INTER. ACCTNG. (LOOSE) W/ALEK+CONNECT
9th Edition
ISBN: 9781307040166
Author: SPICELAND
Publisher: MCG/CREATE
expand_more
expand_more
format_list_bulleted
Concept explainers
Question
Chapter A, Problem 1E
To determine
Derivatives: Derivatives are some financial instruments which are meant for managing risk and safeguard the risk created by other financial instruments. These financial instruments derive the values from the future value of underlying security or index. Some examples of derivatives are forward contracts, interest rate swaps, futures, and options.
Hedging: This is the business deal entered into, by a company to produce exposure or coverage over the exposure caused by the existing deal. In simple terms, this is the transaction which produces gains to cover the losses produced by existing transaction.
Fair value hedge: If the company uses any derivative to cover the risk due to fair value changes of asset, liability, or a commitment, the derivative is classified as fair value hedge. This type of hedge focusses to control the risk due to future price changes.
Cash flow hedge: If a company uses any derivative to cover the risk due to cash flow changes of asset, or a liability, or a commitment to buy or sell, the derivative is classified as cash flow hedge. This type of hedge focusses to control the risk due to current price changes, like more
Foreign currency hedge: A multinational company faces the risk due to changes in foreign currency rate, when the transactions of its foreign operations are denominated in foreign currency, and such transactions require settlements through translation. The derivative used to hedge such type of foreign currency risk is designated as foreign currency hedge.
To indicate: The type of hedge against the activity given
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
Indicate the type of hedge each activity described below would represent.
Activity
1. An options contract to hedge possible future price changes of inventory.
2. A futures contract to hedge exposure to interest rate changes prior to replacing bank notes when they mature.
3. An interest rate swap to synthetically convert floating rate debt into fixed rate debt.
4. An interest rate swap to synthetically convert fixed rate debt into floating rate debt.
5. A futures contract to hedge possible future price changes of timber covered by a firm commitment to sell.
6. A futures contract to hedge possible future price changes of a forecasted sale of aluminum.
7. ExxonMobil's net investment in offshore drilling operations in Brazil.
8. An interest rate swap to synthetically convert floating rate interest on an available-for-sale debt investment into
fixed rate interest.
9. An interest rate swap to synthetically convert fixed rate interest on a held-to-maturity debt investment into
floating rate…
What is the correct strategy when the asset backing the futures contract
differs from the asset whose price is being hedged?
O Short hedge
O Long hedge
O Perfect hedge
O Tailing the hedge
O Cross hedge
Define each of the following terms:
a. Derivatives
b. Enterprise risk management
c. Financial futures; forward contract
d. Hedging; natural hedge; long hedge; short hedge; perfect hedge; symmetric hedge; asymmetric hedge
e. Swap; structured note
f. Commodity futures
Chapter A Solutions
INTER. ACCTNG. (LOOSE) W/ALEK+CONNECT
Ch. A - Prob. A.1QCh. A - Prob. 2QCh. A - Prob. A.2QCh. A - Prob. 3QCh. A - Prob. A.3QCh. A - Prob. 4QCh. A - Prob. A.4QCh. A - What is the effect on interest of an interest rate...Ch. A - Prob. A.5QCh. A - How are derivatives reported on the balance sheet?...
Ch. A - Prob. A.6QCh. A - When is a gain or a loss from a cash flow hedge...Ch. A - Prob. A.7QCh. A - Prob. 1ECh. A - Prob. A.1ECh. A - Derivatives; interest rate swap; fixed rate debt...Ch. A - Derivatives; interest rate swap; fixed rate...Ch. A - Derivatives; interest rate swap; fixed rate debt;...Ch. A - Prob. 5ECh. A - Derivatives; interest rate swap; fixed-rate debt;...Ch. A - Derivatives; interest rate swap On January 1,...Ch. A - Derivatives; interest rate swap; comprehensive...Ch. A - Derivatives; interest rate swap; fixed rate debt;...Ch. A - Real World Case A1 Derivative losses; recognition...Ch. A - Research Case A4 Issue related to the derivatives...Ch. A - Prob. A.4BYP
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, accounting and related others by exploring similar questions and additional content below.Similar questions
- Define each of the following terms: a. Derivatives b. Enterprise risk management c. Financial futures; forward contract d. Hedging; natural hedge; long hedge; short hedge; perfect hedge; symmetric hedge; asymmetric hedge e. Swap; structured note f. Commodity futuresarrow_forwardA swap: Group of answer choices B. Gives the holder the right to see the underlying bond. A. Allows the buyer to purchase the underlying instrument. C. Is an OTC agreement to exchange the cash flows of two different securities. D. Not effective at managing interest rate risks.arrow_forwardHow are derivatives valued on the balance sheet? How is the adjustment to fair value recorded differently for a cash flow hedge versus a fair value hedge? That is, how does the fair value adjustment of each type of hedge affect current period net income and the accounting equation? What are the three criteria that must be met for a derivative to be classified as a hedge? Once entities decide to buy or sell derivatives to hedge economic risks, they then need to decide whether they want to use hedge accounting; it is an election, not a requirement, even when the derivatives are for the economic purpose of hedging. This election is reminiscent of inventory accounting. Just like when a company selects an inventory method, a company is not required to select the accounting method (LIFO, FIFO, weighted average, specific unit) that most closely corresponds with the physical movement of inventory, although they are free to do so. If entities decide to elect hedge accounting, the following…arrow_forward
- Consider a security that pays income to its holders (e.g., a dividend-paying stock, or acoupon bond). Should the forward price of this security (for a contract that matures attime T), F0,T, be higher than, lower than, or equal to the security's current spot price?Why?.arrow_forwardDiscuss the following operating hedge strategies 1. Risk Shifting 2. Price Adjustment clauses 3. Exposure nettingarrow_forwardHow can exchange-rate risk be hedged using forward, futures, and options contracts? OA. Firms can buy a put option to hedge against a rise in the exchange rate. OB. Firms can buy a call option to hedge against a rise in the exchange rate. OC. Firms can sell forward contracts to hedge against a rise in the exchange rate. OD. All of the above.arrow_forward
- Which derivative does not reduce financial risk?a. optionsb. swapsc. futuresd.forwardse. answer not givenarrow_forwardCan a derivative security's value be determined by an underlying single stock (e.g., IBM, MMM, GE)? If no, explain. Can a derivative security's value be determined by an underlying fixed income index? If yes, explain. What is the difference objective, if any, between a long futures contract, a put option contract, and a long forward contract? What are the two primary functions of derivative securities (i.e., what classifications of participants do they serve)? Finally, what does "market efficiency" suggest? Explain the significant advantage and disadvantage of Inflation Protected Treasury Bonds (TIPS). Who or what investor would likely prefer a municipal bond issued by the Commonwealth of Virginia? If a corporate bond yields 8%, to be competitive (e.g., indifferent), what would a municipal bond need to yield for an investor in the 40% tax bracket? In municipals, what, if any, is the difference between a general obligation and revenue bond? What is a pass-through security, a conforming…arrow_forwardDerivative instruments acquired to hedge exposure may be classified as either a fair value hedge or a cash flow hedge. Discuss these two types of hedges and provide numerical examples for each.arrow_forward
- An inflation hedge is an asset that increases in value at a rate equal to or greater than the rate of inflation. Group of answer choices a. True b. Falsearrow_forwardIndicate whether each statement is true or false.a) A naive hedge is the hedge of a cash asset on a direct dollar-for-dollar basis with a forward or futures contract. (…….)b) Liability side risk arises from transactions whereby a creditor, depositor, or other claim holder demands cash in exchange for the claim. (…….)c) To manage liquidity risk a Depository Institution can use purchased liquidity management or stored liquidity management. (…….)d) Stored liquidity management involves borrowing funds in the money/purchasedfunds market. (…….) Kindly answer allarrow_forwardThe purpose of the hedger in futures trading is () A. Transfer price risk B. Transfer ownership of goods C. Obtain risky profits D. Obtain physical goodsarrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning
Intermediate Financial Management (MindTap Course...
Finance
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Cengage Learning