Académique Documents
Professionnel Documents
Culture Documents
Derivatives
and Related
Accounting
Issues
Derivatives, defined
Financial instruments that derive their value
from changes in the value of a related asset
or liability.
Characteristics of Derivatives
Underlyings - the rates or prices that relate to the
asset or liability underlying the derivative instrument
Notional amount - the number of units or quantity
that are specified in the derivative instrument
Minimal initial investment - a derivative requires
little or no initial investment because it is an
investment in a change in value rather than an
investment in the actual asset or liability
No required delivery- generally the parties to the
contract, the counterparties, are not required to actually
deliver an asset that is associated with the underlying
Forward Contracts
A contract to buy or sell a specified amount of
an asset at a specified fixed price with delivery
at a specified future point in time.
The value of the contract at inception is zero and
typically does not require an initial cash outlay.
The total change in the value of the forward
contract is measured as the difference between
the forward rate and the assets spot rate at the
forward date.
Holder
of the
Contract
Futures Contracts
Like a forward contract except that futures are:
Traded on an organized exchange
The exchange clearinghouse becomes the intermediary
between the buyer and seller of the contract
Contracts are standardized versus customized
An initial deposit of funds is required to create a
margin account
Buy oil
Buy oil
Clearing
House
Sell oil
The
Long
Option Contracts
Represent a right rather than an obligation to
either buy or sell some quantity of a particular
underlying.
The buy or sell price is referred to as the strike
price or exercise price
A call option allows the holder to buy an
underlying whereas a put option allows the
holder to sell an underlying
Example of an Option
Option
Writer
Option
Holder
Call
Option A
$1,000
30,000
29,500
No
Yes
No
1,000
Call
Option B
$1,000
30,000
30,800
No
No
Yes
800
200
Put
Option C
$1,000
30,000
29,200
No
No
Yes
800
200
Swaps
A type of forward contract represented by a
contractual obligation, arranged by an
intermediary that requires the exchange of cash
flows between two parties.
For example, a company with a loan payable with
a fixed (variable) interest rate exchanges the fixed
rate of interest expense for a variable (fixed) rate
of interest.
Pays a
variable
rate
Receives
8% fixed
Issuer Of
$10 Million
Debt
Pays 8%
fixed
Creditors
$
$
$
1,000
1,300
(300)
$
$
$
2,000
2,200
(200)
$
$
$
(1,300)
1,300
-
$
$
$
(2,200)
2,200
-
$
$
(300)
(300)
$
$
(200)
(200)
Desired
Position
$ 149,500
(120,000)
$ 29,500
29,500
29,500
Without the
Hedge
$ 146,000
(120,000)
$ 26,000
26,000
With the
Hedge
$ 146,000
(116,500)
$ 29,500
$
3,500
(3,500)
$ 29,500
26,000
(500)
29,000
$
$
$
2,500
2,000
500
$
$
$
1,500
3,000
(1,500)
2,000
3,000
$
$
2,000
500
500
$
$
3,000
(1,500)
(1,500)
Date Inventory
Is Sold
$
$
(5,000)
(5,000)
5,000
5,000
Desired
Position
$ 225,000
(149,000)
(30,000)
$ 46,000
$ 46,000
Without the
Hedge
$ 225,000
(154,000)
(30,000)
$ 41,000
41,000
With the
Hedge
$ 225,000
(154,000)
(30,000)
$ 41,000
5,000
$ 46,000
(1,000)
$ 45,000