Financial Instruments and Hedge Accounting by Dr Uche

7/24/2019 Financial Instruments and Hedge Accounting by Dr Uche

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FINANCIAL INSTRUMENTS,DERIVATIVES AND HEDGE

ACCOUNTINGBY

UCHE UWALEKE PhD


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Understand key fnancialinstruments

Learn how deriaties could !eused as Hed"in" instrumentsBe #amiliar with the main

re$uirements o# %&'( ) withre"ard to Hed"e Accountin"

Lecture Objective


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%*+',DUC+%,*-,*EY -A'KE+ %*(+'U-E*+(

CAP%+AL -A'KE+ %*(+'U-E*+(&%*A*C%AL DE'%.A+%.E(HED/E ACC,U*+%*/ P'%*C%PLE(

C,*CLU(%,*(

Presentti!n Out"ine


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&inancial %nstruments can !ediided into two !road "rou0snamely1

-oney market instrumentsCa0ital market instruments

INTRODUCTION


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+reasury Bills 2+Bs34 short term!orrowin" instruments o# the #edissued throu"h the central !ank5

Certifcate o# De0osits 2CDs340romissory note issued !y a

!ank in #orm o# a certifcateentitlin" the !earer to receieinterest5

MONE# MAR$ETINSTRUMENTS


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Commercial Pa0ers 2CPs34 short termunsecured 0romissory note issued !y lar"ecom0anies and fnancial institutions at adiscounted alue on #ace alue5

Banker6s Acce0tance 2BAs34 a !ill o#e7chan"e drawn !y a 0erson and acce0ted!y a !ank5 A !uyer6s 0romise to 0ay to the

seller a certain s0ecifed amount at certaindate "uaranteed !y the !anker o# the !uyer5

%%%% M!ne& 'r(etInstru'ents


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'e0urchase A"reements 2'e0os34transactions or short4term loansin which two 0arties a"ree to selland re0urchase the samesecurity5

%%%M!ne& 'r(etInstru'ents


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Common (tock8E$uities8,rdinaryshares4 certifcates are le"aldocuments that eidenceownershi0 in a com0any

Pre#erred (tock8(hares en9oy

0rior claims oer the ordinaryshareholders and carry a f7edrate o# diidend5

C)it" Mr(etInstru'ents


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De!entures and Bonds4 %nterest!earin" de!t instrument5

Conerti!les4 (ecurities that can!e conerted to ordinary shares5

%%%C)it" Mr(etInstru'ents


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Deriaties re#er to a !road class o#instruments which derie their alue #romthe 0rice o# the underlyin" asset5

%n the case o# commodity deriaties:underlyin" asset can !e wheat: "old: oil etc5 &or fnancial deriaties: it can !e stock:

currency etc5

+he #ocus o# this section is on fnancialderiaties

DERIVATIVES


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&orward Contract4 An a"reement!etween two 0arties to !uy orsell an asset in #uture5 +he 0ricewhich is 0aid8receied !y the0arties is decided at the time o#enterin" into the contract5

(ee %llustration

Finnci" Derivtives


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&utures4 a standardi;ed #orwardcontract to !uy or sell theunderlyin" asset at a s0ecifed0rice in the #uture throu"h anor"ani;ed E7chan"e5

+here are mar"in re$uirements to0roide sa#e"uard5

(ee illustration

%%%Finnci" Derivtives


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,0tions Contract4 An o0tion is ari"ht !ut not the o!li"ation to !uyor sell somethin" at a stated dateand s0ecifed 0rice5

A call o0tion "ies one the ri"htto !uy< a 0ut o0tion the ri"ht tosell5

(ee %llustration

%%%Finnci" Derivtive


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(wa0 Contract4 an a"reement!etween 0arties: calledcounter0arties: to e7chan"estreams o# cash =ows oer a0eriod o# time in the #uture

%%%Finnci" Derivtives


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Hed"ers4 use deriaties toreduce the risk associated withthe 0rice o# an asset5

(0eculators4 !et on #uturemoements in the 0rice o# an

asset with a iew to makin"0roft5Ar!itra"eurs4 take adanta"e o#

a discre0ancy !etween 0rices o#

%%%Finnci" Derivtives*Prtici)nts


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%A( ?) and %&'( ) deal with allfnancial assets and lia!ilitiesincludin" deriaties5

+he !asic 0rinci0le is that allderiaties are carried at #air

alue with "ains and lossesca0tured in the incomestatement5

He+e Acc!untin


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+he #air alue o# a fnancial asset or lia!ilityis the amount #or which the fnancial assetcould !e e7chan"ed or the fnancial lia!ilitysettled !etween knowled"ea!le: willin"0arties in an arm6s len"th transaction5

Underlyin" this conce0t o# #air alue is the0resum0tion that an entity is a "oin"

concern

%%%He+e Acc!untin* Fir V"ue


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+he item !ein" hed"ed must !eidentifed and desi"nated at theince0tion o# the hed"e5

+he hed"in" instrument must !eidentifed and desi"nated at the

ince0tion o# the hed"e5

%%%He+e Acc!untin*Criteri


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+he e>ectieness o# the hed"emust !e tested re"ularlythrou"hout its li#e5

E>ectieness must #all within aran"e o# @ 4 oer the

li#e o# the hed"e

%%%He+e Acc!untin*Criteri


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+he hed"ed item can !e an assetor lia!ility and must e70ose theentity to risk o# chan"es in #airalue5

+hese risks include e$uity 0rice

risk: #orei"n currency risk:interest rate risk etc

%%%He+e+ ite's


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-ost deriatie fnancialinstruments may !e desi"natedas hed"in" instruments 0roidedthey are with an e7ternal 0arty5

An entity6s own e$uity

instruments do not $uali#y

%%%He+in Instru'ent


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Hed"e accountin" ceases whenany o# the #ollowin" occurs1

A hed"e #ails an e>ectienesstest

Hed"ed item is sold or settled

Hed"in" instrument is sold:terminated or e7ercised

%%%Disc!ntinuin He+eAcc!untin


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+hree ty0es o# Hed"e Accountin" arereco"ni;ed !y %&'( )

&air alue Hed"e

Cash =ow Hed"e *et %nestment in a #orei"n o0eration

(ee illustrations #or s0ecifc accountin"treatment o# these hed"in" relationshi0s

%%% Acc!untin Entries


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&inancial instruments are either short termor medium to lon" term known as money orca0ital market instruments res0ectiely5

&inancial deriaties can !e used ashed"in" instruments5

+he !asic 0rinci0le o# %&'( ) is that allderiaties are carried at #air alue with

"ains and losses reco"ni;ed in the incomestatement in the 0eriod in which they arise5

C!nc"usi!ns


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+hanks #or your attention

THE END

Financial Instruments and Hedge Accounting by Dr Uche

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