financial instruments, derivatives and hedge accounting

 Understand
key financial
 Learn how derivatives could be
used as Hedging instruments
 Be familiar with the main
requirements of IFRS 9 with
regard to Hedge Accounting
Financial Instruments can be
divided into two broad groups
 Money market instruments
 Capital market instruments
 Treasury
Bills (TBs)- short term
borrowing instruments of the fed
issued through the central bank.
 Certificate of Deposits (CDs)promissory note issued by a bank
in form of a certificate entitling
the bearer to receive interest.
Commercial Papers (CPs)- short term
unsecured promissory note issued by large
companies and financial institutions at a
discounted value on face value.
Banker’s Acceptance (BAs)- a bill of exchange
drawn by a person and accepted by a bank. A
buyer’s promise to pay to the seller a certain
specified amount at certain date guaranteed
by the banker of the buyer.
 Repurchase
Agreements (Repos)transactions or short-term loans
in which two parties agree to sell
and repurchase the same security.
 Common
shares- certificates are legal
documents that evidence
ownership in a company
 Preferred Stock/Shares enjoy prior
claims over the ordinary
shareholders and carry a fixed
rate of dividend.
 Debentures
and Bonds- Interest
bearing debt instrument.
 Convertibles- Securities that can
be converted to ordinary shares.
Derivatives refer to a broad class of
instruments which derive their value from the
price of the underlying asset.
In the case of commodity derivatives,
underlying asset can be wheat, gold, oil etc.
For financial derivatives, it can be stock,
currency etc.
The focus of this section is on financial
 Forward
Contract- An agreement
between two parties to buy or sell
an asset in future. The price which
is paid/received by the parties is
decided at the time of entering
into the contract.
 See Illustration
 Futures-
a standardized forward
contract to buy or sell the
underlying asset at a specified
price in the future through an
organized Exchange.
 There are margin requirements to
provide safeguard.
 See illustration
 Options
Contract- An option is a
right but not the obligation to buy
or sell something at a stated date
and specified price.
 A call option gives one the right
to buy; a put option the right to
 See Illustration
 Swap
Contract- an agreement
between parties, called
counterparties, to exchange
streams of cash flows over a
period of time in the future
 Hedgers-
use derivatives to
reduce the risk associated with
the price of an asset.
 Speculators- bet on future
movements in the price of an
asset with a view to making profit.
 Arbitrageurs- take advantage of a
discrepancy between prices of the
same asset in different markets.
39 and IFRS 9 deal with all
financial assets and liabilities
including derivatives.
 The basic principle is that all
derivatives are carried at fair value
with gains and losses captured in
the income statement.
The fair value of a financial asset or liability is
the amount for which the financial asset
could be exchanged or the financial liability
settled between knowledgeable, willing
parties in an arm’s length transaction.
Underlying this concept of fair value is the
presumption that an entity is a going concern
 The
item being hedged must be
identified and designated at the
inception of the hedge.
 The hedging instrument must be
identified and designated at the
inception of the hedge.
 The
effectiveness of the hedge
must be tested regularly
throughout its life.
 Effectiveness must fall within a
range of 80% - 125% over the life
of the hedge
 The
hedged item can be an asset
or liability and must expose the
entity to risk of changes in fair
 These risks include equity price
risk, foreign currency risk,
interest rate risk etc
 Most
derivative financial
instruments may be designated as
hedging instruments provided
they are with an external party.
 An entity’s own equity
instruments do not qualify
Hedge accounting ceases when
any of the following occurs:
 A hedge fails an effectiveness test
 Hedged item is sold or settled
 Hedging instrument is sold,
terminated or exercised
Three types of Hedge Accounting are
recognized by IFRS 9
Fair value Hedge
Cash flow Hedge
Net Investment in a foreign operation
See illustrations for specific accounting
treatment of these hedging relationships
Financial instruments are either short term or
medium to long term known as money or
capital market instruments respectively.
Financial derivatives can be used as hedging
The basic principle of IFRS 9 is that all
derivatives are carried at fair value with gains
and losses recognized in the income
statement in the period in which they arise.
Thanks for your attention

similar documents