By Graeme Tosen
Graeme Tosen, the executive for technical accounting at HBOS Treasury companies in London, has written a step by step advisor to realizing and enforcing the hugely technical accounting ideas of the foreign monetary Reporting criteria (IFRS) that observe to derivatives and based finance.
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Extra info for A Practical Guide to IFRS for Derivatives and Structured Finance
The first is the time value and intrinsic value of options, which can be split and only one of the elements used as the hedging instrument. The second is the interest element and spot price of a forward contract. • Hedging instruments cannot be designated for a portion of their lives. The entity must at the designation date designate the derivative for the entire remaining maturity at that date. • One instrument hedging more than one risk is allowed. For instance, the entity can therefore have a derivative hedging the interest rate risk and the foreign currency risk of a hedged item.
Does Entity A separate the embedded derivative as the cap is in the money? No. A cap embedded in a debt host contract is only separated if the cap was below market rates when the entity initially assessed the embedded derivative (that is, when they first became party to the contract). As the cap was above market rates at initial recognition, separation was not required and will not be required for the rest of the duration of the loan, except if the terms of the loan are changed. 33 Embedded derivatives Example 3: Foreign exchange option and foreign exchange forward contracts Entity A has two loans, both of which were made in sterling (GBP).
It is therefore possible to legally contract for a total return swap where you swap two flows that are unrelated and the value of which is not affected by the change in any underlying. This would however not constitute a derivative. Are any derivatives not accounted for at fair value? Certain derivatives, although legally classified as derivatives, are not accounted for as derivatives based on the principle of substance over legal form. It is possible, for example, to have a total return swap under an ISDA agreement that has cash flows that do not change based on a change in the underlying.
A Practical Guide to IFRS for Derivatives and Structured Finance by Graeme Tosen