Week 10_Hedging - 5/18/2009 Issues in Corporate Financial...

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5/18/2009 1 1 Issues in Corporate Financial Reporting and Analysis (ACCT3563/3573) Week 10 Hedging Associate Professor Richard Morris 2 Learning Objectives ± Accounting for Foreign Currency Forward Contracts ± Accounting for Options ± Accounting for Futures Contracts
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5/18/2009 2 3 References ± Picker, Chapter 5 (parts 5.3.6 – 5.4 …… pp. 158-167) ± Deegan, Chapter 15 (“Derivatives Used Within a Hedging Arrangement”, pp. 522-534) ± Deegan, Chapter 35 (Section 35.6 , pp. 1218-1223 ONLY) ± Kruger, J, Shaping Hedges, Accountancy Magazine, December 2005, pp. 504-517 ± AASB 139 “Financial Instruments: Recognition and Measurement” (skim relevant parts only) Introduction to hedging: ± A hedge is (usually) a derivative financial instrument whose fair value or cash flows will offset changes in fair value or cash flows of an underlying “hedged item” ± The underlying “hedged item” can be an asset, liability, highly probable future transaction, or a net investment in a foreign operation. ± The “hedged item” must expose the firm to risk of changes in fair value or cash flows and must be designated as being hedged ± See AASB 139 para 9 for definitions 4
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5/18/2009 3 Introduction to hedging ± The derivatives that we will cover are: ± Forward rate contracts for foreign currency ± Put and Call Options (on shares) ± Futures contracts ± They all involve relatively small initial outlays compared to the underlying “hedged item” ± Gains and losses on them are driven partly or fully by changes in value of “hedged item” ± They are settled in the future 5 Introduction to hedging ± Example: a gold miner sells gold in US$s. Underlying hedged item is gold produced. If concerned that the price of gold received in Aus$s will fall in the next 6 months, he could hedge against this risk by: ± Taking out a forward exchange contract to receive US$s in 6 months at a fixed forward exchange rate, and either ± Purchasing a put option to sell his gold in US$s at a fixed US$ selling price in 6 months time; or ± Taking out a “sell” futures contract to sell gold at a fixed price in Aus$s in 6 months time 6
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5/18/2009 4 Introduction to hedging ± Three main types of hedges: ± Fair value hedges – where the underlying “hedged item” has already been recorded at fair value and all later movements in fair values of hedge and “hedged item” go to P&L (most common type) ± Cash flow hedges – usually where “hedged item” has not yet been recorded but the hedge has. Changes in fair value of hedge go to Equity not to P&L. These hedges become fair value hedges when “hedged item” is first recorded. ± Hedge of net investment in a foreign operation 7 Introduction to hedging ± Hedge accounting (AASB 139): To qualify for hedge accounting, a number of conditions in AASB 139 must be met most of which revolve around: ± The hedge being formally designated as such ± The hedge being “highly effective” (80%- 125% test) throughout its life What is hedge accounting?? See illustrations 8
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5/18/2009 5 Introduction to hedging ±
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This note was uploaded on 05/02/2010 for the course ACCT 3756 taught by Professor Leung during the Three '09 term at University of Sydney.

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Week 10_Hedging - 5/18/2009 Issues in Corporate Financial...

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