In 1984, Financial Accounting Standards no. 80, Accounting for Futures Contracts, also known as FAS 80 had become effective. This document included all hedge accounting practices for entities in the United States. But FAS 80 had several faults. One of its faults was that it was bounded to exchange-traded futures and options and not to over the counter (OTC) derivatives. In 1999, FAS 80 was replaced by Financial Accounting Standards no.133, Accounting for derivative instruments and hedging activities. Despite, the numerous amendments, clarifications and interpretations this document had over the years, it still remains at the core of current derivatives accounting practices. This essay tends to provide a definition of a derivative, its characteristics …show more content…
The key distinguishing features of derivatives are: 1. Settlement in cash or equivalents – a derivative will be settled at a future date with an exchange of cash or assets that are easily convertible to cash (such as marketable securities)
2. Underlying price and Notional amount – the total value of the derivatives will be calculated by multiplying the index by a specific number of units specified in the contract, which is known as the notional amount (units, bushels, pounds). The value of the derivative will be based on some variable, such as a price index, which is known as the underlying (specified price, interest rate, exchange rate).
3. No net investment – at the time the derivative contract is entered into, there will be no payment by either side in most cases. Payment occurs at the time of settlement only. In the case of options-based derivatives, the party that is acquiring the option normally pays a premium, but this is still considered to be no net investment as long as the payment is less than the cost of acquiring the underlying.
There are several types of derivative contracts. Three of the most common types are forwards, futures and
Based on the 1988 Supreme Court case of Corn Product Refining Co. v. Commissioner (350 U.S. 46; 76 S.Ct. 20; 100 L.Ed. 29), hedging transactions were determined to be used to support business practices of certain commodities. Such hedging transactions are normal for businesses engaged in commodity sales such as coal or corn to protect against market
The derivatives program was reducing risk when the firm was investing in foreign currency futures for the first four months from the implementation date (February 1991 to May 1991). This is seen by the negative correlation of (0.94226594) between the derivative (futures) cash flow and the unhedged cash flow. A purpose of a perfect hedge is to obtain a net of zero or in other words, reduce your risk to nothing not including the cost of the hedge. If a correlation is negative, as it was for the first three
10. The current price of silver is $750. Storage costs are $8 per ounce per quarter payable in advance. The interest rate is 12% p.a. with continuous compounding. Calculate the futures price of silver for delivery in six months (to two decimal places).
At the time of the sale, the company receives immediate payment for the stated principal amount of the installment contract and a portion of the finance participation resulting from the interest rate differential. The remainder of the interest rate differential is retained by the financial institution as a security against credit losses and is paid to the company in proportion to customer payments received by the financial institution.
Derivative contracts were either negotiated with specific counterparties (over-the-counter) or were standardized contracts executed and traded on an exchange. Negotiated over-the-counter derivatives were comprised of forwards, swaps, and specialized options contracts. Over the counter derivatives can be tailored to meet the customers’ needs with respect to time and quantity and they are not traded in an organized exchange. On the other hand, standardized exchange-traded derivatives consisted of futures and options contracts. Even though over-the-counter derivatives were usually not traded like securities in an exchange, they might be terminated or assigned to an alternative counterparty. Standardized derivatives trade on an exchange and have time and quantity that are fixed.
* Unrealized loss/gain on derivative instruments Operating derivatives is not a core activity of the company. (These are used to hedge and diminish potential risks)
Analyze the derivatives market and determine the use of derivatives to efficiently manage investment risks in an investment portfolio.
guarantee.” In this instance, the guarantee takes the form of a European put option (called a “Right”
In order to reduce risk, the company is using two hedging derivatives: forward contracts and put options to sell dollars. The aim of the paper is to determine an appropriate hedging policy which answers two main questions: how much to hedge, and in what proportions of forwards
Spot deferred contract has some characteristics of forward sale but is more flexible since the SEC sellers have a choice when to deliver the gold. Though the threshold for this vehicle to hedge risk is very high, only for companies in good shape in terms of reserves, costs and leverage, American Barrick’s excellence qualifies it to implement this vehicle. We regard it a salutary vehicle, to the effect of which the gradually increasing use of it in American Barrick
The definition of "derivatives" is also very wide, and includes options and warrants, whoever they are issued by, as well as rights and interests in respect of listed securities (or other derivatives).
Hedge funds are investment vehicles that explicitly pursue absolute returns on their underlying investments. Hedge Fund incorporate to any absolute return fund investing within the financial markets (stocks, bonds, commodities, currencies, derivatives, etc) and/or applying non-traditional portfolio management techniques including, but not restricted to, shorting, leveraging, arbitrage, swaps, etc. Hedge funds can invest in any number of strategies. Hedge fund managers typically invest money of their own in the fund they manage, which serves to align their interests with
a liability for the face amount of the bonds and paid-in capital for the premium over the face amount.
The value of this contract is computed using the three-month HK$/DEM forward rate. There will be a cash inflow of DEM 4 million on October 15th. This amount will be hedged using the forward rate of HK$ 4.3535/DEM. By multiplying the cash inflow denominated in DEM by the forward rate,
Hedging is a significant measure of financial risk management. Since the 1970s, the increasing number of powerful companies started to control the risk of the exchange rate, the interest rate and commodity by using financial derivatives. ISDA (2013) based on the Global 500 Annual Report 2012 survey found that 88 percent of companies use foreign exchange derivatives. Modigliani & Miller (1958) believed that if the financial markets were under perfect conditions, for instance, there was no agency costs, asymmetric information, taxes and transaction costs, hedging would not increase the company 's value because investors can hedge by themselves. However, a large number of practical studies have shown that hedging is beneficial