FAS 138 Benchmark Interest Value-Locked Debt Accounting Case:
The FASB's Example 1 on Benchmarked Interest Accounting
Bob Jensen at Trinity University
The table below contains Example 1 in Section 1 that can be downloaded from the following FASB website:
FAS 138 Examples: http://www.rutgers.edu/Accounting/raw/fasb/derivatives/examplespg.html
Section 1: Hedging the Benchmark Interest Rate
In the United States, hedging the benchmark rate of interest refers to hedging either the risk-free rate or the LIBOR swap rate. An example of a fair value hedge of the LIBOR swap rate is provided below.
Example: Fair Value Hedge of the LIBOR Swap Rate in a $100 Million A1-Quality 5-Year Fixed-Rate Noncallable Debt
On April 3, 20X0, Global Tech issues at par a $100 million
A1-quality 5-year fixed-rate noncallable debt instrument with an annual
8 percent interest coupon payable semiannually. On that date, Global
Tech enters into a 5-year interest rate swap based on the LIBOR swap
rate and designates it as the hedging instrument in a fair value hedge
of the $100 million liability. Under
the terms of the swap, Global Tech will receive a fixed interest rate at
8 percent and pay variable interest at LIBOR plus 78.5 basis points
(current LIBOR 6.29%) on a notional amount of $101,970,000 (semiannual
settlement and interest reset dates).
A duration-weighted hedge ratio was used to calculate the
notional amount of the swap necessary to offset the debtís fair value
changes attributable to changes in the LIBOR swap rate.
PV01 debt = 4.14
PV01 swap = 4.06
Hedge ratio = PV01 debt / PV01 swap = 4.14/4.06 = 1.0197
Swap notional = 1.0-197 x $100 million = $101,970,000
The example assumes that the LIBOR swap rate increased 100
basis points to 9 percent on June 30, 20X0.
The change in fair value of the swap for the period from April 3
to June 30, 20X0 is a loss of $4,016,000.
The change in fair value of the debt attributable to changes in
the benchmark interest rate for the period April 3 to June 30, 20X0 is
calculated as follows:
As of June 30, 20X0, 9.5 periods
remain and the cash flows are discounted at 9 percent; determined as the
initial 8-percent yield plus a 100 basis point increase attributable to
the 100 basis point increase in the LIBOR swap rate.
The accrual for the first quarter interest was excluded.
The following journal entries illustrate the swap and debt fair
value changes, attributable to changes in the LIBOR swap rate, excluding
Cr. Swap liability
The net earnings impact of the hedge was $240,380 due to
some imprecision in the calculated hedge ratio.