Table of Contents

Chapter 1 - Derivatives and Hedging Transactions............................................................................................................. 1

What is a Derivative?................................................................................................................................................................ 1

What is a Hedge?........................................................................................................................................................................ 2

What is Risk?............................................................................................................................................................................... 3

Foreign Exchange Risk......................................................................................................................................................... 3

Interest Rate Risk................................................................................................................................................................... 4

Credit Risk.............................................................................................................................................................................. 5

Foreign Exchange Risk Management Alternatives............................................................................................................... 6

Take No Action...................................................................................................................................................................... 6

Avoid Risk.............................................................................................................................................................................. 6

Shift Risk................................................................................................................................................................................. 7

Time Compression................................................................................................................................................................. 7

Build Reserves........................................................................................................................................................................ 8

Maintain Local Reserves...................................................................................................................................................... 8

Hedging................................................................................................................................................................................... 8

Interest Rate Risk Management Alternatives......................................................................................................................... 8

Take No Action...................................................................................................................................................................... 9

Avoid Risk.............................................................................................................................................................................. 9

Asset and Liability Matching............................................................................................................................................... 9

Hedging................................................................................................................................................................................... 9

Credit Risk Management Alternatives.................................................................................................................................... 9

Take No Action...................................................................................................................................................................... 9

Alter the Credit Policy........................................................................................................................................................ 10

Enhance Collection Activities........................................................................................................................................... 10

Foreign Exchange Hedging Instruments............................................................................................................................. 10

Loan Denominated in a Foreign Currency...................................................................................................................... 10

The Forward Contract......................................................................................................................................................... 11

The Futures Contract........................................................................................................................................................... 12

The Currency Option.......................................................................................................................................................... 12

The Cylinder Option........................................................................................................................................................... 13

Swaps..................................................................................................................................................................................... 14

Interest Rate Hedging Instruments........................................................................................................................................ 14

The Forward Rate Agreement........................................................................................................................................... 14

The Futures Contract........................................................................................................................................................... 16

Interest Rate Swaps............................................................................................................................................................. 18

Interest Rate Options.......................................................................................................................................................... 19

Interest Rate Swaptions...................................................................................................................................................... 21

Credit Risk Hedging Instruments.......................................................................................................................................... 22

Credit Risk............................................................................................................................................................................ 22

Credit Default Swaps.......................................................................................................................................................... 23

Chapter 2 - Accounting for Derivatives and Hedges......................................................................................................... 26

Other Comprehensive Income................................................................................................................................................ 26

Derivative Accounting............................................................................................................................................................. 28

Hedge Accounting - General.................................................................................................................................................. 28

Hedge Accounting Fair Value Hedges.............................................................................................................................. 30

Hedge Accounting Cash Flow Hedges.............................................................................................................................. 32

Hedge Accounting Net Investment Hedges....................................................................................................................... 35

Embedded Derivatives............................................................................................................................................................. 35

Hedging Controls..................................................................................................................................................................... 36

Sample Hedging Procedure.................................................................................................................................................... 37

Unhedged Foreign Exchange Gains and Losses................................................................................................................ 39

Presentation of Hedges........................................................................................................................................................... 40

Derivative and Hedging Disclosures.................................................................................................................................... 40

General Disclosures............................................................................................................................................................ 40

Fair Value Hedge Disclosures........................................................................................................................................... 42

Cash Flow Hedge Disclosures........................................................................................................................................... 42

Answers to Chapter Questions................................................................................................................................................ 46

Glossary......................................................................................................................................................................................... 49

Index............................................................................................................................................................................................... 51

 

CPE Exam,,53