FRM Powerpoints 2011 Unit IVA Accounting and Disclosure of Risk Management Activity

FRM Powerpoints 2011 Unit IVA Accounting and Disclosure of Risk Management Activity

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IV. Implementing a Risk Management Program A.Accounting and Disclosure of Risk Management Activity
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Version: January 3, 2011 Unit IV.A p. 2 of 24 Derivatives Accounting o FAS 133, effective June 2000 o Older rules: hedge accounting n subject to abuses n Very little information reported
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Version: January 3, 2011 Unit IV.A p. 3 of 24 Derivatives Accounting (cont.) Example of a hedge : A company is engaged in the business of buying gold from mining companies and selling it to jewelry manufacturers. It holds gold in its inventory. It hedges the risk of the holding of gold by selling forward contracts on gold. Suppose on January 15, it buys 10,000 ounces of gold that it anticipates it will sell on May 15. The gold costs $388/oz. It sells forward contracts at a price of $392/oz. On March 31, its quarter ends and it is required to publish its financial statements. On May 15, the forward contract expires and it delivers the gold, receiving a price of $392. At that time, the spot price of gold is $385/oz.
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Version: January 3, 2011 Unit IV.A p. 4 of 24 Derivatives Accounting (cont.) o What accounting entries are done on n January 15? n March 31? n May 15? o Hedge accounting is subject to abuses.
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Version: January 3, 2011 Unit IV.A p. 5 of 24 Derivatives Accounting (cont.) o Mark-to-market accounting n How would this affect the hedge? n Earnings volatility would increase
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Version: January 3, 2011 Unit IV.A p. 6 of 24 Derivatives Accounting (cont.) o U. S. Accounting Rules n FASB, oversight by PCAOB, as authorized by SOX n Early accounting rules o FAS 52 (foreign currency) o FAS 80 (futures) o FAS 105 (off-balance sheet and credit risk) o FAS 107 (fair value disclosure) o FAS 119 (fair value disclosure)
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Version: January 3, 2011 Unit IV.A p. 7 of 24 Derivatives Accounting (cont.) o FAS 133, amended by 137 and 138 and related to FAS 115, 157, and 159, regulates accounting for derivatives today n Four types of transactions o fair value hedges o cash flow hedges o hedges of net investment in foreign operations o speculation
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Version: January 3, 2011 Unit IV.A p. 8 of 24 Derivatives Accounting (cont.) o Definition of a derivative in FAS 133 n A derivative instrument is a contract with one or more underlyings and one or more notional amounts. Its value changes as the value of the underlying changes. Its initial
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