Derivatives and Hedge Accounting (F6:M3)

Question 1

what is a FV hedge and how is the G/L recognized?

Answer 1

an instrument designed as a hedge of the exposure to changes in FAIR VALUE

recognized in net income

*already have an asset or liability on the BS

Question 2

what are the 4 characteristics of a derivative instrument?

Answer 2

one or more underlying (e.g., stock price)

one or more notional amounts (e.g., number of shares)

requires no initial net investment or one that is smaller than would be required for other types of similar contracts (option contract requires initial net investment)

terms require or permit a net settlement

Question 3

is a firm commitment considered a FV hedge or CF hedge?

Answer 3

FV

Question 4

how are derivatives held for speculative purposes recorded?

Answer 4

at FV

recognized in net income

Question 5

what is the key characteristic of a perfect hedge?

Answer 5

no possibility of future G/L

Question 6

what portion of a cash flow hedge G/L is recorded in OCI?

Answer 6

the effective portion

ineffective portion recorded in net income

Question 7

what two risks are inherent of all derivative instruments?

Answer 7

market risk (possibility of incurring a loss)

credit risk (other party will default and not pay you)