Chapter 11 - Solution Manual

Underlying and a notional amount the price of the

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underlying and a notional amount (the price of the security and its denomination), and it does not require an initial net investment in the contract. Consequently, if the forward contract requires delivery of a security that is readily convertible to cash or otherwise meets the net settlement criterion as discussed beginning in paragraph 815-10-15-99, it is subject to the requirements of this Subtopic. > > > Short Sales (Sales of Borrowed Securities) 55-57The following discussion applies only to short sales with the characteristics described. Some groups of transactions that are referred to as short sales may have different characteristics. If so, a different analysis would be appropriate, and other derivative instruments may be involved. Short sales (sales of borrowed securities) typically involve all of the following activities: a. Selling a security (by the short seller to the purchaser) b. Borrowing a security (by the short seller from the lender) c. Delivering the borrowed security (by the short seller to the purchaser) d. Purchasing a security (by the short seller from the market) e. Delivering the purchased security (by the short seller to the lender). Those five activities involve three separate contracts. 55-58A contract that distinguishes a short sale involves activities in (b) and (e) in the preceding paragraph, borrowing a security and replacing it by delivering an identical security. Such a contract has two of the three characteristics of a derivative instrument. The settlement is based on an underlying (the price of the security) and a notional amount (the face amount of the security or the number of shares), and the settlement is made by delivery of a security that is readily convertible to cash. However, the other characteristic, no initial net investment or an initial net investment that is smaller by more than a nominal amount than would be required for other types of contracts that would be expected to have a similar response to changes in market factors, is not present. (See paragraphs 815-10-15-94 through 15- 96.) The borrowed security is the lender's initial net investment in the contract. Consequently, the contract relating to activities in (b) and in (e) in the preceding paragraph is not a derivative instrument. 55-59The other two contracts (one for activities in paragraph 815-10-55-57[a] and in paragraph 815-10- 55-57[c] and the other for activity in paragraph 815-10-55-57[d]) are routine and do not generally involve derivative instruments. However, if a forward purchase or forward sale is involved, and the
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247 contract does not qualify for the exception in paragraphs 815-10-15-15 through 15-17, it is subject to the requirements of this Subtopic. > > > Take-or-Pay Contracts 55-60Whether a take-or-pay contract is subject to this Subtopic depends on its terms. For example, if the product to be delivered is not readily convertible to cash and there is no net settlement option, the contract fails to meet the net settlement criterion in paragraph 815-10-15-83(c) and is not subject to the requirements of this Subtopic. In certain circumstances, a take-or-pay contract may represent or contain a lease that should be accounted for in accordance with Topic 840. (Paragraph 815-10-15-79 explains
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