Appendix A Derivatives
QUESTIONS FOR REVIEW OF KEY TOPICS
Question A–1
These instruments “derive” their values or contractually required cash flows from some
other security or index.
Question A–2
The FASB has taken the position that the income effects of the hedge instrument and
the income effects of the item being hedged should be recognized at the same time.
Question A–3
If interest rates change, the change in the debt’s fair value will be less than the change
in the swap’s fair value. The gain or loss on the $500,000 notional difference will not be
offset by a corresponding loss or gain on debt. Any increase or decrease in income
resulting from a hedging arrangement designated as a fair value hedge would be a result of
differences such as this. As long as the derivative instrument is considered “highly
effective” in offsetting the changes in fair value of the debt, then hedge accounting may be
used.
Question A–4
A futures contract is an agreement between a seller and a buyer that calls for the seller
to deliver a certain commodity (such as wheat, silver, or Treasury bond) at a specific
future date, at a predetermined price. Such contracts are actively traded on regulated
futures exchanges. When the contract involves a financial instrument, such as a Treasury
bill, commercial paper, or a CD, the contract is called a financial futures agreement.
Question A–5
An interest rate swap exchanges fixed interest payments for floating rate payments, or
vice versa, without exchanging the underlying notional amount. The interest expense then
reflects the rate(s) to which the interest has been swapped. If the interest rate swap is
designated as a fair value hedge, the interest expense also reflects offsetting gains and
losses on the fair value of the swap and the fair value of the hedged asset or liability.
Solutions Manual, Appendix A A–1
.
QUESTIONS FOR REVIEW OF KEY TOPICS
Question A–1
These instruments “derive” their values or contractually required cash flows from some
other security or index.
Question A–2
The FASB has taken the position that the income effects of the hedge instrument and
the income effects of the item being hedged should be recognized at the same time.
Question A–3
If interest rates change, the change in the debt’s fair value will be less than the change
in the swap’s fair value. The gain or loss on the $500,000 notional difference will not be
offset by a corresponding loss or gain on debt. Any increase or decrease in income
resulting from a hedging arrangement designated as a fair value hedge would be a result of
differences such as this. As long as the derivative instrument is considered “highly
effective” in offsetting the changes in fair value of the debt, then hedge accounting may be
used.
Question A–4
A futures contract is an agreement between a seller and a buyer that calls for the seller
to deliver a certain commodity (such as wheat, silver, or Treasury bond) at a specific
future date, at a predetermined price. Such contracts are actively traded on regulated
futures exchanges. When the contract involves a financial instrument, such as a Treasury
bill, commercial paper, or a CD, the contract is called a financial futures agreement.
Question A–5
An interest rate swap exchanges fixed interest payments for floating rate payments, or
vice versa, without exchanging the underlying notional amount. The interest expense then
reflects the rate(s) to which the interest has been swapped. If the interest rate swap is
designated as a fair value hedge, the interest expense also reflects offsetting gains and
losses on the fair value of the swap and the fair value of the hedged asset or liability.
Solutions Manual, Appendix A A–1
.
