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