ACCT370 Read & Interact: Revsine, Collins, Johnson, Mittelstaedt, & Soffer: Chapter 19
Which of the following are true of options?
- A call option gives the holder the right to buy an asset for a specific price. - A put option gives the holder the right to sell an asset for a specific price.
Which of the following are true of accounting for stand-alone derivatives?
- Changes in the fair value of the derivatives must be recognized in income as they occur. - They must be carried on the balance sheet at fair value.
Options
- hedge against downside risk while retaining the opportunity to benefit from favorable movement. - gives the holder the right but not the obligation to buy or sell an asset.
A swap contract
- hedges foreign currency exchange rate risk. - hedges interest rate risk.
Which of the following is true of hedge effectiveness?
A highly effective hedge qualifies for special hedge accounting treatment.
GAAP defines hedge effectiveness as which of the following?
GAAP does not define effectiveness but rather provides general guidelines.
______ is the derivative's ability to generate offsetting changes in the fair value or cash flows of the hedged item.
Hedge effectiveness.
Which of the following is not true of swap contracts?
They are used to hedge commodities purchases.
A swap contract can result in
an asset or a liability.
A company enters into an interest rate swap that requires it to receive the LIBOR variable rate and pay a 6% fixed rate on a $1,000,000 notional value. If the LIBOR rate increases to 7%, The company would
be owed $10,000 by the swap dealer.
A foreign currency exposure hedge protects against
changes in currency exchange rates of an existing asset or liability.
A fair value hedge protects against
changes in the fair value of an existing asset or liability.
Prince Company enters into an interest rate swap to convert variable rate debt to fixed rate debt. Under the swap, the firm agrees to receive variable and pay fixed on a notional amount of $1,000,000. Variable rates for the subsequent year are determined at the end of each year. At the end of the first year, the swap decreases in value by $125,000. To record the decline in the swap value under cash flow hedge accounting, Prince would
credit Derivatives-Swap contract for $125,000.
In September 2021, Lynd Company buys March 2022 futures contracts for 1,000,000 pounds of frozen concentrated orange juice that it needs for its production in 2022. Lynd has a December 31 calendar year. During 2021, both the price of orange juice and Lynd's futures contracts decline in value. If the futures contracts decline by $52,000 during 2021 and remain at the same level until the contract expires in March 2022, Lynd would
debit Cost of goods sold.
In September 2021, Lynd Company buys March 2022 futures contracts for 1,000,000 pounds of frozen concentrated orange juice that it needs for its production in 2022. Lynd has a December 31 calendar year. During 2021, both the price of orange juice and Lynd's futures contracts decline in value. If the futures contracts decline by $52,000 during 2021, Lynd would
debit Other comprehensive income.
Jackson Company uses a futures contract to lock-in the $1,000,000 value of its cocoa inventory. The cocoa inventory value falls by $200,000, and the futures contract increases in value by $200,000. Jackson appropriately accounts for the futures contract as a fair value hedge. To record the change in the inventory and futures values, Jackson would
debit the Derivatives-Futures contracts account for $200,000.
Jackson company uses a futures contract to lock-in the $1,000,000 value of its cocoa inventory. The cocoa inventory value falls by $200,000, and the futures contract increases in value by $200,000. Jackson appropriately accounts for the futures contract as a fair value hedge. To record the change in the values of the futures contract and the inventory, Jackson would
decrease net assets by $0.
A company sells futures contracts for 250,000 bushels for $5 per bushel. Corn prices subsequently increase by $1. The value of the futures contract
decreases by $250,000.
A futures contract differs from a forward contract in that
futures contracts are publicly traded.
A futures contract differs from a forward contract in that
futures contracts do not have a predetermined settlement date.
When a derivative is accounted for under hedge accounting,
gains on the derivative will offset losses on the hedged item in the same period.
Hedge effectiveness refers to
how well a hedging instrument offsets a hedged risk.
All of the following items could be hedged, except
industrial accidents.
All of the following items would qualify as hedging instruments, except
insurance contracts.
One characteristic of a derivative is that
it carries significant risk relative to the initial investment.
A company produces 250,000 bushels of corn and plans to sell the corn in January. If the company sells futures contracts for 250,000 bushels of corn for $5 per bushel,
it eliminates both losses and gains associated future changes in corn prices.
One characteristic of a derivative is that
it requires a small or no initial investment.
One characteristic of a derivative is that
its value is based on the value of an underlying asset, rate, or index.
A forward contract
locks in a price for a future delivery.
In the absence of a hedging transaction, derivatives
must be carried on the balance sheet at fair value.
To synthetically convert interest payments denominated in Yen to interest payments denominated in U.S. dollars, a company would enter into a swap contract where it
pays U.S. dollars and receives Yen.
To synthetically convert interest payments denominated in U.S. dollars to interest payments denominated in Yen, a company would enter into a swap contract where it
pays Yen and receives U.S. dollars.
To convert synthetically fixed rate debt to floating rate debt, a company would enter into a swap agreement where it
pays the variable rate and receives the fixed rate.
A forward contract
requires a payment when goods are delivered in the future.
Hedge effectiveness is
the derivative's ability to generate offsetting changes in the fair value or cash flows of the hedged item.
