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Appendix A Solutions Manual Paper

Reflective thinking . Appendix A: Derivatives The McGraw-Hill Companies, Inc. , 2013 A-I QUESTIONS FOR REVIEW go KEY TOPICS Question A-I These instruments “derive” their values or contractually required cash flows from some other security or index. Question A-2 The FAST has taken the position that the income effects Of the hedge instrument and the income effects of the item being hedged should be recognized at the same time. Question A-3 If interest rates change, the change in the debts fair value will be less than the change in the swap’s fair value.

The gain or loss on the $500,000 notional preference will not be offset by a corresponding loss or gain on debt. Any increase or decrease in income resulting from a hedging arrangement would be a result of hedge ineffectiveness such as this. A futures contract is an agreement between a seller and a buyer that calls for the seller to deliver a certain commodity (such as wheat, silver, or Treasury bond) at a specific future date, at a predetermined price. Such contracts are actively traded on regulated futures exchanges.

If the “commodity” is a financial instrument, such as a Treasury bill, commercial paper, or a CD, the contract is called a financial futures agreement. An interest rate swap exchanges fixed interest payments for floating rate payments, or vice versa, without exchanging the underlying notional amount. 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 Fasts definition of assets or liabilities and (b) fair value is the most meaningful measurement.

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Question A-7 A gain or loss from a cash flow hedge is deferred as other comprehensive income until it can be recognized in earnings along with the earnings effect of the item Ewing hedged. ;O The McGraw-Hill Companies, Inc. , 2013 Intermediate Accounting, e EXERCISES Exercise Indicate (by abbreviation) the type of hedge each activity described below would represent Hedge Type IV Pair value hedge CB Cash flow hedge SEC Foreign currency hedge N Would not qualify as a hedge Activity IV 1 An options contract to hedge possible future price changes of inventory.

CB 2. A futures contract to hedge exposure to interest rate changes prior to replacing bank notes when they mature. CB 3. An interest rate swap to synthetically convert floating rate debt into fixed rate debt. IV 4 An interest rate swap to synthetically convert fixed rate debt into floating IV S. A futures contract to hedge possible utter price changes of timber covered by a firm commitment to sell. CB 6. A futures contract to hedge possible future price changes of a forecasted sale of tin.

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