T5 - Tutorial 5 Financial Instruments CHAPTER 16 QUESTIONS 1(a Financial instruments may be classified as primary such as accounts receivable

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1 Tutorial 5 – Financial Instruments CHAPTER 16 - QUESTIONS 1 (a) Financial instruments may be classified as primary , such as accounts receivable, accounts payable, loans receivable, loans payable and equity securities, or as derivative (secondary) financial instruments, such as forward contracts, futures contracts, options, and interest rate and currency swaps. Derivative financial instruments have been defined as those that ‘create rights and obligations that have the effect of transferring one or more of the financial risks inherent in an underlying primary financial instrument, and the value of the contract normally reflects changes in the value of the underlying financial instrument’. For example, an entity with accounts payable in a foreign currency may take out a forward currency exchange contract to reduce the risk from fluctuations in currency exchange rates. Derivative financial instruments do not result in a transfer of the underlying primary financial instruments when the contract is entered into, nor do they necessarily result in a transfer of the underlying primary financial instruments when the derivative financial instruments mature. (b) Simple financial instruments comprise a single financial asset, financial liability or equity instrument, such as a loan receivable, loan payable or ordinary share, whereas compound financial instruments comprise a combination of characteristics of financial assets, financial liabilities and equity instruments. For example, a debt security convertible into ordinary shares comprises two components. They are an arrangement to deliver cash or other financial assets and an option granting the holder the right, for a specified period, to convert the debt security into the ordinary shares of the issuer. 2 The basic idea of a swap is that two borrowers agree to repay each other's loan – that is, they swap loan commitments. The two principal forms of swap are the interest rate swap and the currency swap (discussed in Question 8). With an interest rate swap, a loan that is charged interest on a floating rate basis is swapped for a loan that is charged interest on a fixed-rate basis. It mimics the effect of exchanging a floating rate loan for a fixed-rate loan. In providing an example, it is likely that students will use an example similar to (or the same as) Example 16.4. For some borrowers, interest rate swaps provide access to long-term borrowing at a lower rate of interest than if they borrowed the funds themselves. Thus, for these borrowers, long-term funds at a fixed rate of interest are not available, or are not available at a rate of interest that management is prepared to pay.
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2 Problem 1 Blair Ltd is a speculator and a BUYER of a futures contract Some information that is missing from this problem and from the text reading.
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This note was uploaded on 07/07/2009 for the course ACCT 3102 taught by Professor Drk.herbohn during the Three '09 term at Queensland.

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T5 - Tutorial 5 Financial Instruments CHAPTER 16 QUESTIONS 1(a Financial instruments may be classified as primary such as accounts receivable

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