App00A - Appendix A - Derivatives Appendix A Questions A-1...

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Appendix A - Derivatives Question s A-1 Reflective thinking A-2 Reflective thinking A-3 Analytic A-4 Reflective thinking A-5 Reflective thinking A-6 Reflective thinking A-7 Reflective thinking Exercises Reflective thinking Analytic Analytic Analytic Analytic Analytic Problems Analytic Analytic, Communications Analytic Cases 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 would be a result of hedge ineffectiveness such as this. 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. If the AppA-1 Appendix A    Derivatives QUESTIONS FOR REVIEW OF KEY TOPICS
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Appendix A - Derivatives “commodity” is 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 . Question A-6 All derivatives, without exception, are reported on the balance sheet as either assets or liabilities at fair (or market) value. The rationale is that (a) derivatives create either rights or obligations that meet the FASB’s definition of assets or liabilities and (b) fair value is the most meaningful measurement. Question A-7 A gain or loss from a cash flow hedge is deferred as other comprehensive income until it can be recognized in earnings along with the earnings effect of the item being hedged. AppA-2
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Appendix A - Derivatives EXERCISES Exercise A-1 Indicate (by abbreviation) the type of hedge each activity described below would represent. Hedge Type FV Fair value hedge CF Cash flow hedge FC Foreign currency hedge N Would not qualify as a hedge Activity FV 1. An options contract to hedge possible future price changes of inventory. CF 2. A futures contract to hedge exposure to interest rate changes prior to replacing bank notes when they mature. CF 3. An interest rate swap to synthetically convert floating rate debt into fixed rate debt.
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App00A - Appendix A - Derivatives Appendix A Questions A-1...

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