported in earnings each year, Income from Cont’d operations.

Question 20

When elected not to bifurcate a hybrid instrument, how is this disclosed on the F/S

Answer 20

1. As seperate line items for the fair value and non-fair value instruments on the balance sheet.
2. As an aggregate amount of all hybrid instruments with the amount of the hybrid instruments at fair value shown in parantheses.

Question 21

Highly effective hedge

Answer 21

Hedge will offset any gains or losses on the of the hedging item by 80%-125% of that change.

Question 22

Criteria for unrecognized firm commitment to qualify as a hedged item

Answer 22

1. binding on both parties
2. specific with respect to all significant terms
3. contains a nonperformance clause

Question 23

Cash flow hedge

Answer 23

Effective Portion- reported in OCI

Ineffective Portion and/or excluded components are reported on a cumulative basis - Income from continuing operations.

Question 24

Foreign Currency Hedge - Unrecognized Firm Commitment

Answer 24

PO or contract.
treated as a FV Hedge
Unreal gains and losses - Income from Cont’d operations

Question 25

Foreign Currency Hedge - Avail for sale securities

Answer 25

Treated as a fair value hedge

Unreal gains/losses - Income from cont’d operations

Question 26

Foreign Currency Hedge - Foreign currency denominated forecasted transactons

Answer 26

Treated as a CF Hedge
Unreal gains/losses - Effective Portion- OCI
Ineffective Portion - Income from Con’t ops

Question 27

Foreign Currency Hedge- Net investments in foreign operations

Answer 27

Treated as a CF Hedge
Unreal gains/losses - Effective Portion- OCI
Ineffective Portion - reported on a cumulative basis to reflect the lesser of the cumulative gain/loss on the derivative or the cumulative gain/loss from the change in expected cash flows from the hedged instrument.

Question 28

Hedges held for Speculative purposes

Answer 28

“gambling”

unrealized gains/losses - Income from continuing operations

Question 29

Disclosures for Financial Instruments both derivative and non derivative that are used as hedging instruments

Answer 29

Objectives and the stragies for achieving them
Context to understand the instrument
Risk management policies and
A list of hedged instruments.

Question 30

Fair value and Concentration of Credit Risk Disclosures of Financial Instruments other than Derivatives

Answer 30

Disclosures of FVs of financial instruments are required if it is practicable to estimte fair value.
Disclosures of concentration of credit risk is required.

Question 31

Credit risk

Answer 31

The risk that a loss will occur because parties to the instrument do not perform as expected.

Question 32

Off-balance-sheet risk

Answer 32

the possible amount of loss from an instrument that is not reflected on the B/S.

Question 33

Market risk

Answer 33

the risk that future changes in market prices may make a financial instrument less valuable.

Question 34

IFRS Hedging Instruments

Answer 34

Fair value hedge - unreal G/L profit and loss (income from cont’d operations.
Cash flow hedge - unreal G/L Other comp Income
Hedge of a net investment in operations - unreal G/L - Other comp Income

Question 35

At the money

Answer 35

price of the underlying is equal to the strike or exercise price.

Question 36

Embedded Derivative

Answer 36

A feature on a financial instrument or other contract, which if it stood alone, would meet the definition of a derivative.

Question 37

Firm commitment

Answer 37

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

Question 38

Forecasted transaction

Answer 38

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

Question 39

In the money

Answer 39

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

Question 40

Forward exchange contract

Answer 40

An agreement to exchange at a specified future date currencies of different countries at a specified rate (forward rate)

Question 41

Intrinsic value

Answer 41

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 42

Out of the money

Answer 42

Call option is out of the money if they 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 43

Put option

Answer 43

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 44

Swap

Answer 44

Forward based contract or agreement generallhy between two counterparties to exchange streams of cash flows over a specified period in the future.

Question 45

Hedge acounting is permitted for (types of hedges)

Answer 45

Unrecognized firm commitments
Avail-for-sale securities
Foreign currency denominated hedge forecasted transactions
Net investments in foreign operations

Question 46

General criteria for a hedging instrument

Answer 46

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

Question 47

Forward Contract

Answer 47

An agreement between two parties to buy and sell a specific quantity of a commodity, foreign currency, or financial instrument at an aggregated upon price, with delivery and/or settlement at a designated future date. Not formally regulated by an organized exchange, each party to the contract is subject to the default of the other party.

Question 48

Futures Contract

Answer 48

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. Frequently has provisions for cash settlement. Traded on a regulated exchange, involves less credit risk than a forward contract.