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Chapter 13
Basic Derivatives

NAME: Date:
Professor: Section: Score:

1. Which of the following is not among the characteristics of a derivative?

a. it must have at least two or more notional amounts
b. its value changes in response to the change in an underlying
c. it requires no initial net investment or only a very minimal initial net investment
d. it is settled at a future date

2. Which of the following can be an underlying for a derivative?

a. temperature or climate c. interest or exchange rate
b. specified price d. all of these

3. Which of the following can be a notional amount for a derivative?

a. share price c. number of currency units
b. interest rate d. exchange rate

4. Entity X enters into a forward contract to sell 1,000,000 foreign currency units at a forward rate
of ₱0.50. At the reporting date and on settlement date, the current rates are ₱0.48 and ₱0.52,
respectively. Identify the notional amount and the underlying in the contract.

Notional amount Underlying

a. ₱0.50 1,000,000
b. 1,000,000 currency units Foreign currency
c. 1,000,000 currency units Forward rates
d. ₱0.50, ₱0.48 and ₱0.52 1,000,000

Use the following information for the next two questions:

ABC Co. expects the value of the won to increase in the next 30 days. Accordingly, on December 15,
20x1, ABC Co. enters into a 30-day forward contract to buy 10,000 wons at the forward rate of ₱1.24.
On December 31, 20x1, the forward rate was ₱1.27 and by January 15, 20x2, the spot rate moved to
₱1.30.

5. How much is the carrying amount of the derivative on December 31, 20x1?
a. 0 c. 300 liability
b. 300 asset d. 1,400 asset

6. How much is the net cash settlement on January 15, 20x1?

a. 300 receipt c. 600 receipt
b. 300 payment d. 600 payment
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Use the following information for the next two questions:

On December 1, 20x1, ABC Co. enters into a futures contract to sell 10,000 units of a commodity on
January 31, 20x2 for ₱100 per unit. The broker requires an initial margin deposit of ₱10,000. The
quoted prices per unit are as follows:

Dec. 1, 20x1 Dec. 31, 20x1 Jan. 31, 20x2

100 98 97

7. How much is the gain (loss) on the remeasurement of the derivative on December 31, 20x1?
a. 10,000 gain c. 20,000 loss
b. 20,000 gain d. 0

8. How much is the net cash settlement on January 31, 20x1?

a. 30,000 receipt c. 40,000 receipt
b. 30,000 payment d. 40,000 payment

9. Drive Co. acquires a call option on 1,000 units of a commodity at a strike price of ₱100 for ₱400
on March 1, 20x1. The call option is exercisable on July 1, 20x1. The movements in prices are
shown below:

Mar. 1, 20x1 June 30, 20x1

Spot prices ₱100 ₱120
Time value of option 400 100

How much is the net cash settlement on January 31, 20x1?

a. 20,000 receipt c. 20,100 receipt
b. 20,000 payment d. 20,100 payment

10. Tuba Co. enters into a “receive variable, pay fixed” interest swap on January 1, 20x1 for a
notional amount of ₱1,000,000. Under the terms of the contract, if the current rate increases
above 12% (i.e., the set rate), Tuba Co. shall receive the excess interest. If the current rate falls
below 12%, Tuba Co. shall pay the deficiency. Swap payment shall be made on December 31,
20x2. The current rates are as follows:
Jan. 1, 20x1……………………………12%
Jan. 1, 20x2……………………………15%

How much is the carrying amount of the derivative on December 31, 20x1?
a. 30,0000 liability c. 26,087 asset
b. 30,000 asset d. 26,087 liability

“Trust in the Lord with all your heart and lean not on your own understanding; in
all your ways acknowledge him, and he will make your paths straight.” (Proverbs 3:5-6)

- END -
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SOLUTIONS:
1. A
2. D
3. C
4. C

5. B (see entries below)

6. C (see entries below)

 Dec. 15, 20x1 (Contract date)

Hedged item – None Forward contract (Derivative)

Dec. 15, 20x1
No entry

 Dec. 31, 20x1 (Reporting date)

The value of the derivative is computed as follows:

Purchase price under the forward contract (10,000 x 1.24) 12,400

Purchase price in the market (10,000 x 1.27) 12,700
Gain/ Derivative asset 300

Dec. 31, 20x1

Forward contract (asset).. 300
Gain on forward contract.. 300
[(1.27 forward rate – 1.24 forward rate) x
10K]

 Jan. 15, 20x2 (Settlement date)

Net cash settlement

Hedged item – None Forward contract (Derivative)

Jan. 15, 20x2 Jan. 15, 20x2
Cash [(1.30 – 1.24) x 10K]….. 600
Forward contract (asset)… 300
Gain on forward contract.... 300
[(1.30 – 1.27) x 10K]

7. B (see entries below)

8. C (see entries below)
Hedged item – None Futures contract (Derivative)
Dec. 1, 20x1
Deposit with broker ……..10K
Cash………………………..10K

to record the initial margin deposit with

the broker

Hedged item – None Futures contract (Derivative)

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Dec. 31, 20x1

Futures contract (asset)...20K
Gain on futures contract…..20K
[(100 - 98) x 10,000]

to record the value of the derivative

computed as the change in the underlying
multiplied by the notional amount.

Hedged item – None Futures contract (Derivative)

Jan. 31, 20x2
Cash ……………………… 40K
Deposit with broker…….....10K
Futures contract (asset)…. 20K
Gain on futures contract….10K
[(98 - 97) x 10,000]

to record the net cash settlement of the

futures contract.

9. A (see entries below)

Hedged item – None Call option (Derivative)

Mar. 1, 20x1
Call option ……..…….. 400
Cash………..……………… 400

Hedged item – None Call option (Derivative)

June 30, 20x1
Call option ……..…….. 20,000
[(120 – 100) x 1,000]
Gain on call option………. 20,000

to record the increase in the fair value of

the call option due to the increase in
intrinsic value.

June 30, 20x1

Loss on call option……….300
(400 – 100)
Call option……………………..300

to record the decrease in the fair value of

the call option due to the decrease in
time value.

Hedged item – None Call option (Derivative)

July 1, 20x1
Cash…………………20,000
[(120 – 100) x 1,000]
Loss on call option…....100
Call option ……..……..…..20,100
(400 + 20,000 – 300)

to record the net settlement of the call

option contract.
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10. C
Solution:
 Jan. 1, 20x1

Hedged item – None Interest rate swap (Derivative)

Jan. 1, 20x1
No entry

 Dec. 31, 20x1

The net cash settlement on the swap is determined as follows:

20x1 20x2
Receive variable a 120,000 150,000
Pay 12% fixed 120,000 120,000
Net cash settlement - receipt - 30,000

a
The interest rates used are the current rates as at the beginning of the year (i.e., 1M x 12% = 120,000) &
(1M x 15% = 150,000).

The net cash settlement in 20x2 is discounted to determine the fair value of the derivative on Dec. 31,
20x1:

30,000 x PV of 1 @ 15%, n=1 = 26,087 (asset)

Hedged item – None Interest rate swap (Derivative)

Dec. 31, 20x1
Interest rate swap…..26,087
Gain on int. rate swap…..26,087

to recognize the change in the fair value

of the interest rate swap

 Dec. 31, 20x2

Hedged item – None Interest rate swap (Derivative)

Dec. 31, 20x2
Cash…………………30,000
Interest rate swap……....26,087
Gain on int. rate swap…...3,913
to record the net cash settlement of the
interest rate swap