Question 1

How are derivatives reported on the balance sheet? Why?

Accepted Answer

All derivatives without exception are reported on the balance sheet as either assets or liabilities at fair (or market) value. The rationale is that (a) derivatives create either rights or obligations that meet the FASB's definition of assets or liabilities and (b) fair value is the most meaningful measurement.

Question 2

Which of the following is not an example of a derivative?

Accepted Answer

A)  interest rate swap.
B)  cash.
C)  stock option.
D)  forward contract. B

Question 3

An interest rate swap to synthetically convert floating rate debt into fixed rate debt would:

Accepted Answer

A)  Represent a cash flow hedge.
B)  Represent a fair value hedge.
C)  Represent a foreign currency hedge.
D)  Not qualify as a hedge. A

Question 4

The effectiveness of a hedge is influenced by the closeness of the match between the item being hedged and the financial instrument chosen as a hedge.

Accepted Answer

A) True 
 B)False

Question 5

Arshan Inc. engaged in an interest rate swap on several of its fixed interest debenture notes in order to hedge against interest rate reduction that would raise the value of its debt. Possibly, investor perceptions may cause the value of the debentures to rise beyond the prices due to changes in general interest rates. If they do, the additional increase in the value of the debt:

Accepted Answer

A)  Would be recorded as an extraordinary loss in that accounting period.
B)  Would be recorded as part of continuing operations in that period's income statement.
C)  Would be recorded as an unrealized loss in that period's income statement.
D)  Would be ignored in that accounting period.

Question 6

USA Jewelers' hedge of its net investment in a South African diamond mine:

Accepted Answer

A)  Represents a cash flow hedge.
B)  Represents a fair value hedge.
C)  Represents a foreign currency hedge.
D)  Not qualify as a hedge.

Question 7

An options contract to hedge possible future price changes of an inventory of supply parts would:

Accepted Answer

A)  Represent a cash flow hedge.
B)  Represent a fair value hedge.
C)  Represent a foreign currency hedge.
D)  Not qualify as a hedge.

Question 8

Derivatives create either rights or obligations that meet the definition of assets or liabilities.

Accepted Answer

A) True 
 B)False

Question 9

The key criterion for qualifying as a hedge is that the hedging relationship must be highly effective in achieving offsetting changes in fair values or cash flows based on the hedging company's specified risk management objective and strategy. Explain what happens if a swap is used ineffectively to hedge the fair value of a note.

Accepted Answer

The answer of The key criterion for qualifying as a...

Question 10

Explain why a stock option is a type of derivative instrument.

Accepted Answer

The answer of Explain why a stock option is a...

Question 11

Some financial instruments are called derivatives. Why? According to the FASB, should gains and losses on a fair value hedge be recorded as they occur, or should they be recorded to coincide with losses and gains on the item being hedged?

Accepted Answer

The answer of Some financial instruments are called derivatives. Why?...

Question 12

The financial futures market exists to provide a mechanism to buy and sell the underlying financial instruments.

Accepted Answer

A) True 
 B)False

Question 13

Green Import Company held a fixed-rate debt of $4 million. The company wanted to hedge its fair value exposure with an interest rate swap. However, the only notional available at the time on the type of swap it desired was $4.5 million. What will be the effect of any gain or loss on the $500,000 notional difference?

Accepted Answer

The answer of Green Import Company held a fixed-rate debt...

Question 14

If a derivative is not designated as a hedging instrument, or doesn't qualify as one, any gain or loss from fair value changes is not recognized immediately in earnings.

Accepted Answer

A) True 
 B)False

Question 15

A futures contract to hedge possible future price changes of a forecasted sale of copper:

Accepted Answer

A)  Represents a cash flow hedge.
B)  Represents a fair value hedge.
C)  Represents a foreign currency hedge.
D)  Does not qualify as a hedge.

Question 16

An agreement by a British company to import manufactured goods from Thailand, denominated in US dollars:

Accepted Answer

A)  Represents a cash flow hedge.
B)  Represents a fair value hedge.
C)  Represents a foreign currency hedge.
D)  Does not qualify as a hedge.

Question 17

In an annual report to shareholders, Merck & Co., Inc. disclosed the following in regard to its financial instruments:

Accepted Answer

The answer of In an annual report to shareholders, Merck...

Question 18

Hedging is used to deal with exposure to:

Accepted Answer

A)  Fair value risk.
B)  Cash flow risk.
C)  Foreign exchange risk.
D)  All of these are correct.

Question 19

What is a futures contract? A financial futures contract? Provide an example of each.

Accepted Answer

The answer of What is a futures contract? A financial...

Question 20

The key criterion for qualifying as a hedge is that the hedging relationship:

Accepted Answer

A)  Must be highly effective in achieving offsetting changes in fair values or cash flows.
B)  Must have predictable results.
C)  Must have fixed outcomes.
D)  None of these.

Exam 22: Appendix a Derivatives

How are derivatives reported on the balance sheet? Why?

Which of the following is not an example of a derivative?

An interest rate swap to synthetically convert floating rate debt into fixed rate debt would:

The effectiveness of a hedge is influenced by the closeness of the match between the item being hedged and the financial instrument chosen as a hedge.

USA Jewelers' hedge of its net investment in a South African diamond mine:

An options contract to hedge possible future price changes of an inventory of supply parts would:

Derivatives create either rights or obligations that meet the definition of assets or liabilities.

Explain why a stock option is a type of derivative instrument.

Some financial instruments are called derivatives. Why? According to the FASB, should gains and losses on a fair value hedge be recorded as they occur, or should they be recorded to coincide with losses and gains on the item being hedged?

The financial futures market exists to provide a mechanism to buy and sell the underlying financial instruments.

If a derivative is not designated as a hedging instrument, or doesn't qualify as one, any gain or loss from fair value changes is not recognized immediately in earnings.

A futures contract to hedge possible future price changes of a forecasted sale of copper:

An agreement by a British company to import manufactured goods from Thailand, denominated in US dollars:

In an annual report to shareholders, Merck & Co., Inc. disclosed the following in regard to its financial instruments:

Hedging is used to deal with exposure to:

What is a futures contract? A financial futures contract? Provide an example of each.

The key criterion for qualifying as a hedge is that the hedging relationship: