JBOvAao*DN e<eTV@@VL5L1.y)\# Vf, py T%*`I(7D_ ¦z[HK>Vhf^^eEXXON 1995 10Kh M svst@uvw@u4 trueASYM_BeenHere1 s4b=&Button} tTHHH2 EXXON 1995 SEC 10k Report u#T JHHH2text"85 Auto_ScrollGtbk_wid_nameOR Scroll to view more text ---------> 1. Summary of Accounting Policies Financial Instruments. Interest rate swap agreements are used to modify the interest rates on certain debt obligations. The interest differentials to be paid or received under such swaps are recognized over the life of the agreements as adjustments to interest expense. Currency exchange contracts are used to reduce the risk of adverse foreign currency movements related to certain foreign currency debt obligations. The gains or losses arising from currency exchange contracts offset foreign exchange gains or losses on the underlying assets or liabilities and are recognized as offsetting adjustments to the carrying amounts. Commodity swap and futures contracts are used to mitigate the risk of unfavorable price movements on certain crude and petroleum product purchases and sales. Gains or losses on these contracts are recognized as adjustments to purchase costs or to sales revenue. Related amounts payable to or receivable from counterparties are included in current assets and liabilities. Investments in marketable debt securities are expected to be held to maturity and are stated at amortized cost. The fair value of financial instruments is determined by reference to various market data and other valuation techniques as appropriate. Inventories. Crude oil, products and merchandise inventories are carried at the lower of current market value or cost (generally determined under the last-in, first-out method-LIFO). Costs include applicable purchase costs and operating expenses, but not general and administrative expenses or research and development costs. Inventories of materials and supplies are valued at cost or less. -------------------------------------------------------------------------------------------------------------------- 11. Interest Rate Swap, Currency Exchange and Commodity Contracts The corporation limits its use of financial derivative instruments to simple risk management activities. The corporation does not hold or issue financial derivative instruments for trading purposes nor does it use financial derivatives with leveraged features. Derivative instruments are matched to existing assets, liabilities or transactions with the objective of mitigating the impact of adverse movements in interest rates, currency exchange rates or commodity prices. These instruments normally equal the amount of the underlying assets, liabilities or transactions and are held to maturity. Instruments are either traded over authorized exchanges or with counterparties of high credit standing. As a result of the above factors, the corporation's exposure to market and credit risks from financial derivative instruments is considered to be negligible. Interest rate swap agreements are used to adjust the ratio of fixed and floating rates in the corporation's debt portfolio. Interest rate swap agreements, maturing 1996-1999, had an aggregate notional principal amount of $510 million and $604 million at year-end 1995 and 1994, respectively. Currency exchange contracts are used to reduce the risk of adverse foreign currency movements related to certain foreign currency debt obligations. Currency exchange contracts, maturing 1996-2005, totaled $1,795 million at year-end 1995 and $2,998 million at year-end 1994. These amounts included contracts in which affiliates held positions which were effectively offsetting totaling $810 million in 1995 and $2,209 million in 1994. Excluding these, the remaining currency exchange contracts totaled $985 million and $789 million at year-end 1995 and 1994, respectively. The corporation makes limited use of commodity swap and futures contracts of short duration to mitigate the risk of unfavorable price movements on certain crude and petroleum product purchases and sales. These contracts had an aggregate notional amount of $4 million at year-end 1995, maturing in 1996, and $37 million at year-end 1994. 12. Fair Value of Financial Instruments The fair value of financial instruments is determined by reference to various market data and other valuation techniques as appropriate. Long-term debt is the only category of financial instruments whose fair value has differed materially from the recorded book value. The estimated fair value of total long-term debt, including capitalized lease obligations, at December 31, 1995 and 1994 was $8.8 billion and $8.9 billion, respectively, as compared to recorded book values of $7.8 billion and $8.8 billion. ``+-/``PTjQS```` v{e"!PShowGlossaryMi" S7J)&; ; ;&#+U!8'f$glossarybuttonUp} glossary}_Show Glossarytrue>>)eSFAS1072teh M3&s v ,pfrt9u9v:;wu4 true"truee)W Zbc&Button p<+HHH2 SFAS 107 (Fair Value) r <# pHHH3 8textEH^[ Auto_Scrollmtbk_wid_nameu7x7`5X5 Scroll to view more text ---------> Click here to view Appendices A and B Statement of Financial Accounting Standards No. 107 Disclosures about Fair Value of Financial Instruments STATUS Issued: December 1991 Effective Date: For fiscal years ending after December 15, 1992 Affects: Amends FAS 105, paragraph 6 and footnotes 2 and 3 Affected by: Paragraph 8(a) amended by FAS 112 Paragraphs 10 and 13 amended by FAS 119 Other Interpretive Release: FASB Special Report, Illustrations of Financial Instrument Disclosures Summary This Statement extends existing fair value disclosure practices for some instruments by requiring all entities to disclose the fair value of financial instruments, both assets and liabilities recognized and not recognized in the statement of financial position, for which it is practicable to estimate fair value. If estimating fair value is not practicable, this Statement requires disclosure of descriptive information pertinent to estimating the value of a financial instrument. Disclosures about fair value are not required for certain financial instruments listed in paragraph 8. This Statement is effective for financial statements issued for fiscal years ending after December 15, 1992, except for entities with less than $150 million in total assets in the current statement of financial position. For those entities, the effective date is for fiscal years ending after December 15, 1995. Contents Paragraph Numbers Introduction 1-2 Standards of Financial Accounting and Reporting: Definitions and Scope 3-9 Disclosures about Fair Value of Financial Instruments 10-15 Effective Dates and Transition 16-17 Appendix A: Examples of Procedures for Estimating Fair Value 18-29 Appendix B: Illustrations Applying the Disclosure Requirements about Fair Value of Financial Instruments 30-33 Appendix C: Background Information and Basis for Conclusions 34-88 INTRODUCTION 1. The FASB added a project on financial instruments and off-balance-sheet financing to its agenda in May 1986. The project is expected to develop broad standards to aid in resolving existing financial accounting and reporting issues and other issues likely to arise in the future about various financial instruments and related transactions. 2. Because of the complexity of the issues about how financial instruments and transactions should be recognized and measured, the Board decided that, initially, improved disclosure of information about financial instruments is necessary. The first disclosure phase was completed in March 1990 with the issuance of FASB Statement No. 105, Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk. The second phase, which resulted in this Statement, considers disclosures about fair value of all financial instruments, both assets and liabilities recognized and not recognized in the statement of financial position, except those listed in paragraph 8. STANDARDS OF FINANCIAL ACCOUNTING AND REPORTING Definitions and Scope 3. A financial instrument is defined as cash, evidence of an ownership interest in an entity, or a contract that both: a. Imposes on one entity a contractual obligation (1) to deliver cash or another financial instrument to a second entity or (2) to exchange other financial instruments on potentially unfavorable terms with the second entity b. Conveys to that second entity a contractual right (1) to receive cash or another financial instrument from the first entity or (2) to exchange other financial instruments on potentially favorable terms with the first entity. 4. The definition in paragraph 3 is essentially the same as that in paragraph 6 of Statement 105, which is hereby amended to conform to this Statement. Appendix A of Statement 105 provides examples of instruments that are included in and excluded from the definition of a financial instrument. 5. For purposes of this Statement, the fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. If a quoted market price is available for an instrument, the fair value to be disclosed for that instrument is the product of the number of trading units of the instrument times that market price. 6. Under the definition of fair value in paragraph 5, the quoted price for a single trading unit in the most active market is the basis for determining market price and reporting fair value. This is the case even if placing orders to sell all of an entity's holdings of an asset or to buy back all of a liability might affect the price, or if a market's normal volume for one day might not be sufficient to absorb the quantity held or owed by an entity. 7. This Statement requires disclosures about fair value for all financial instruments, whether recognized or not recognized in the statement of financial position, except for those specifically listed in paragraph 8. It applies to all entities. It does not change any requirements for recognition, measurement, or classification of financial instruments in financial statements. 8. The disclosures about fair value prescribed in paragraphs 10-14 are not required for the following: |a. Employers' and plans' obligations for pension benefits, other | postretirement benefits including health care and life insurance | benefits, employee stock option and stock purchase plans, and other | forms of deferred compensation arrangements, as defined in FASB | Statements No. 35, Accounting and Reporting by Defined Benefit Pension | Plans, No. 87, Employers' Accounting for Pensions, No. 106, Employers' | Accounting for Postretirement Benefits Other Than Pensions, and No. 43, | Accounting for Compensated Absences, and APB Opinions No. 25, | Accounting for Stock Issued to Employees, and No. 12, Omnibus Opinion-- | 1967 b. Substantively extinguished debt subject to the disclosure requirements of FASB Statement No. 76, Extinguishment of Debt, and assets held in trust in connection with an in-substance defeasance of that debt c. Insurance contracts, other than financial guarantees and investment contracts, as discussed in FASB Statements No. 60, Accounting and Reporting by Insurance Enterprises, and No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments d. Lease contracts as defined in FASB Statement No. 13, Accounting for Leases (a contingent obligation arising out of a cancelled lease and a guarantee of a third-party lease obligation are not lease contracts and are included in the scope of this Statement) e. Warranty obligations and rights f. Unconditional purchase obligations as defined in paragraph 6 of FASB Statement No. 47, Disclosure of Long-Term Obligations g. Investments accounted for under the equity method in accordance with the requirements of APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock h. Minority interests in consolidated subsidiaries i. Equity investments in consolidated subsidiaries j. Equity instruments issued by the entity and classified in stockholders' equity in the statement of financial position. 9. Generally accepted accounting principles already require disclosure of or subsequent measurement at fair value for many classes of financial instruments. Although the definitions or the methods of estimation of fair value vary to some extent, and various terms such as market value, current value, or mark-to-market are used, the amounts computed under those requirements satisfy the requirements of this Statement and those requirements are not superseded or modified by this Statement. Disclosures about Fair Value of Financial Instruments |10. An entity shall disclose, either in the body of the financial | statements or in the accompanying notes, the fair value of financial | instruments for which it is practicable to estimate that value. An entity | also shall disclose the method(s) and significant assumptions used to | estimate the fair value of financial instruments. 11. Quoted market prices, if available, are the best evidence of the fair value of financial instruments. If quoted market prices are not available, management's best estimate of fair value may be based on the quoted market price of a financial instrument with similar characteristics or on valuation techniques (for example, the present value of estimated future cash flows using a discount rate commensurate with the risks involved, option pricing models, or matrix pricing models). Appendix A of this Statement contains examples of procedures for estimating fair value. 12. In estimating the fair value of deposit liabilities, a financial entity shall not take into account the value of its long-term relationships with depositors, commonly known as core deposit intangibles, which are separate intangible assets, not financial instruments. For deposit liabilities with no defined maturities, the fair value to be disclosed under this Statement is the amount payable on demand at the reporting date. This Statement does not prohibit an entity from disclosing separately the estimated fair value of any of its nonfinancial intangible and tangible assets and nonfinancial liabilities. |13. For trade receivables and payables, no disclosure is required under | this Statement when the carrying amount approximates fair value. 14. If it is not practicable for an entity to estimate the fair value of a financial instrument or a class of financial instruments, the following shall be disclosed: a. Information pertinent to estimating the fair value of that financial instrument or class of financial instruments, such as the carrying amount, effective interest rate, and maturity b. The reasons why it is not practicable to estimate fair value. 15. In the context of this Statement, practicable means that an estimate of fair value can be made without incurring excessive costs. It is a dynamic concept: what is practicable for one entity might not be for another; what is not practicable in one year might be in another. For example, it might not be practicable for an entity to estimate the fair value of a class of financial instruments for which a quoted market price is not available because it has not yet obtained or developed the valuation model necessary to make the estimate, and the cost of obtaining an independent valuation appears excessive considering the materiality of the instruments to the entity. Practicability, that is, cost considerations, also may affect the required precision of the estimate; for example, while in many cases it might seem impracticable to estimate fair value on an individual instrument basis, it may be practicable for a class of financial instruments in a portfolio or on a portfolio basis. In those cases, the fair value of that class or of the portfolio should be disclosed. Finally, it might be practicable for an entity to estimate the fair value only of a subset of a class of financial instruments; the fair value of that subset should be disclosed. Effective Dates and Transition 16. This Statement shall be effective for financial statements issued for fiscal years ending after December 15, 1992, except for entities with less than $150 million in total assets in the current statement of financial position. For those entities, the effective date shall be for financial statements issued for fiscal years ending after December 15, 1995. Earlier application is encouraged. In the initial year of application of this Statement, it need not be applied to complete interim financial statements. 17. Disclosures required by paragraphs 10-14 that have not previously been reported need not be included in financial statements that are being presented for comparative purposes for fiscal years ending before the applicable effective date of this Statement for an entity. For all subsequent fiscal years, the information required to be disclosed by this Statement shall be included for each year for which a statement of financial position is presented for comparative purposes. The provisions of this Statement need not be applied to immaterial items. This Statement was adopted by the unanimous vote of the six members of the Financial Accounting Standards Board: Dennis R. Beresford, Chairman Joseph V. Anania Victor H. Brown James J. Leisenring A. Clarence Sampson Robert J. Swieringa 8 -1*8V'8y*8;8y>8 9"xncl)&; ; ;&&#+U!8;&#+9!['f3SFAS107SFAS107appendicesABbuttonClick;buttonClick "SFAS107appendicesAB" close ""3;9 t>9"_99h" R8I)&; ; ;&#+9!['f$SFAS107buttonUp} close SFAS107 }9Click Here to Hide This Viewer: u:$ n;;" z )& ; ; !#hP+<, !1'f<Type the word or word string to search for in the above textbuttonUp:} ("Type the gg ␤above " ⑃IT}7;Click Here to Search for a Topice; vh;z;G"<w;ShowGlossary;i" S7J)&; ; ;&#+U!8'f$glossarybuttonUp} glossary}<Show Glossary?< wB<2z=w="n)&; ; ;a&#+U!8;A#+>0 #+U!!;*#+> #+9$@!'fWtextcontents1996 FASB Update1996FASBupdatebuttonClickkbuttonClick "1996FASBupdate" "contents" "1996 # Update" ߈"" "1996 A = 0c=1996 Update= x=>>"xncl)&; ; ;&&#+U!8;&#+9!['f3SFAS107SFAS107appendicesABbuttonClick;buttonClick "SFAS107appendicesAB" close ""3>Click Here to View Appendices A and BASYM_BeenHereFKFKFK*eSFAS107 Appendicesh M3J"U)& ; ; ;@#+U!!;b #+U!8>?" .&?-;< #+> #+9>,$$@!'fstextAxsvScrollNumberstartupenterPageY}startup4svScrollNumber = y  = 0߈"" "7" = 3 ݨ prtFuGvBIwJxFyPzP%(8u45 trueGASYM_BeenHereM y<<#n<<#nstartup<+<#F"_G$ nBIG"J Pb&ButtonQ pP<+THHH9Y\ SFAS 107 Appendices A and B rP<# HHH Ftext   Auto_Scrolltbk_wid_name#E&EAA Scroll to view more text ---------> Click here to view SFAS 107 Main Body Appendix A EXAMPLES OF PROCEDURES FOR ESTIMATING FAIR VALUE 18. This appendix provides examples of procedures for estimating the fair value of financial instruments. The examples are illustrative and are not meant to portray all possible ways of estimating the fair value of a financial instrument in order to comply with the provisions of this Statement. 19. Fair value information is frequently based on information obtained from market sources. In broad terms, there are four kinds of markets in which financial instruments can be bought, sold, or originated; available information about prices differs by kind of market: a. Exchange market. An exchange or "auction" market provides high visibility and order to the trading of financial instruments. Typically, closing prices and volume levels are readily available in an exchange market. b. Dealer market. In a dealer market, dealers stand ready to trade-- either buy or sell--for their own account, thereby providing liquidity to the market. Typically, current bid and asked prices are more readily available than information about closing prices and volume levels. "Over-the-counter" markets are dealer markets. c. Brokered market. In a brokered market, brokers attempt to match buyers with sellers but do not stand ready to trade for their own account. The broker knows the prices bid and asked by the respective parties, but each party is typically unaware of another party's price requirements; prices of completed transactions are sometimes available. d. Principal-to-principal market. Principal-to-principal transactions, both originations and resales, are negotiated independently, with no intermediary, and little, if any, information is typically released publicly. Financial Instruments with Quoted Prices 20. As indicated in paragraph 11 of this Statement, quoted market prices, if available, are the best evidence of fair value of financial instruments. Prices for financial instruments may be quoted in several markets; generally, the price in the most active market will be the best indicator of fair value. 21. In some cases, an entity's management may decide to provide further information about the fair value of a financial instrument. For example, an entity may want to explain that although the fair value of its long-term debt is less than the carrying amount, settlement at the reported fair value may not be possible or may not be a prudent management decision for other reasons; or the entity may want to state that potential taxes and other expenses that would be incurred in an actual sale or settlement are not taken into consideration. Financial Instruments with No Quoted Prices 22. For financial instruments that do not trade regularly, or that trade only in principal-to-principal markets, an entity should provide its best estimate of fair value. Judgments about the methods and assumptions to be used in various circumstances must be made by those who prepare and attest to an entity's financial statements. The following discussion provides some examples of how fair value might be estimated. 23. For some short-term financial instruments, the carrying amount in the financial statements may approximate fair value because of the relatively short period of time between the origination of the instruments and their expected realization. Likewise, for loans that reprice frequently at market rates, the carrying amount may normally be close enough to fair value to satisfy these disclosure requirements, provided there is no significant change in the credit risk of those loans. 24. Some financial instruments (for example, interest rate swaps and foreign currency contracts) may be "custom-tailored" and, thus, may not have a quoted market price. In those cases, an estimate of fair value might be based on the quoted market price of a similar financial instrument, adjusted as appropriate for the effects of the tailoring. Alternatively, the estimate might be based on the estimated current replacement cost of that instrument. 25. Other financial instruments that are commonly "custom-tailored" include various types of options (for example, put and call options on stock, foreign currency, or interest rate contracts). A variety of option pricing models that have been developed in recent years (such as the Black-Scholes model and binomial models) are regularly used to value options. The use of those pricing models to estimate fair value is appropriate under the requirements of this Statement. 26. For some predominantly financial entities, loans receivable may be the most significant category of financial instruments. Market prices may be more readily available for some categories of loans (such as residential mortgage loans) than for others. If no quoted market price exists for a category of loans, an estimate of fair value may be based on (a) the market prices of similar traded loans with similar credit ratings, interest rates, and maturity dates, (b) current prices (interest rates) offered for similar loans in the entity's own lending activities, or (c) valuations obtained from loan pricing services offered by various specialist firms or from other sources. 27. An estimate of the fair value of a loan or group of loans may be based on the discounted value of the future cash flows expected to be received from the loan or group of loans. The selection of an appropriate current discount rate reflecting the relative risks involved requires judgment, and several alternative rates and approaches are available to an entity. A single discount rate could be used to estimate the fair value of a homogeneous category of loans; for example, an entity might apply a single rate to each aggregated category of loans reported for regulatory purposes. An entity could use a discount rate commensurate with the credit, interest rate, and prepayment risks involved, which could be the rate at which the same loans would be made under current conditions. An entity also could select a discount rate that reflects the effects of interest rate changes and then make adjustments to reflect the effects of changes in credit risk. Those adjustments could include (a) revising cash flow estimates for cash flows not expected to be collected, (b) revising the discount rate to reflect any additional credit risk associated with that group of loans, or some combination of (a) and (b). 28. A fair value for financial liabilities for which quoted market prices are not available can generally be estimated using the same techniques used for estimating the value of financial assets. For example, a loan payable to a bank could be valued at the discounted amount of future cash flows using an entity's current incremental rate of borrowing for a similar liability; alternatively, the discount rate could be the rate that an entity would have to pay to a creditworthy third party to assume its obligation, with the creditor's legal consent (sometimes referred to as the "settlement rate"), or the rate that an entity would have to pay to acquire essentially risk-free assets to extinguish the obligation in accordance with the requirements of Statement 76. 29. For deposit liabilities with defined maturities, such as certificates of deposit, an estimate of fair value might also be based on the discounted value of the future cash flows expected to be paid on the deposits. The discount rate could be the current rate offered for similar deposits with the same remaining maturities. For deposit liabilities with no defined maturities, paragraph 12 of this Statement requires that the fair value to be disclosed be the amount payable on demand at the reporting date. Appendix B ILLUSTRATIONS APPLYING THE DISCLOSURE REQUIREMENTS ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS 30. The examples that follow are guides to implementation of the disclosure requirements of this Statement. Entities are not required to display the information contained herein in the specific manner illustrated. Alternative ways of disclosing the information are permissible as long as they satisfy the disclosure requirements of this Statement. Paragraphs 12 and 21 of this Statement describe possible additional voluntary disclosures that may be appropriate in certain circumstances. Example 1--Financial Entity 31. Bank A might disclose the following: Note V: Disclosures about Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: Cash and short-term investments For those short-term instruments, the carrying amount is a reasonable estimate of fair value. Investment securities and trading account assets For securities and derivative instruments held for trading purposes (which include bonds, interest rate futures, options, interest rate swaps, securities sold not owned, caps and floors, foreign currency contracts, and forward contracts) and marketable equity securities held for investment purposes, fair values are based on quoted market prices or dealer quotes. For other securities held as investments, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Loan receivables For certain homogeneous categories of loans, such as some residential mortgages, credit card receivables, and other consumer loans, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Deposit liabilities The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. Long-term debt Rates currently available to the Bank for debt with similar terms and remaining maturities are used to estimate fair value of existing debt. Interest rate swap agreements The fair value of interest rate swaps (used for hedging purposes) is the estimated amount that the Bank would receive or pay to terminate the swap agreements at the reporting date, taking into account current interest rates and the current creditworthiness of the swap counterparties. Commitments to extend credit, standby letters of credit, and financial guarantees written The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of guarantees and letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. The estimated fair values of the Bank's financial instruments are as follows: 19X9 19X8 ---------------- ---------------- Carrying Fair Carrying Fair Amount Value Amount Value -------- ----- -------- ----- Financial assets: Cash and short-term investments $XXX $XXX $XXX $XXX Trading account assets XXX XXX XXX XXX Investment securities XXX XXX XXX XXX Loans XXX XXX Less: allowance for loan losses (XXX) (XXX) ---- ---- Loans, net of allowance XXX XXX XXX XXX ==== ==== Financial liabilities: Deposits XXX XXX XXX XXX Securities sold not owned XXX XXX XXX XXX Long-term debt XXX XXX XXX XXX Unrecognized financial instruments:<*> Interest rate swaps In a net receivable position XXX XXX XXX XXX In a net payable position (XXX) (XXX) (XXX) (XXX) Commitments to extend credit (XXX) (XXX) (XXX) (XXX) Standby letters of credit (XXX) (XXX) (XXX) (XXX) Financial guarantees written (XXX) (XXX) (XXX) (XXX) Example 2--Nonfinancial Entity [In this example, it is assumed that the carrying amounts of the short-term trade receivables and payables approximate their fair values.] 32. Corporation B might disclose the following: Note X: Disclosures about Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: Cash and short-term investments The carrying amount approximates fair value because of the short maturity of those instruments. Long-term investments The fair values of some investments are estimated based on quoted market prices for those or similar investments. For other investments for which there are no quoted market prices, a reasonable estimate of fair value could not be made without incurring excessive costs. Additional information pertinent to the value of an unquoted investment is provided below. Long-term debt The fair value of the Corporation's long-term debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Corporation for debt of the same remaining maturities. Foreign currency contracts The fair value of foreign currency contracts (used for hedging purposes) is estimated by obtaining quotes from brokers. The estimated fair values of the Corporation's financial instruments are as follows: 19X9 19X8 ----------------- ----------------- Carrying Fair Carrying Fair Amount Value Amount Value -------- ----- -------- ----- Cash and short-term investments $XXX $XXX $XXX $XXX Long-term investments for which it is: - Practicable to estimate fair value XXX XXX XXX XXX - Not practicable XXX --- XXX --- Long-term debt (XXX) (XXX) (XXX) (XXX) Foreign currency contracts XXX XXX (XXX) (XXX) It was not practicable to estimate the fair value of an investment representing 12 percent of the issued common stock of an untraded company; that investment is carried at its original cost of $XXX (19X8, $XXX) in the statement of financial position. At year-end, the total assets reported by the untraded company were $XXX (19X8, $XXX) and the common stockholders' equity was $XXX (19X8, $XXX), revenues were $XXX (19X8, $XXX), and net income was $XXX (19X8, $XXX). Example 3--Small Nonfinancial Entity 33. Corporation C, whose only financial instruments are cash, short-term trade receivables and payables for which their carrying amounts approximate fair values, and long-term debt, might disclose the following: Note Z: Long-Term Debt Based on the borrowing rates currently available to the Corporation for bank loans with similar terms and average maturities, the fair value of long-term debt is $XXX (19X8, $XXX). F -1FVFxF)Fx,FF"xncl)&; ; ;&&#+9![;&#+U!8'f3SFAS107SFAS107appendicesABbuttonClick;buttonClick close "SFAS107appendicesAB" ""3)G tP,G"_GGt" ^FU)&; ; ;&#+9!['f$SFAS107appendicesABbuttonUp)} close "SFAS107appendicesAB" }GClick Here to Hide This Viewer!H uP$H$ nII" z )& ; ; !#hP+<, !1'f<Type the word or word string to search for in the above textbuttonUp:} ("Type the gg ␤above " ⑃IT}?IClick Here to Search for a TopicmI vPpIIG" JIShowGlossaryJi" S7J)&; ; ;&#+U!8'f$glossarybuttonUp} glossary}JShow GlossaryGJ wPJJKK"xncl)&; ; ;&&#+9![;&#+U!8'f3SFAS107SFAS107appendicesABbuttonClick;buttonClick close "SFAS107appendicesAB" ""3tGKClick Here to View Main Body of SFAS 1071{D xtField~ NM$ Z K"yUo)&; ; 5"z-<"!&<+E !!9 <+U!8!9"!}5!y:*!!<+U!!@#+U!8; #+.0!n@!n @!;o #+.04!;@#+U!8;+>X #+U!!;+>\ #+U!!;, #+9$@!"!} @#:$'ftextauthorHide Menu BarSystemSmallFontsstatusbardefaultenterPage+TO HANDLE --{entering fshort } $= , = default d statusbar > 'P$ d 9 } 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 0syslockScreen నsvASYM_TpID! 9504021118513691351731203655; p $e"P!#2 arrows#&!#2!2W }Zh: $e"P! "eNext Page`" JAA)&; ; >;#+5!'f$buttonUp} Ӑt} ":W!)"`) {&,: $e"P!7Next Pageo|& o!!!t"Qr!t"!Q $ P!Kv JBackGg" QLH)&; ; !!:M'f+buttonUp} d .}_bKv (` $ P!Next Page%g" QLH)&; ; !!:M'f+buttonUp} d .}]oh!``m`  \ $rnSmallFonts  5$n!Show Menu Bar" l}c)&; ; !9!;+> #+U!8+U!!'f8Hide Menu BarbuttonUp5} d B"Hide Menu Bar" / }Show Menu Bar  D$P$ Hide Menu Bar " l}c)&; ; !!;+> #+U!8+U!!'f8Show Menu BarbuttonUp5} d B"Show Menu Bar" / } Hide Menu Bar   K$bn!  Table of Contents "knG_)&; ; r;#+6r!'f0Table of ContentsbuttonClick+buttonClick "Table Contents"" Table of Contents  > $nB  LargeFonts? @" *!)& ; ; ; #$@"-$?J >,!">,!J Y!HV?~;t #+.0!n@!n@!;+>h #+U!!;+>h #+U!8;+9;+>S #F@!; #+9>,$$@!'ftextAxsvScrollNumberlargeFontsArialsmallFontsbuttonUp}4svScrollNumber = ߈""  > 12 ' = , + 12 捈"" W= "Arial" W= 16 Hide B"largeFonts" / Show B"smallFonts" / = B"/-- g1 "" ߈ "" = }W Increase Font Size {|:}&b( pD".n")& ; ; ; #$@"-$?J >,!">,!J Y!EV?;t #+.0!nj@!n @!;+>o #+U!8;+>i #+U!!;+9;+>I #F@!; #+9>,$$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = ߈""  > 12 ' = , - 12 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = Decrease Font Size eDow Chemical 1995 10Kh Msvst@uvw@ u4trueASYM_BeenHere1 s4b=&Button} tTHHH9R Dow Chemical 1995 SEC 10k Report u$T JHHHvERtext"85 Auto_ScrollGtbk_wid_nameO:R7 Scroll to view more text ---------> A Summary of Significant Accounting Policies Financial Instruments Interest differentials on swaps and forward rate agreements designated as hedges of exposures to interest rate risk are recorded as adjustments to interest expense over the contract period. Premiums for early termination of derivatives designated as hedges are amortized as adjustments to interest expense over the original contract period. Interest deriv tives not designated as hedges are marked-to-market at the end of each accounting period. The Company calculates the fair value of financial instruments using quoted market prices whenever available. When quoted market prices are not available, the Company uses standard pricing models for various types of financial instruments (such as forwards, options, swaps, etc.) which take into account the present value of estimated future cash flows. Investments in debt and marketable equity securities are cla sified as either Trading, Available-for-Sale or Held-to-Maturity . Investments classified as Trading are reported at fair value with unrealized gains and losses included in income. Investments classified as Available-for-Sale are reported at fair value with unrealized gains and losses recorded in a separate component of stockholders' equity. Investments classified as Held-to-Maturity are recorded at amortized cost. The cost of investments sold is determined by specific identification. -------------------------------------------------------------------------------------------------------------------------------------------------- Notes to Financial Statements In millions, except for share amounts - --------------------------------------------------------------------------- J Financial Instruments Fair Value of Financial Instruments at December 31 1995 1994 ----------------------------------------------------------------------------------------------------------------------------------------------------- Cost Gain Loss Fair Cost Gain Loss Fair Value Value ----------------------------------------------------------------------------------------------------------------------------------------------------- Nonderivatives: Interest-bearing deposits $ 571 - - $ 571 $ 92 - - $ 92 Marketable equity and debt securities: Trading 2,293 - - 2,293 414 $20 - 434 Available-for-Sale: Debt securities 1,256 $ 38 $ (1) 1,293 824 3 $(22) 805 Equity securities 367 100 (33) 434 454 64 (45) 473 Held-to-Maturity 54 - - 54 408 1 (1) 408 Other 262 26 - 288 337 - (7) 330 - -------------------------------------------------------------------------------------------------------------------------------------------------- Total investments $ 4,803 $ 164 $ (34) $ 4,933 $2,529 $ 88 $(75) $ 2,542 - -------------------------------------------------------------------------------------------------------------------------------------------------- Long-term debt $(4,705) - $(442) $(5,147) $(5,303) $33 - $(5,270) - -------------------------------------------------------------------------------------------------------------------------------------------------- Derivatives relating to: Foreign currency - $ 48 $(46) $ 2 - $52 $(70) $ (18) Interest - 23 (53) (30) - 37 (45) (8) Cross-currency swaps - 1 (161) (160) - 15 (93) (78) ----------------------------------------------------------------------------------------------------------------------------------------------------- Cost Gain Loss Fair Cost Gain Loss Fair Value Value - --------------------------------------------------------------------------------------------------------------------------------------------------- 1995 1994 The cost approximates the fair value for all other financial instruments. ------------------------------------------------------------------------------------------------------------------------------------------------------ Foreign Currency Risk Management The Company's global operations require active participation in the foreign exchange markets. The Company enters into foreign exchange forward contracts and options to hedge various currency exposures or create desired exposures. Exposures primarily relate to (a) assets and liabilities denominated in foreign currency in Europe, Asia and Canada; (b) bonds denominated in foreign currency; and (c) economic exposure derived from the risk that currency fluctuations could affect the dollar value of future cash flows at the operating income level. The primary business objective of the activity is to optimize the U.S. dollar value of the Company's assets, liabilities and future cash flows with respect to exchange rate fluctuations. Hedging is done on a net exposure basis. Namely, assets and liabilities denominated in the same currency are netted and only the balance is hedged. At December 31, 1995 and 1994, the Company had forward contracts outstanding with various expiration dates (primarily in January of the next year) to buy, sell or exchange foreign currencies with a U.S. dollar equivalent of $5,805 and $6,573, respectively. The unrealized gains or losses on these contracts, based on the foreign exchange rates at December 31, 1995 and 1994, were a gain of $2 and a loss of $18, respectively, and were included in income in "Interest income and foreign exchange-net." At December 31, 1995 and 1994, the Company had cross-currency swaps outstanding with a notional principal amount of $2,247 and $1,427, respectively. The $1 in gains and $161 in losses in 1995 and the $15 in gains and $93 in losses in 1994 related to cross-currency swaps were primarily recognized in income in "Interest income and foreign exchange-net" and offset the gains and losses from the assets and liabilities being hedged. ``+/``[_`t``bf````^``` v 2 {e"! / ShowGlossary i" S7J)&; ; ;&#+U!8'f$glossarybuttonUp} glossary} Show Glossary trueyJ{Gtopic index-&~"R  #N*Rr` bZX 45 8ON` Z 4wz 950402112725420560224541245ASYM_TpID ;ad2Letter7 :;adF2CLetterKiu$mBH 2topics SpHide Menu Bar" l}c)&; ; !!;+> #+U!8+U!!'f8Show Menu BarbuttonUp5} d B"Show Menu Bar" / }Hide Menu Bar SShow Menu Bar" l}c)&; ; !9!;+> #+U!8+U!!'f8Hide Menu BarbuttonUp5} d B"Hide Menu Bar" / }Show Menu Bar wS##2arrows!#2r!2G JX!S# "UNext Page`" JAA)&; ; >;#+5!'f$buttonUp} Ӑt} "*W!)"` !S#'Next Page_"U#4!t"Qbo!t"!Q wS!Kv :Back7g" QLH)&; ; !!:M'f+buttonUp} d .}ORKv `} rwS!Next Pageg" QLH)&; ; !!:M'f+buttonUp} d .}Mr  4`P]` xSv Exits "jn^)&; ; B!}!, @#:$:F!'fAbuttonClickVTO HANDLE buttonClick--{}sysSuspendMessages Pѱd--Ѳ4䰨䇰>4END} Exit  (#~!+2 alphabet " E0)&JF< JF<  ; ; #=, +#, /31,!FJ#=, +#, /31,!Y!HFJE"JE"+.0EqQ42h, /EqQ31h<" <"6EV.&"EJY!HFEJY!EF, /EqQ31h;+> #+;, .@!;+(mw"C;i#+9;+(m`w, /, "LqJ@Y!EqQ31+%@!9<"!;+9F@!+<!1;+9F@!;+9+4A!+<, #>, !1;B#"z;#h+..@#, "Qq+*0@"qY!E;B#, /31,!"%+* $@"qY !qQ$@!/, "LqJY!EqQ#Ph4<"'f topics TopicsѳalphaIndexAletterCLin|cbuttonUp}L 1 ($1)P 1 + 2 ($1)L > 0 P > 0 FLin BL c Sp c = "|" c = " " FP = 1 FP P + 1찅P P - 1삣肣--c SP g芍"letter" /c--⑃calphaIndex <> yFselectedTextLines J"Topics" \ ((W(c) - 64) I)谅c = "A" F y ⑃Ő"A"찅 z󊐟y週y⑃Ő(LF & c)selectedTextState <> yF"N"U() - E\< 2 =ő߈>zc o((c)-1) Zc = "C"삣肣䂣}FC`V| A | B | C| D | E | F| G| H| I | J | K | L| M| N| O| P| Q| R| S| T| U| V| W| X| Y| Z|W  ?u$! ?u$+#yH$ ?u$ Z+#yH$!+#yH$+#y$bX#yH$'+#y$!O  *_^n   O   } @  n n ,X#yH$!O  ^n   O   } @  n n , Z ?u$! Scroll= - N!- N@UXNj- q Nj!0 2 (click on a red locater letter)`  - q!6f16;ufq x t2y|@Short Glossary 1990 IBM Corporationnn.,__eGlossaryContents Contentsh  :7"!U)&; ; 5"z-<"!<+E !!9<+U!8!9"!}5!y:*!!<+U!!@#+U!8;@#+U!8;+>B #+U!!;A#+9$@!"!} @#:$'fauthorHide Menu BartopicsstatusbardefaultenterPageTO HANDLE --{entering fshort } $= , = default d statusbar > 'P$ d 9 } }/ B"Hide Menu Bar" / ߈JN= 0syslockScreen న`\a>VbWcd[d\e]f\\] _ W_(u4scrolltxt$true7ASYM_BeenHere?BMNPNJJ Accounting Exposure Used in alternate ways. In one context, accounting exposure depicts foreign exchange exposure that cannot be captured by the accounting model. In some textbooks accounting exposure is synonymous with translation exposure. See translation exposure. Attribute The quantifiable characteristic of an item that is measured for accounting purposes. For example, historical cost and replacement cost are attributes of an asset. Benchmark A foreign currency translation rate used as an internal budget rate or as a reference rate for measuring alternative hedging decisions. Blockage factor The impact upon financial instrument valuation of a large enougn "block" of voting rights to influcence stragegy and control of an organization (e.g., a 51% block of the voting shares versus 1% non-block). If voting power is widely dispersed, less than 51% may constitute a blockage factor if the "block" is significant enough to excercise control. The FASB does not allow blockage factors to influence the estimation of fair value. Capital Asset Pricing Model (CAPM) A method for valuing a corporation in which estimated future cash flows are discounted at a rate equal to the firm's weighted average cost of capital multiplied by the beta, which is a measure of the volatility of a firm's stock price. CAP contracts in which the cap writer, in return for a premium, agrees to limit, or cap , the cap holder's risk associated with an increase in interest rates. If rates go above a specified interest-rate level (the strike price or the cap rate ), the cap holder is entitled to receive cash payments equal to the excess of the market rate over the strike price multiplied by the notional principal amount. Issuers of floating-rate liabilities often purchase caps to protect against rising interest rates, while retaining the ability to benefit from a decline in rates. CMO Collateralized mortgage obligation. This is considered a derivative financial instrument because the value is derived from another asset whose value, in turn, varies with global and economic circumstances. Commitment Exposure Economic exposure arising from the effects of foreign currency fluctuations on the cost curves of competitors. Competitive Exposure Economic exposure arising from the effects of foreign currency fluctuations on the cost curves of competitors. Comprehensive income The change in equity of a business entity during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners (FASB Concepts Statement No. 6, Elements of Financial Statements , paragraph 70). Convered Call Simultaneous ownership of a call option and the underlying asset such as the underlying stock. A covered call reduces upside risk. Conversion The exchange of one currency for another. Cross Rate The exchange rate between two currencies other than the dollar, calculated using the dollar exchange rates of those currencies. CTA CTA has alternate meanings: Commodity Trading Advisor - One who provides advice on investing in currencies as a separate asset class. Some also act in a separate function as overlay managers, advising on hedging the currency risk in international asset portfolios. Cumulative Translation Adjustment - An entry in a translated balance sheet in which gains and losses from transactions have been accumulated over a period of years. Currency Swap A transaction in which two counterparties exchange specific amounts of two different currencies at the outset and repay over time at a predetermined rate that reflects interest payments and possibly amortization of the principal as well. The payment flows are based on fixed interest rates in each currency. Current Rate The exchange rate in effect at the relevant-financial-statement date. Derivative A financial instrument whose value is derived from changes in the value of some underlying asset such as a commodity, a share of stock, a debt instrument, or a unit of currency. Derivative financial instrument A financial instrument that by its terms, at inception or upon the occurrence of a specified event, provides the holder (or writer) with the right (or obligation) to participate in some or all of the price changes of an underlying (that is, one or more referenced financial instruments, commodities, or other assets, or other specific items to which a rate, an index of prices, or another market indicator is applied) and, except as noted below, does not require that the holder or writer own or deliver the underlying. A contract that requires ownership or delivery of the underlying is a derivative financial instrument if (a) the underlying is another derivative, (b) a mechanism exists in the market (such as an organized exchange) to enter into a closing contract with only a net cash settlement, or (c) the contract is customarily settled with only a net cash payment based on changes in the price of the underlying. Discount When the forward exchange rate is below the current spot rate. Dynamic Portfolio Management A technique of assessing the risk and managing a portfolio or group of assets and liabilities. Dynamic management is characterized by continuous assessment and periodic adjustment of the portfolio components. Economic Foreign Currency Exposure Exposure of the firm's value to unexpected future currency rate changes. Exposed Net Asset Position The excess of assets that are measured or denominated in foreign currency and translated at the current rate over liabilities that are measured or denominated in foreign currency and translated at the current rate. Fair value The estimated best disposal (exit, liquidation) value in any sale other than a forced sale. The Financial Accounting Standards board (FASB requires estimation of fair value for many types of financial instruments, including derivative financial instruments. The main guidelines are spelled out in SFAS 107. According to the FASB, fair value is the amount at which an asset (liability) could be bought (incurred) or sold (settled) in a current transaction between willing parties, that is, other than in a forced or liquidation sale. Quoted market prices in active markets are the best evidence of fair value and should be used as the basis for the measurement, if available. If a quoted market price is available, the fair value is the product of the number of trading units times that market price. If quoted market prices are not available, the estimate of fair value should be based on the best information available in the circumstances. The estimate of fair value should consider prices for similar assets and liabilities and the results of valuation techniques to the extent available in the circumstances. Examples of valuation techniques include the present value of estimated expected future cash flows using a discount rate commensurate with the risks involved, option-pricing models, matrix pricing, option-adjusted spread models, and fundamental analysis. Valuation techniques for measuring assets and liabilities should be consistent with the objective of measuring fair value. Those techniques should incorporate assumptions that market participants would use in their estimates of values, future revenues, and future expenses, including assumptions about interest rates, default, prepayment, and volatility. The fair value of foreign currency forward contracts should be based on the change in the forward rate and should consider the time value of money. In measuring liabilities at fair value by discounting estimated future cash flows, an objective is to use discount rates at which those liabilities could be settled in an arm's-length transaction. Financial instrument Cash, evidence of an ownership interest in an entity, or a contract that both: a. Imposes on one entity a contractual obligation* (1) to deliver cash or another financial instrument** to a second entity or (2) to exchange other financial instruments on potentially unfavorable terms with the second entity b. Conveys to that second entity a contractual right*** (1) to receive cash or another financial instrument from the first entity or (2) to exchange other financial instruments on potentially favorable terms with the first entity. The definition of financial instrument includes commodity-based contracts that provide the holder with an option to receive from the issuer either a financial instrument or a nonfinancial commodity. Firm commitment An agreement with an unrelated party, usually legally enforceable, under which performance is probable because of a sufficiently large disincentive for nonperformance. All significant terms of the exchange should be specified in the agreement, including the quantity to be exchanged and the fixed price. Forecasted Transaction A transaction that is expected to occur but as to which there has been no firm commitment. Because no transaction or event has yet occurred and the transaction or event when it occurs will be at the prevailing market price, a forecasted transaction does not give an entity any present rights to future benefits or obligations for future sacrifices. Foreign Currency A currency other than the currency of the country being referred to; a currency other than the reporting currency of the enterprise being referred to. Foreign-Currency Financial Statements Financial statements that employ foreign currency as the unit of measure. Foreign-Currency Transactions Transactions (for example, sales or purchases of goods or services or loans payable or receivable) whose terms are stated in a currency other than the entity's functional currency. Foreign-Currency Translation The process of expressing amounts denominated or measured in one currency in terms of another currency by use of the exchange rate between the two currencies. Foreign Operation An operation whose financial statements are (1) combined or consolidated with or accounted for on an equity basis in the financial statements of the reporting enterprise and (2) prepared in a currency other than the reporting currency of the reporting enterprise. Forward Exchange Contract An agreement to exchange at a specified future date currencies of different countries at a specified rate (forward rate). Forward Rate The rate quoted today for delivery of a specific currency amount at a specific exchange rate on a specific future date. Forward Transaction or Forward Contract An agreement made to convert foreign currency at a specific rate on a specific date in the future, such as in 30, 90, or 180 days. Functional Currency The primary currency in which an entity conducts its operation and generates and expends cash. It is usually the currency of the country in which the entity is located and the currency in which the books of record are maintained. Futures Contract An exchange-traded contract between a buyer or seller and the clearinghouse of a futures exchange to buy or sell a standard quantity and quality of a commodity, financial instrument, or index at a specified future date and price. Futures contracts commonly require daily settlement payments (known as the variation margin) for changes in the market price of the contract and often permit or require a final net cash settlement, rather than an actual purchase or sale of the underlying asset. Group of Thirty This is a private and independent, nonprofit body that examines financial issues, In its July 1993 study Derivatives: Practices and Principles, the Group of Thirty called for disclosure of information about management's attitude toward financial risks, how derivatives are used and how risks are controlled, accounting policies, management's analysis of positions at the balance sheet date and the credit risk inherent in those positions, and, for dealers, additional information about the extent of activities in derivatives. Derivatives also were the subject of major studies prepared by several federal agencies, all of which cited the need for improvements in financial reporting for derivatives. Hard Currency A currency actively traded and easily converted to other currencies on world markets. Hedge To enter into a transaction to protect the home currency value of foreign-currency-denominated assets, liabilities, or revenue streams. Hedge Accounting Accounting treatment that allows gains and losses on hedging instruments such as forward contracts and derivatives to be deferred and recognized when the offsetting gain or loss on the item being hedged is recognized. Historical Rate The foreign-exchange rate that prevailed when a foreign-currency asset or liability was first acquired or incurred. In The Money See option . Interest Rate Swap A transaction in which two parties exchange interest payment streams of differing character based on an underlying principal amount. See notional, legal settlement rate, and [Loan + Swap] rate. Legal settlement Rate The internal rate of return that discounts estimated future interest rate swap cash flows back down to a time t value equal to future swap receipts discounted at the swap receivable rate minul the swap payables discounted at the swap payable rate. Loan + Swap Rate An underlying notional loan rate (e.g., the interest rate on bonds payable) plus the difference between the swap receivable rate minus the swap payable rate. LIBOR The London InterBank Offering Rate interest rate at which banks borrow in London. The rate is commonly used as an index in floating rate contracts, interest rate swaps, and other contracts based upon interest rate fluctuations. Local Currency Currency of a particular country being referred to; the reporting currency of a domestic or foreign operation being referred to. Mark To Market To revalue securities at prevailing market prices or, in the case of some exotic derivatives, estimated fair value. Monetary Items Obligations to pay or rights to receive a fixed number of currency units in the future. Notional The underlying loan (e.g. bonds payable) whose interest rate is swapped in an interest rate swap contract. The "notional amount" is the book value of the notional loan. The "notional rate" is the current interest rate on the notional loan. Option A contract that gives the purchaser the right to buy or sell an asset (such as a unit of foreign currency) at a specified price within a specified time period. A call option gives the holder the right to buy the underlying asset; a put option gives the holder the right to sell it. An option is "in the money" if the holder would benefit from exercising it now. A call option is in the money if the strike price (the exercise price) is below the current market price of the underlying asset; a put option is in the money if the strike price is above the market price. An option is "out of the money" if the holder would not benefit from exercising it now. A call option is out of the money if the strike price is above the current market price of the underlying asset; a put option is out of the money if the strike price is below the market price. See "call" and "put." Out Of The Money See option . Overlay Program A program designed to reduce the currency risk in an international asset portfolio. Participating Strategy A combination of a purchased option and a written option, with the written option on a smaller foreign currency amount. Range Forward A combination of a purchased option and a written option on equal amounts of currency with a "range" between the strike prices. The premium on the written option offsets the premium on the purchased option. Reporting Currency The currency in which an enterprise prepares its financial statements. Settlement Date The date at which a payable is paid or a receivable is collected. Soft Currency A currency that depreciates rapidly because of the country's high inflation rate. Soft currencies are less actively traded on world markets than hard currencies and are often subject to strict controls by the country's central bank. Spot Rate The exchange rate for immediate exchange of currencies. Stop-loss/Take-profit A strategy under which a company asks a dealer to buy or sell a currency if and when a particular rate is reached. Assuming the willingness and reliability of the dealer, it can be an inexpensive alternative to an option. Stock Appreciation Right A form of employee compensation that gives cash or stock to employees based upon a contractual formula pegged to the change in common stock price. Strategic Foreign Exchange Exposure Exposure of a company's overall strategy to foreign currency fluctuations. Strike Price The exercise price of an option. See option . Swap An agreement in which two parties exchange payments over a period of time. The purpose is normally to transform debt payments from one interest rate base to another, for example, from fixed to floating or from one currency to another. See currency swap, interest rate swap . Tom/Next Tomorrow next, a spot foreign exchange quotation for settlement the next business day rather than in the usual two business days. Rates for "tom/next" quotations are adjusted on a present-value basis. Transaction A particular kind of external event, namely, an external event involving transfer of something of value (future economic benefit) between two (or more) entities. The transaction may be an exchange in which each participant both receives and sacrifices value, such as purchases or sales of goods or services; or the transaction may be a nonreciprocal transfer in which an entity incurs a liability or transfers an asset to another entity (or receives an asset or cancellation of a liability) without directly receiving (or giving) value in exchange (FASB Concepts Statement 6, paragraph 137). Internal cost allocations or events within a consolidated reporting entity are not transactions. Internal cost allocations include depreciation and cost of sales. Events within a consolidated reporting entity include intercompany dividends and sales. Transaction Date The date at which a transaction (for example, a sale or purchase of merchandise or services) is recorded in a reporting entity's accounting records. Transaction Exposure Exposure of a transaction denominated in a foreign currency to changes in the exchange rate between when it is agreed to and when it is settled. Translation Adjustments Translation adjustments result from the process of translating financial statements from the entity's functional currency into the reporting currency. Translation Exposure Exposure that occurs when the financial statements of subsidiaries with foreign functional currencies are translated into the home currency of the parent for the purpose of conso for the purpose of conso ;V  Zi>V #E58;  ! +oqtGZT h      W WWX \ f   " % D ^ 3 V    ,v6W?[1Syd[+! ?!!!!##%#;#>#$$$H%m%%%&&P'b'm(())))))<*O*;+K+<-K--(- 000v0{01112|222 222r334475<5%64666>7L77788<-<4< ;<><M<<<7=D=>*>u>>>>?? @@AAAA#B/BXB _BbBfBZC |CCCUDbDGG`HtH I IIIIIOVaRVW"n)&; ; ;b&#+U!8;B#+>1 #+U!!;+#+> #+9$@!'fXtextcontents1996 FASB Update1996FASBupdatebuttonClicklbuttonClick "1996FASBupdate" "contents" "1996 # Update" ߈"" "1996 A = 285dW fWbWa["rnef' )& <  ; ;  #+U!8;+> #+> #+9@!;+> #+>\ #+9@!;+>x #+> #+9@!;>5, #I+;!'fPauseAudioClip4 svClipNamecentersvStageNameAudioClipControlsPlayAudioClipStopAudioClipButtonClickTO HANDLE ButtonClick--This plays audio clips4syStageName svStageName = O4svClipName = 44 stage - "AudioClipControls" /-- "VideoClipControls" / ZB"PlayAudioClip""O /= P ZB"PauseAudioClip" "v /= ZB"StopAudioClip""Ϝ /= mmPlay autoClose--%video --4--4-- #-- " /-- " /-- ZB"PlayVideoClip"" /= P-- ZB"PauseVideoClip" "3/= -- ZB"StopVideoClip""[/= --  ֶ ҥ ENDu[cx[\"n)&; ; ;b&#+U!8;B#+>1 #+U!!;+#+> #+9$@!'fXtextcontents1996 FASB Update1996FASBupdatebuttonClicklbuttonClick "1996FASBupdate" "contents" "1996 # Update" ߈"" "1996 A = 285d\ `d#D\KKK\%] d(]- $!]]l"Vn@J)&; ; ;&#+9!['f$GlossarybuttonClick&buttonClick close "Glossary"]Click Here to Hide Viewer ^ e^x"!^^"knS_)&; ;  !.'fc:\mtb30jen\acc\glossary\finglos.tbkbuttonClick<buttonClick "c:\mtb30jen\acc\glossary\finglos.tbk"4_Click Here to Open the Huge Finance Glossary Book_ true&7+) +*7.26%Z5RɘZ@CPl^W\Z  s0j4/  n \l F2 ύ } 2B ,( *k ֪ `6UnD{ܗ=ِ2aCb*_f 5T_/p5vR[u'7^K j #!b}!Ӻ!-"ƶ#T$_%BO'"'6(7Gz(#(#+*/2 45xq ,)&    u<+        ; ; .'?.'?.'?Z',"JY!HV?p;@"-%?T{pageNameImaSecretstartingPage totClipenterBookIP)&; ; ;&#+V!8'f$Audio ControlsaudioControlsSZ)&; ; ;&#+V!8'f$CD Audio Track SelectionCDAudioPlayer$KU)& ; ; > , !.'f)Kn svMplayerMediaPlayers4M)&; ; ;&#+V!8'f$PathChangespage1>MA)&; ; ;&#+V!8'f$PathChangesmediaPaths( )&   ; ; >$, !.>?, !.>!, !.'fQsvAudioRecordersvAudioMixerKn svMplayerAudioRecord[v)& ; ; > , !.'f) svVideoRecorderVideoRecord,}Y)& ; ; > , !.'f)AxsvVideoEditorVideoEditQSoE)&; ;  !.'fc:\mdiabltz\scoremkr.tbkScoreMaker NR$_)&; ;  !.'fc:\mdiabltz\clipmkr.tbkClipMakerT vU)& ; ; > , !.'f)Kn svMplayerDevicePlay 5 )&  ; ; >.'" ;+? #+V!8;~ #+V!8>y.'"0r;>, #+7r!;+?] #+V!8>7.'"r;Y#+7r!'fquestionsAxPageTypeIndicatorPageIndicatorGroup5QuestionMapNo QuestionsQuestions\ Y)& ; ;  !.'f%c:\windows\Notepad.exeWindowsNotepadWordProcessor  )& ; ; 2S#?, #h,%!J,""!9'fMWhat maginification do you request?For example, you may only enter 1, 2, 4, or 16.requestZoom A<)&; ; !!'fnormalZoom@ scX)&; ;  !.'fc:\cdrom20\pw20.exe pw20.ctl -U DH -P JOPriceWaterhouseResearcher AQer)&; ;  !.'fc:\winpass\winpass.exeCPAreview <Tor)&; ;  !.'fc:\mtb30jen\acc\edgar.tbkEDGAR<FL)&; ; ;&#+V!8'f$calculatorShowCalculator=J)&; ; ;&#+V!8'f$DateTimeDateandTimeSQ )&; ;  !.'fc:\windows\winfile.exeWindowsFileManagerO_)&; ; r;#+7r!'f0Table of ContentsTableofContentsqHO )&; ; !;&#+V!8'f)Glossaryglossaryn]F)& ; ; > , !.'f) svFinGlossaryPathHugeFinancialGlossary/LTio)& ; ; > , !.'f)|=svEDpathExposureDrafte[H1)&       ; ; ,"J" .'?.'?.>?8;>A, &#+V!8.'?'fsvScrollDialog>{scrollLine)svDialogTextViewersvDialogTextLineEndFASBProspectus1 1svDialogTextLineStartFASBProspectus1e[H?)&       ; ; ,"J" .'?.'?.>?8;>Q, &#+V!8.'?'fsvScrollDialog>{scrollLineFASBProspectus2)svDialogTextViewersvDialogTextLineEnd 1svDialogTextLineStartFASBProspectus2Wd[H?)&       ; ; s,"J" .'?.'?>>?H;>Q, &#+V!8.'?'fFASBProspectus3svScrollDialog>{scrollLine)svDialogTextViewersvDialogTextLineEnd 1svDialogTextLineStartFASBProspectus3d[H?)&       ; ; ,"J" .'?.'?.>?8;>A, &#+V!8.'?'fsvScrollDialog>{scrollLine)svDialogTextViewerFASBProspectus4svDialogTextLineEnd 1svDialogTextLineStartFASBProspectus4'7J)&; ; ;&#+V!8'f$EITF8407EITF8407b7J)&; ; ;&#+V!8'f$EITF8436EITF84367J)&; ; ;&#+V!8'f$EITF8808EITF88087J)&; ; ;&#+V!8'f$EITF9017EITF90177J)&; ; ;&#+V!8'f$EITF9104EITF9104N1H)&; ; ;&#+V!8'f$SFAS80SFAS80UT#)&; ; ;&#+V!8'f$SFAS80AppendicesABSFAS80AppendicesABORA)&; ; ;&#+V!8'f$SFAS80AppendixC1SFAS80AppendixC1/OR)&; ; ;&#+V!8'f$SFAS80AppendixC2SFAS80AppendixC24I)&; ; ;&#+V!8'f$SFAS119SFAS119O_)&; ; r;#+7r!'f0call option graphcallOptionGraphL^)&; ; r;#+7r!'f0put option graphputOptionGraph_H\#)&; ; r;#+7r!'f0dividend graphdividendGraphMV)&; ; !;&#+V!8'f)General EconomyGraph01LUec)&; ; !;&#+V!8'f)Revenue TrendsGraph02LOXex)&; ; !;&#+V!8'f)Net Income TrendsGraph03NWsv)&; ; !;&#+V!8'f)Operating IncomeGraph04PY$_)&; ; !;&#+V!8'f)Earnings Per ShareGraph05ET\xt)&; ; !;&#+V!8'f)Price Earnings RatiosGraph06OX&)&; ; !;&#+V!8'f)Investment TrendsGraph07KS>)&; ; !;&#+V!8'f)Total AssetsGraph08? QZt)&; ; !;&#+V!8'f)Common Share PricesGraph09 T]p)&; ; !;&#+V!8'f)Debt vs Long Term DebtGraph10 LU)&; ; !;&#+V!8'f)Net Cash FlowsGraph11c.'" ;+?f #+V!8;j #+V!8>1,"J"";+?J #+V!8;+?& #+V!8'fAxPageTypeIndicatorPageIndicatorGrouptabletTablet '6 )&  ; ; >.'" ;+? #+V!8; #+V!8>o.'"0r;>~, #+7r!;+?S #+V!8>-.'"r;O#+7r!'fAxPageTypeIndicatorPageIndicatorGroup5QuestionMapNo QuestionsreferencesReferences(9 r)&  ; ; >.'"";+? #+V!8;+? #+V!8>o.'"0r;>, #+7r!;+?S #+V!8>-.'"r;[#+7r!'fAxPageTypeIndicatorPageIndicatorGroupAnswerSheet5QuestionMapNo QuestionsAnswerSheet?*0 )&    ; ; >.'"E@" ;+? #+V!8; #+V!8>o.'"0r;>, #+7r!;+?S #+V!8>-.'"r;p#+7r!'fAxPageTypeIndicatorPageIndicatorGroup7AnswerKeyPasswordAnswerKey5QuestionMapNo QuestionsWhat is the answer key password?ImaSecretAnswerKey_,S_3)&; ; r;#+7r!'f0Book InstructionsBookInstructions,=L_)&; ; ;&#+V!8'f$calculatorCalculator,]V)&; ; ;+? #+V!8'f&PageIndicatorGroupPageIndicatorX-[c)&; ; r;#+7r!'f0Teaching control pageTeachingControlPage- )&  ; ; >,"J",r;#+7r!;+?r #+V!8>L.'"-;+#I+F !~#, 8;#+/0#>, 8;#+/0#>, 8;#+/0#>, 8;#+/.@#, , !;;}#+/.@#, , !;;#+/.@#, , !;;z#+/.@#, , !;, !<+F !:M!.'f PageNumberAxPageTypeIndicatorPageIndicatorGroupAnswerSheetQuestionMapPageNamePage Put a blank floppy disc into Drive a of your computer. Click OK when the disc is in place.c:\windows\notepad.exe a:\Sears91.txt = a:\sears91.txtdefaulttimeoutExportThisPage2)?)& <     ; ; .'?U;w#@"-$?T>L,"JY!EV?<;@"-$h;#I+F !;?#@"-$?>,"JY!HV?;@"-%?%# >,"F,"E"6r;, #+7r!>^.'">L.'";#+/0"#>, 8;#+/0#>, 8;c#+/0-#>, 8;#+/0#>, 8;8#+/.@#, , !;;#+/.@#, , !;;#+/.@#, , !;;#+/.@#, , !;,"Y ! V E", !@<+F !r;, #+7r!!.'f PageNumberAxPageTypeIndicatoriAnswerSheety@endingPage Questions TemplateTable of ContentsPageNamePagePut a blank floppy disc into Drive a of your computer. Click OK when the disc is in place.c:\windows\notepad.exe a:\sears91.txt = a:\sears91.txtdefaulttimeoutstartingPageExportAllPages7'5 )&   JF ; ; >.'"#+h>,"J"#+h, "qn, "`>, #h?:!}, !:!}F"z-$, /.', " #, #+h, #h:!}F"z-$, `.', ")> , ! #, #+h;>J, #+<.@!JF ! #"IEK}"=>, #(h;>, #+/0, 8EKY!HF>y, !:!}'f CancelAxpageTypeIndicatorImporting text will overwrite any text presently on this page's tabletHqfileNameOverwrite?Indicate the complete path of the text file to be imported.oJrecordfieldNameTabletCannot import text into this page's tabletImportTextIntoFieldTablet=: 4)&            <+  ; ; 5!y!9!9a<+V!8 .' .' .' h!:*jB#:6$'fsysIndentstatusbarauthor?x4)&             ; ; 5!y!!G<+V!!:*!}5!yjB#:>$jB#:>$'fstatusbarreaderCl|)&; ; !!!!#jB#:$'fUclose allleaveBook} 2{H xtField~ NMJm$ }Z K%yUo)&; ; 5"z-<"!&<+F !!9 <+V!8!9"!}5!y:*!!<+V!!@#+V!8; #+/0!n@!n @!;o #+/04!;@#+V!8;+?X #+V!!;+?\ #+V!!;, #+:$@!"!}jB#:$'ftextauthorHide Menu BarSystemSmallFontsstatusbardefaultenterPage+TO HANDLE --{entering fshort } $= , = default d statusbar > 'P$ d 9 } 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 0syslockScreen నsvASYM_TpID! 9504021118513691351731203655} p $e"P!#2 arrows#&!#2!2W }Zh: $e"P! "eNext Page`% JAA)&; ; >;#+6!'f$buttonUp} Ӑt} ":W!)"`) {&,: $e"P!7Next Pageo|& o!! J!t"Qr!t"!Q $ P!Kv JBackGg" QLH)&; ; !!:M'f+buttonUp} d .}_bKv (` $ P!Next Page%g" QLH)&; ; !!:M'f+buttonUp} d .}]oh! J``m`  \ $rnSmallFonts  5$n!Show Menu Bar" l}c)&; ; !9!;+> #+U!8+U!!'f8Hide Menu BarbuttonUp5} d B"Hide Menu Bar" / }Show Menu Bar  D$P$ Hide Menu Bar " l}c)&; ; !!;+> #+U!8+U!!'f8Show Menu BarbuttonUp5} d B"Show Menu Bar" / } Hide Menu Bar   K$bn!  Table of Contents %knG_)&; ; r;#+7r!'f0Table of ContentsbuttonClick+buttonClick "Table Contents"" Table of Contents   > $nB  LargeFonts? @" *!)& ; ; ; #$@"-$?J >,!">,!J Y!HV?~;t #+.0!n@!n@!;+>h #+U!!;+>h #+U!8;+9;+>S #F@!; #+9>,$$@!'ftextAxsvScrollNumberlargeFontsArialsmallFontsbuttonUp}4svScrollNumber = ߈""  > 12 ' = , + 12 捈"" W= "Arial" W= 16 Hide B"largeFonts" / Show B"smallFonts" / = B"/-- g1 "" ߈ "" = }W Increase Font Size {|:}&b( pD".n")& ; ; ; #$@"-$?J >,!">,!J Y!EV?;t #+.0!nj@!n @!;+>o #+U!8;+>i #+U!!;+9;+>I #F@!; #+9>,$$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = ߈""  > 12 ' = , - 12 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = Decrease Font Sizem(eGabe Knapp 2h M}smv p>rsm>u4 trueASYM_BeenHere/ 2b;&Button{ pX ~HHH0R Gabe Knapp r#T HHHHF;text 63 Auto_ScrollEtbk_wid_nameMP Scroll to view more text ---------> December 20, 1996 Dear Dr. Jensen, I hope that you have had a wonderful holiday season. I am currently on vacation with my family in Hawaii, so I am catching up on my card writing. I am still at Arthur Andersen and am enjoying it. You will be pleased to know that I recently got promoted to our Risk Management group. We do financial consulting for many oil and gas companies with derivative instruments. During busy season I am still doing auditing, and the rest of my time will be spent with this group. I hope that you are enjoying teaching a more computer science based curriculum. Hope all is well with you. Sincerely, Gabe ite well. Hope all is well with you. Sincerely, Gabe  @@.]=/{IStop: Top~|vM]@ASYM_TpID 9504011022255068593862614155]3 +6<# <#B?Tabletad<t"KJ#VK"J $<t"!" p g)&; ; ;+>" #+U!!!!<+U!!'f9tabletstatusbarbuttonUp{} --questions / tablet / d statusbar --B"Hide Menu Bar" / --B"Show /}Hide Tablet%KJ#V!1Tablet) *,K"J!K"J<9TabletPage[^"JK(J, J'"J%Vj0PageName (K(J!:RTabletPage) Tablet Pageeeeei)l J%~^k2yPageNumber,*+- /4 4<# K#Questions L"lK";KJ#VK -N="!XU" s j)&; ; ;+>" #+U!!!<+U!!!'f9questionsstatusbarbuttonUpy} questions / --tablet / d statusbar --B"Hide Menu Bar" / --B"Show /}iHide Questions 2<"J!K";QuestionPagea";"K; R;/lR"J%j0PageName2_ 0lb<J!th"v]s#!M%(jXu4startT 33756M  &!+ :ZU#d.4R3~6{@!Derivative Financial Instruments PageIndicator   CCn7RProfessor Robert E. Jensen http://www.trinity.edu/~rjensen Trinity University 715 Stadium Drive San Antonio, TX 78212 Telephone: 210-736-7347 Fax: 210-736-8134 email: rjensen@trinity.eduuuuu =? NB2 v2 vm% WTN)&; ; ;&#+V!8'f$StartingPagebuttonUp1}--񐯀"Starting Page"StartingPagev<2 [+ Gv%8xt Pagem M2 [2 [p2 [ P U, {PKI<2 [b *}, ;Y  dw w? .< w+:vV      l_  ;b pdJ< PG~ CUC_  (drxb D qP   A \ y  <0 x Z  M   )7. s ]   ^ ^ k n  2 k } [  L  -    Y2 } E2 c TQ Q 2 QA   P _ !A  aCZCQ K< U, {DYMTD5,Y6YJL<K^p^p|Yz enterPageexit32  S xZ# xZ#\"Fn&:)&; ; +U!!'fbuttonClickbuttonClick Z& Z# xZ  P Z% RautoPageNumber i%SYNI)&; ; +<;@"-$, .@!'f,enterPage!notifyBefore o%   qp tbk_wid_name  autoPageNumber tbk_wid_values # 10c Qf  x Z#% | Ru autoPageName g%QYHG)&; ; +<;@#, .@!'f*enterPage!notifyBefore op- B 0 n Z qp? tbk_wid_nameW  autoPageNamek tbk_wid_valuesy   Title Page RxZ % ?R  PageM dP [ beresforde 1994m h w 4 P Q  ] ,K  }% g^)&; ; B!}!,jB#:$:F!'fAbuttonup;G sysSuspendMessages Pѱd--Ѳ4䰨䇰>4 Exit Program ^  ^F$0 LA% +b"/ )&<    ; ; ; #+V!!;.',  #+V!!;.',  #+V!8>h, #>, /#>, >g, #>, )#>h, !.'fpath\mplayer.exe :\video\acc\deriv95\derfasb1.avisvWindowsPath- svCDpathberesfordbuttonUp}4svWindowsPath4svMTBPath4svCDpath beresford 1994 1995 & = ("" &P &"\mplayer.exe " &I &":\video\acc\deriv95\derfasb1.avi") q-- u-- "c:\windows\Z g:\J:}  7multimediaI% #0,"",91SSWAP.WAV ,0,36595,"",""WLe _J7$0 28% "N/ )&<    ; ; ; #+V!8;.',  #+V!8;.',  #+V!!>G, #>, /#>, >F, #>, T#>h, !.'fpath\mplayer.exe svWindowsPath- svCDpathberesford:\audio\acc\deriv01.wavbuttonUp}4svWindowsPath4svMTBPath4svCDpath beresford 1994 1995 & = ("" &P &"\mplayer.exe " &I &":\audio\acc\deriv01.wav") h-- k-- "c:\windows\P g:\@0}7multimedia/% #0,"",91SSWAP.WAV ,0,36595,"",""GLf h H<$HHHLR1995(V%pnJd)&; ; +V!!;.',  #+V!!;.',  #+V!!'fGbuttonClick*buttonClick 1994 1995z 5=@ Jb v_a z 5= ` Vb(x c @ JClick Here to Hide This Picture g^ O &h HHHCRe@:Dennis Beresford Chairman of the FASB August 1994 in NYC(  >9!(! 0  7multimedia% #0,"",91SSWAP.WAV ,0,36595,"",""sec\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick #zDennis Beresford Chairman of the FASB August 1995 in Orlando Click Here to Hide This Black WindowQ ip fT > 7$0 c7% !X/ )&<    ; ; ; #+V!!;.',  #+V!!;.',  #+V!!>^, #>, F#>, >], #>, #>h, !.'f:\video\acc\prunes.avipath\mplayer.exe svWindowsPath- svCDpathberesfordbuttonUp}4svWindowsPath4svMTBPath4svCDpath beresford 1994 1995 & = ("" &P &"\mplayer.exe " &I &":\video\acc\prunes.avi") g-- k-- "c:\windows\P g:\@deriv95\derfasb1.B}7multimedia% #0,"",91SSWAP.WAV ,0,36595,"",""WLeG jJ,~ Gk%Un<I)&; ; ;&#+V!8'f$fishnetbuttonClickbuttonClick fishnetFishnet Networking% a{ !3 [p(QT3 [p8A  $% x G 8 Ma{ !3 [p*5PW[[CM *p p .E ' $   1 . +  5c <= '2       M + i  l J 3 ~6 C  n  ^ 8   6ml U! M$Gp w C .<.MG9D9$!   p    5K [ m| f_ MW K +Q f i  X F p c Q mW <k   @ n      n  s Z = = . ~  / ) , l! l   z z D   z TG TX 5   Q  l ! C! i ` U D 5 $     $ 3 J ^ f i =q! 8GM@MG8AM MR`al'hLV{ Title Page)`V~1/1 Title Page1V~ * v%`nFT)&; ; ; #+V!8;+:F@!'f3secbuttonClick#buttonClick sec = y Levitt!9!  n $@ z tn@ zu4trueASYM_BeenHere gz!i  7)j @Ob&Button t _i" S9J)&; ; ;&#+9!['f$EITF8407buttonUp} close EITF8407 }Click Here to Hide This Viewer u $vn" z )& ; ; !#hP+<, !1'f<Type the word or word string to search for in the above textbuttonUp:} ("Type the gg ␤above " ⑃IT}Click Here to Search for a Topic/ x2"m"Wn?K)&; ; ;&#+9!['f$SwapGraphbuttonClick%buttonClick close SwapGraphClick Here to Hide This Viewer- y06HHH23 ;>@(Interest Rate Swap Credit Risk Exposures {PMo"YnBM)&; ; ;&#+U!8'f$Yield CurvebuttonClick%buttonClick "Yield Curve"qClick Here to View Yield Curve ~bHY*'f"Pn6D)&; ; ; #+U!8'f$DAbuttonClickbuttonClick DAkClick Here for Comparison of Diffusion vs Amortization Effects iP # iP #& DA# \"Fn2:)&; ; +U!!'fbuttonClickbuttonClick ; > iP #R x#{ niP #R!~ KKK2 `NThe early rise in risk exposure tyically is due to a "diffusion effect" of diversion between initial interest rates and rising rates over time that give more value to a swap in the early periods. The diffusion effect is offset by the "amortization effect" which arises due to the declining impact of discounting the values of more distant cash flows as the swap contract approaches maturity. Since there is no payment of principal at the termination, the exposure approaches zero. The amortization effect is much more dominant for interest rate swaps than for foreign currency swaps. nx#! = Click Here to Hide the Red Noteq t x# x# } source \"Fn2:)&; ; +U!!'fbuttonClickbuttonClick   s#a$x#Q @ s#a!T KKK2Y \ !Jeremy A. Gluck, "Measuring and Controlling the Credit Risk of Derivatives," in Derivatives Risk and Responsibility, Edited by Klein and Lederman (Chicago: Irwin Publishing, 1996, 130)O @ x#!RwClick Here to Hide the Source Note 5W!aTHHH2textQj"Tn:H)&; ; ; #+U!8'f$sourcebuttonClickbuttonClick sourceY\ Source true  4eForeign Currency Graphh& M3#"tnYh)&; ; @#+U!8; #+U!!; #+U!!'fADAsourcebuttonClick,buttonClick } DA source$1 4 tuy{|~R 2 B ^  ^  u4trueASYM_BeenHereW{"c7 @5)Z b&Button t"P!h" R8I)&; ; ;&#+9!['f$FCgraphbuttonUp} close FCgraph }}Click Here to Hide This Viewer uk $n" z )& ; ; !#hP+<, !1'f<Type the word or word string to search for in the above textbuttonUp:} ("Type the gg ␤above " ⑃IT}Click Here to Search for a Topic/ y258HHH25 =@@+Foreign Currency Swap Credit Risk Exposures |bHY>;f"Pn6D)&; ; ; #+U!8'f$DAbuttonClickbuttonClick DAClick Here for Comparison of Diffusion vs Amortization Effects iP # iP #:DA7\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick ORiP #R x# ~iP #R!KKK2  @,The early rise in risk exposure tyically is due to a "diffusion effect" of diversion between initial interest rates and rising rates over time that give more value to a swap in the early periods. The diffusion effect is offset by the "amortization effect" which arises due to the declining impact of discounting the values of more distant cash flows as the swap contract approaches maturity. Since there is payment of "principal" at the termination, the amortization effect is not as dominant in comparison to interest rate swaps having no principal.  7 x#!: [ Click Here to Hide the Red Note  x# x# source \"Fn2:)&; ; +U!!'fbuttonClickbuttonClick / 2 s#aB x#o ^ s#a!r KKK2w z ? Jeremy A. Gluck, "Measuring and Controlling the Credit Risk of Derivatives," in Derivatives Risk and Responsibility, Edited by Klein and Lederman (Chicago: Irwin Publishing, 1996, 131)m ^ x#!p  Click Here to Hide the Source Note  8"r HHH2 texto j"Tn:H)&; ; ; #+U!8'f$sourcebuttonClickbuttonClick sourcew z Source  trueܔ8eCapsGraphteh& M3#"tnYh)&; ; @#+U!8; #+U!!; #+U!!'fADAsourcebuttonClick,buttonClick } DA source$14 tuy|$} 0 L P  r ܶ$L r u4trueASYM_BeenHere!}|"*a4( b&Button t"P!j" T:K)&; ; ;&#+9!['f$CapsGraphbuttonUp} close CapsGraph }Click Here to Hide This Viewer uz $n" z )& ; ; !#hP+<, !1'f<Type the word or word string to search for in the above textbuttonUp:} ("Type the gg ␤above " ⑃IT}Click Here to Search for a TopicY y\KI bHHH2_ gj@4Credit Risk Exposure Patterns for Interest Rate Caps00 }}I "nvP )&        ; ; ,!J" .&?.&?>>?H;>Q, &#+U!8.&?'f4 svClipNamesvScrollDialog>{scrollLine)svDialogTextViewersvDialogTextLineEnd 1svDialogTextLineStartFITF02ButtonClickTO HANDLE ButtonClick4svDialogTextViewer--SPECIFY THE TEXT VIEWER , = FITF024svDialogTextLineStart--SPECIFIY >STARTING { ENDING OLINES =- = 3624svDialogTextLineEnd d= 3814svClipName = 76--S SPECIFICATIONSϗ <= 1 Ϣ = 24svScrollDialog  = 0--B"ViewerControl" /4scrollLine = 4svVideo4svAudio X i = 0--This plays video clips--4syStageName--4-- svStageName-- "AudioClipControls" /-- "VideoClipControls" /-- ZB"PlayVideoClip""1 /= P-- ZB"PauseVideoClip" "Z /= -- ZB"StopVideoClip""ς /= -- mmPlay  stage autoClose END }  x# x# source \"Fn2:)&; ; +U!!'fbuttonClickbuttonClick  s#a0 x#] L s#a!` KKK2e h - Jeremy A. Gluck, "Measuring and Controlling the Credit Risk of Derivatives," in Derivatives Risk and Responsibility, Edited by Klein and Lederman (Chicago: Irwin Publishing, 1996, 132)[ L x#!^  Click Here to Hide the Source Note  H < 9 f"Pn6D)&; ; ; #+U!8'f$DAbuttonClickbuttonClick DA} Click Here for Comparison of Diffusion vs Amortization Effects  iP # iP #8 DA5\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick MPiP #R x# iP #R!KKK2@*The early rise in risk exposure tyically is due to a "diffusion effect" of diversion between initial interest rates and rising rates over time that give more value to a swap in the early periods. The diffusion effect is offset by the "amortization effect" which arises due to the declining impact of discounting the values of more distant cash flows as the swap contract approaches maturity. Since there is payment of "principal" at the termination, the amortization effect becomes dominant much like in the interest rate swaps having no principal.... K x#!NoClick Here to Hide the Red Note 8"LHHH2textIj"Tn:H)&; ; ; #+U!8'f$sourcebuttonClickbuttonClick sourceQ|Ty Source true 2{= xtField~ NM $ Z K%yUo)&; ; 5"z-<"!&<+F !!9 <+V!8!9"!}5!y:*!!<+V!!@#+V!8; #+/0!n@!n @!;o #+/04!;@#+V!8;+?X #+V!!;+?\ #+V!!;, #+:$@!"!}jB#:$'ftextauthorHide Menu BarSystemSmallFontsstatusbardefaultenterPage+TO HANDLE --{entering fshort } $= , = default d statusbar > 'P$ d 9 } 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 0syslockScreen నsvASYM_TpID! 9504021118513691351731203655̾ p $e"P!#2 arrows#&!#2!2W }Zh: $e"P! "eNext Page`" JAA)&; ; >;#+5!'f$buttonUp} Ӑt} ":W!)"`) {&,: $e"P!7Next Pageo|& o!! !t"Qr!t"!Q $ P!Kv JBackGg" QLH)&; ; !!:M'f+buttonUp} d .}_bKv (` $ P!Next Page%g" QLH)&; ; !!:M'f+buttonUp} d .}]oh! ``m`  \ $rnSmallFonts  5$n!Show Menu Bar" l}c)&; ; !9!;+> #+U!8+U!!'f8Hide Menu BarbuttonUp5} d B"Hide Menu Bar" / }Show Menu Bar  D$P$ Hide Menu Bar " l}c)&; ; !!;+> #+U!8+U!!'f8Show Menu BarbuttonUp5} d B"Show Menu Bar" / } Hide Menu Bar   K$bn!  Table of Contents "knG_)&; ; r;#+6r!'f0Table of ContentsbuttonClick+buttonClick "Table Contents"" Table of Contents   > $nB  LargeFonts? @" *!)& ; ; ; #$@"-$?J >,!">,!J Y!HV?~;t #+.0!n@!n@!;+>h #+U!!;+>h #+U!8;+9;+>S #F@!; #+9>,$$@!'ftextAxsvScrollNumberlargeFontsArialsmallFontsbuttonUp}4svScrollNumber = ߈""  > 12 ' = , + 12 捈"" W= "Arial" W= 16 Hide B"largeFonts" / Show B"smallFonts" / = B"/-- g1 "" ߈ "" = }W Increase Font Size {|:}&b( pD".n")& ; ; ; #$@"-$?J >,!">,!J Y!EV?;t #+.0!nj@!n @!;+>o #+U!8;+>i #+U!!;+9;+>I #F@!; #+9>,$$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = ߈""  > 12 ' = , - 12 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = Decrease Font Size>yeInternal Control Referencesvh Md(su\l^ b&Button pr^s.t@+ pB <^+.HHH?R36[ Internal Control References r#T HH>Stexttbk_wid_name Auto_Scroll Scroll to view more text ---------> American Institute of Certified Public Accountants, Order Department, P.O. Box 2209, Jersey City, NJ 07303-2209. Phone: 800-862-42772 AICPA (1996). Internal Control Issues in Derivatives Usage: An Information Tool for Considering the COSO Internal Control --- Framework in Derivatives Applications (Jersey City, NJ: American Institute of Certified Public Accountants, No. 990010NH, $25) AICPA (1996). Internal Control Issues in Derivatives Usage and the original two-volume Internal Control --- Integrated Framework (Jersey City, NJ: American Institute of Certified Public Accountants, No. 990011NH, $45) NH, $25) % -+Y s| p"n!m^.@x>uttonp%ZnBN)&; ; ;&#+:!['f$ICreferencesbuttonClick(buttonClick close ICreferences =Click Here to Hide This Viewerk tnZ3D!}ShowGlossaryi" S7J)&; ; ;&#+U!8'f$glossarybuttonUp} glossary}Show Glossary?|Ru4NltrueaASYM_BeenHerey true 2{> xtField~ NM$ Z K%yUo)&; ; 5"z-<"!&<+F !!9 <+V!8!9"!}5!y:*!!<+V!!@#+V!8; #+/0!n@!n @!;o #+/04!;@#+V!8;+?X #+V!!;+?\ #+V!!;, #+:$@!"!}jB#:$'ftextauthorHide Menu BarSystemSmallFontsstatusbardefaultenterPage+TO HANDLE --{entering fshort } $= , = default d statusbar > 'P$ d 9 } 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 0syslockScreen నsvASYM_TpID! 9504021118513691351731203655 p $e"P!#2 arrows#&!#2!2W }Zh: $e"P! "eNext Page`% JAA)&; ; >;#+6!'f$buttonUp} Ӑt} ":W!)"`) {&,: $e"P!7Next Pageo|& o!! !t"Qr!t"!Q $ P!Kv JBackGg" QLH)&; ; !!:M'f+buttonUp} d .}_bKv (` $ P!Next Page%g" QLH)&; ; !!:M'f+buttonUp} d .}]oh! ``m`  \ $rnSmallFonts  5$n!Show Menu Bar" l}c)&; ; !9!;+> #+U!8+U!!'f8Hide Menu BarbuttonUp5} d B"Hide Menu Bar" / }Show Menu Bar  D$P$ Hide Menu Bar " l}c)&; ; !!;+> #+U!8+U!!'f8Show Menu BarbuttonUp5} d B"Show Menu Bar" / } Hide Menu Bar   K$bn!  Table of Contents "knG_)&; ; r;#+6r!'f0Table of ContentsbuttonClick+buttonClick "Table Contents"" Table of Contents   > $nB  LargeFonts? @% *!)& ; ; ; #$@"-%?J >,"">,"J Y!HV?~;t #+/0!n@!n@!;+?h #+V!!;+?h #+V!8;+:;+?S #F@!; #+:>,%$@!'ftextAxsvScrollNumberlargeFontsArialsmallFontsbuttonUp}4svScrollNumber = ߈""  > 12 ' = , + 12 捈"" W= "Arial" W= 16 Hide B"largeFonts" / Show B"smallFonts" / = B"/-- g1 "" ߈ "" = }W Increase Font Size {|:}&b( pD".n")& ; ; ; #$@"-$?J >,!">,!J Y!EV?;t #+.0!nj@!n @!;+>o #+U!8;+>i #+U!!;+9;+>I #F@!; #+9>,$$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = ߈""  > 12 ' = , - 12 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = Decrease Font Size[ePemberton Project on Market Riskh Ms--v p4rs>tuvwЋxyz{|}~0BTfx**֫«꫋ :NbvƬڬ&4>u4 trueASYM_BeenHere% (b1&Buttonq pytHHHn)Ry|@%Pemberton Project on Risk Measurement r#T ^HHH62S' text36LI Auto_Scroll[tbk_wid_namecnfk}| Scroll to view more text ---------> Table of Contents: Introduction An Argument for the Measurement of Risk Current Methods of Measuring Market Risk A Proposed Standard for the Measurement of Risk An Argument fo the Disclosure of Market Risk Current Methods of Disclosing Market Risk A Revised Standard for the Disclosure of Market Risk Conclusion References Topics: GAO and GAO Lack of Disclosure Drawbacks of Statistical Models VAR Value at Risk Models Used by Banks Software to Calculate and Monitor Market Risk VAR Advantages and Additional Advantages VAR Drawbacks Dow Chemical and Other Corporate Examples Working Paper 001 MEASUREMENT AND DISCLOSURE OF DERIVATIVE RELATED MARKET RISK by Heather A. Pemberton April 29, 1996 INTRODUCTION The use of derivative instruments as a means of reducing risk and changing the nature of an entity's financial exposure has become the latest trend in the financial world. According to Jay Light, Professor of Finance at Harvard Business School, derivatives exist because they offer a way to minimize trading costs, borrowing limitations, margin requirements, taxes, and regulatory restraints in what is otherwise a very restrictive market (Minehan 6). However, while derivatives appear to remedy many of the risks and constraints of investing and borrowing in the financial market, they do not come without risks of their own. As many entities, such as Procter & Gamble and Orange County, have discovered, derivatives can easily evolve from risk-reduction instruments into accounting losses when their risks are not soundly measured or managed. Statement of Financial Accounting Standards Number 105 discusses the risks of accounting losses that arise from the use of financial instruments. It states that the instrument's total risk can be broken down into credit risk and market risk. Credit risk is "the possibility that a loss may occur from the failure of another party to perform according to the terms of a contract" and market risk, such as exchange rate and interest rate risks, is defined as "the possibility that future changes in market prices may make a financial instrument less valuable or more onerous" (SFAS 105 paragraph 7). As an initial step in FASB's project on financial instruments, the statement attempted to solve the question of how to accurately disclose credit and market risk. However, the standard remained very superficial. In fact, paragraph 17 simply states that "an entity shall disclose...the nature and terms (of the instruments), including, at a minimum, a discussion of (1) the credit and market risk of those instruments." The standard went on to discuss credit risk and its disclosure in more detail, but market risk was not covered as thoroughly. As such, entities still lack a comprehensive standard that discusses market risk. Entities know that they are at least to discuss their market risks, but they have no guidelines by which to measure or report them. Entities are still left with burdensome questions: how is market risk to be measured and how should it most effectively be disclosed? AN ARGUMENT FOR THE MEASUREMENT OF MARKET RISK The issues of how to measure market risks are of course very difficult to address, primarily due to the complexity of the derivative market. First of all, a method of the measurement of market risk is troublesome to derive because the risk is dependent upon derivative pricing which is in turn dependent upon many factors, such as exchange rates, interest rates, and the length of time until the instrument expires. In addition, many derivative instruments are traded over-the-counter in uncentralized markets that do not disclose derivative prices, and many hybrid derivatives that are comprised of two or more products with two or more ways of pricing are rapidly appearing. Furthermore, measuring the market risk of derivative products alone is not sufficient to understand an entity's total market risk. This is because the derivatives are often tied to the entity's assets and liabilities that also change in value with changes in exchange and interest rates. Thus, determining an entity's total market risk requires assessing the relationships between its assets, liabilities, and instruments and the subsequent changes in value due to changes in market rates. (GAO 60-62) With such difficulties in measuring an entity's market risk, one must question whether this information is worth deriving. To protect the investors, creditors, and other stakeholders of all entities, the answer must be yes. As John Smith, a partner at Deloitte and Touche, L.L.P., has stated, "there are some different perceptions, perspectives as to what risk is, and my views of risk (and ) my tolerance for risk may be very different than yours" (Smith 2). If a standard way in which to measure market risk is adopted, industry standards and averages can be established that would better define risk and its parameters in relation to specific industries and activities. Thus, an entity in the financial services sector would have a perception of risk that is consistent with that of another financial services company. The consistent perception of risk that would be attained through a standardized method of measuring market risk would help to enhance the secondary quality of comparability that is set out in the second Statement of Financial Accounting Concepts. Stakeholders in these companies would be able to identify similarities and differences between the market risk taken on by different companies and would have better guidelines (i.e. industry and specific activity averages) for determining when the company is venturing too far in its use of market risk. In addition, a standardized measurement method would improve the secondary quality of consistency. For each and every accounting period an entity's measurements of risk would be based upon the same underlying models and formulas, and in addition to the across-firms comparison mentioned above, stakeholders would be able to make comparisons over time as to the market risks being taken on by an entity. Besides alerting outside stakeholders to possible excessive market risk, a more standardized method of measuring market risk will aid financial officers in managing their derivative investments. While no aggregate data exists on derivative losses by corporate end-users, recent regulatory and press reports have indicated that several business entities have suffered large losses due to failures in properly managing hedging activities (GAO 62). This is likely to have been the case for both Procter & Gamble and Orange County, two of the most publicized losers in the derivative market. Both of these entities reported having good controls on their derivative investments (Smith 2), yet they suffered huge losses. This leads to the conclusion that they did not have a reliable system or means of quantifying the risk to which they were susceptible. It is highly probable that these entities' risk measurement systems were not capable of handling the more complex derivative instruments that are becoming more commonplace with each day. A standardized and tested method that measures even the most complex of market risks would help such entities in determining their level of risk and would better protect them and their stakeholders from another surprise onslaught of accounting losses due to derivative investments. CURRENT METHODS OF MEASURING MARKET RISK Information as to the manner in which American companies measure their level of market risk is not readily available. In a survey of eight American-based companies' annual reports from 1994 and 1995, only one, Dow Chemical, even briefly referred to its policy and controls in relation to market risk. The lack of discussion of corporate market risk policies in public reports tends to make one believe that very few companies even implement a market risk control strategy; however, this is not necessarily true. Instead, many companies tend to implement simple market risk controls that focus on market risk at the individual transaction level as outlined in SFAS 52. These entities use financial derivatives, such as an oil future, in order to hedge or counteract a specific financial transaction that is susceptible to market changes, such as a contract to purchase oil from a specific supplier in the future. In this way, the entity is able to eliminate the risk of incurring losses, due in this example to the oil purchase contract, and little or no market risk exists. While this transaction-based means of managing market risk is reliable for entities that enter into a small number of vanilla derivative investments, the method is proving to be too elementary for those companies that are more heavily dependent upon a large number of complex and hybrid derivatives. Instead many entities are turning to a portfolio or firm-level means of measuring market risk, as is supported in SFAS 80. The market risk of each individual transaction, and consequently the risk of incurring a loss with a single transaction, is not eliminated 100 percent. Attempts to measure market risk at this more comprehensive, firm-wide level is what has brought on the realization that market risk is often too difficult to calculate, measure, and monitor. However, statistical models and computer programs do in fact exist that can accurately track and monitor an entity's exposure to market risk. The majority of these statistical models have been developed as a result of the stringent capital requirements placed upon financial institutions. These banks and other financial service organizations must be constantly aware of their exposure to various forms of market risk in order to remain financially stable, and as such have worked to develop statistical computer programs that can reliably inform them of their market risks on a daily, weekly, and/or monthly basis. Among these models are several simple strategy methods that apply various formulas to the market price of the derivative instrument and its underlying asset. The major drawback of these models are that they only recognize offsetting positions in a complex, piecemeal fashion, and as such often can only roughly estimate potential losses (Estrella 29). Other tools for assessing market risk include stress tests and what-if scenarios, but these models "tend to probe not what's probable but what's vaguely possible," and as such do not often faithfully reflect the real world of market risks. A more comprehensive and friendly market risk measurement model that is commonly used by banks is the value-at-risk, or VAR, model. Quite simply, a portfolio's VAR is a measure of its potential losses in terms of some confidence level. This approach uses an aggregation of all positions relating to a given underlying asset, such as a particular exchange rate, and uses the aggregation to account for the netting of opposite positions within a portfolio quite reliably (Estrella 29). Calculating a portfolio's VAR requires two steps. First, the magnitude of historical swings in market values are traced to find the average daily volatilities of every instrument in the portfolio. From this historical pattern, a simple probability calculation is performed to arrive at a volatility figure. These volatility figures are based on standard deviations and are found to be within a particular percentage confidence level depending upon the monitoring needs of the entity. The second step entails setting up a series of correlation factors that "quantify the harmonies and disjunctions of all the various markets" (Carey 60). With this system, the numerous market risks of derivatives, directional, yield-curve, spread, short gamma, vega, and theta, can be easily broken down, analyzed, and monitored (Carey 63). Several software programs that calculate and monitor market risk have appeared on the market within the past several years. For example, J. P. Morgan introduced its RiskMetrics software package in September 1994 (Carey 60), and Algorithmics International Inc., a Toronto-based risk management and financial software firm, is consistently updating its RiskWatch program to fit the unique needs of various markets and companies (Zecher 48). Although these programs exist, are readily available, are reasonably priced, can readily be formatted to fit an entity's personal analytical needs, and are supported by the U. S. Securities and Exchange Commission, the use of VAR models and software packages is far from prevalent in corporate America. Among the most notable of the limited number of users of the model are Dow Chemical Co., PepsiCo, and Sears, Roebuck & Co. (Carey 63). There are numerous reasons as to why the use of VAR has not caught on in the corporate world. First of all, many opponents argue that the model would lead to the spread of misleading and inconsistent information due to the fact that different companies employ different confidence interval levels and use varying amounts of historical data in arriving at their volatility figures. As John Kearney, an assistant treasurer at Merck & Co. argues, "for firms like Merck, that use derivatives primarily for hedging or as part of integrated transactions, such measures are of dubious value" (Kearney 58). Still others claim that the model is not 100 percent foolproof because it can not account for unexpected or irregular events (Carey 63). A PROPOSED STANDARD FOR THE MEASUREMENT OF MARKET RISK After studying the current methods of measuring market risk (transactions vs. portfolio based measurement, simple statistical models, stress tests and what-if scenarios, and value-at-risk) the strengths and weaknesses of each in accurately and reliably measuring market risk become highly evident. In these times of complex, hybrid, and numerous derivatives, measuring and monitoring derivative market risk at the transaction level has become close to impossible. Furthermore, stakeholders in an entity are most concerned with their investment as a whole and not with the risk of particular transactions; therefore, they would rather be aware of the exposure to market risk that the entity faces as a whole, or rather the market risk at the portfolio or firm level (Goldberg 2). With this in mind, the simple statistical models that require the piecemeal evaluation of market risks would not provide accurate information to reliably measure an entity's total exposure to derivative market risk. In addition, the simple stress tests and what-if scenarios that are performed by financial officers are geared more toward the transaction-based measurements and become burdensome when they are applied to more complex derivatives. Also, since they are performed with rudimentary statistics and computer programs they are often unreliable and highly susceptible to human bias and error. Value-at-risk overcomes the weaknesses of the other risk measurement models and presents itself as the best alternative in arriving at a standardized method of measuring market risk. It not only approaches market risk from the portfolio or firm level perspective, but it also is calculated and monitored by high-tech, highly developed computer software that limits the amount of human bias and error. While such highly technological equipment often implies that the systems are complex, technical, and beyond the understanding of most business executives, this is not the case with VAR. The model is based upon the fundamental probability and statistical formulas that all business managers know, and the information is then correlated with a large number of factors and results that only a well-developed computer program can handle. The fact that many can easily understand what the VAR model is actually doing is a tremendous advantage of VAR because people will likely be unafraid of implementing the model, and they will be more likely to trust the analysis' results. Furthermore, the VAR models on the market are reasonably priced, and as such are practical risk management options for any entity that invests in derivatives. This reasonable price also supports the adoption of VAR as the standard market risk measure because the potential losses that can be avoided as a result of monitoring market risk through the continuous use of VAR, along with the other risk management benefits granted by the system, greatly exceed the costs of implementing the model. The various arguments against VAR are valid ones. The results can vary due to different entities using different parameters, but with the standardized use of VAR would come standardized parameters that would limit the amount of variation and make results more comparable across companies. In addition, the model is not designed to predict irregular events, but opponents must realize that this is an unavoidable consequence of statistical models. When rare, chaotic situations occur, the VAR model can be amended to include whatever additional standard deviations are necessary, and in the worst of cases, "VAR practitioners (can) do what they did before the advent of VAR: carry out stress tests" (Carey 64). Opponents of VAR cannot deny that despite these few weaknesses in the system, the model provides the most reliable and accurate snapshots of market risk. Additional reasons to adopt value-at-risk as the standard for measuring derivative market risk are that it more than satisfies the qualitative characteristics of accounting information. As outlined previously, a standardized measurement method will inherently permit the comparability of risk across companies and the consistency of risk over time due to the fact that the standard will be enforced for all companies that invest in derivative instruments. As a method that is adopted as the standard, value-at-risk will satisfy these secondary qualities. Furthermore, the primary quality of reliability and its components of representational faithfulness, verifiability, and neutrality will be enhanced with the adoption of value-at-risk. Due to the fact that VAR is based upon computerized statistics and probability, the model provides for neutral information that is free from human bias and opinion regarding a predetermined result. It will also offer verifiable information as the same data and probabilities can be run over and over again with little or no chance of error. Finally, the information garnered from the VAR system offers the most valid and faithful picture of the real world because out of all the measurement models it is the most able to comprehensively account for numerous variables, factors, and financial positions when deriving the volatility figures and correlations. AN ARGUMENT FOR THE DISCLOSURE OF MARKET RISK As mentioned in the introduction, SFAS No. 105 briefly refers to the disclosure of market risk, namely that the nature and terms of market risk should be discussed in relation to financial instruments. However, the disclosure of market risk is not covered in any further depth anywhere in 105 or in the other statements that cover the disclosure of financial instruments, SFAS Nos. 107 and 119. With such little guidance on how to discuss or disclose an entity's market risk in relation to financial derivatives, companies are left questioning how to best inform their stakeholders of their market risks, and as will be seen later, they often choose to not address the issue at all. For the sake of the many stakeholders of derivative-trading entities, the lack of a standard on market risk disclosure cannot persist. Currently, under SFAS No. 119, companies are required to disclose the kinds of derivatives used, why they are used, how they are accounted for, and quantitative measurements such as the maturity and fair values of the major types of derivatives. It is questionable how much of this information is really of any use to financial statement users. As Merck Assistant Treasurer John Kearney states, the volume of disclosure about derivative financial instruments is becoming disproportionately greater than the disclosures about other, more significant business risks...(Our shareholders and analysts) are interested in knowing we have a hedging program to manage...our primary external risks, but they're not particularly interested in the amount of detail we provide. (Kearney 57-58) This anecdotal evidence provided by Merck indicates that investors and creditors are interested in business risks and in knowing that the companies have programs or systems that monitor the amount of risk to which they are exposed. This expressed desire and need on the part of company stakeholders to know about a company's risks more than justifies the need to disclose the amount of derivative market risk to which a company is exposed and to discuss the means by which a company manages such risks. The above comment by Kearney also alludes to another problem in the debate over market risk disclosure: the growing volume of disclosure notes, in particular those involving derivatives. Questions are being raised as to the effectiveness and cost-benefit of disclosing so much information on a topic that few stakeholders seem to understand and on investments that can be immaterial for many companies. The debate has come down to the dilemma of how much is too much information. In order to resolve this dilemma, the standard setters must return to studying the needs and wants of the financial statement users, for these are the people that really make the reporting of financial positions important. If these stakeholders do not feel comfortable with the information they are provided, they do not invest or lend funds, and as such do not add to the vitality of the businesses. Thus, the goal of all financial statement preparers should be to please these stakeholders by giving them the right amount and kind of information they demand. In the case of financial derivatives, the disclosure issue is very difficult. Many company stakeholders do not fully understand the derivative market and much of the currently disclosed information is above their levels of understanding. However, in the face of such large losses in the derivatives market by fairly strong entities, statement users are also very wary of heavy investments in derivatives and wish to have some understanding as to how and in what ways a company invests in them. The evidence presented by Merck and other derivative-investing companies appears to best pinpoint the amount of information that stakeholders wish to have--a knowledge of the risks to which a company is exposed and a knowledge of the steps being taken to monitor and control these risks. While this solution to simply disclose the risk management (value-at-risk) method and the amount of market risk that it measures appears to be a panacea to the derivative disclosure dilemma, there are still many opponents to the plan. There are those who overtly oppose the disclosure of any risk value because they feel that its measurements will provide stakeholders with misleading information. In addition, there are those who feel that stakeholders will not truly understand what the reported market risk means in relation to the derivatives and the financial stability of the company. These opponents fear that stakeholders will construe this measure of possible losses to be recognized losses, and that they will divest of their investments in the company accordingly. The majority of the reasons for not disclosing a value-at-risk measure are based on the assumption that the users of financial information do not have the ability to understand new information. If the users of these statements and notes are given a brief explanation of what information they are given, they are likely to understand the implications of the numbers and to not construe any unsubstantiated information. Thus, the reasons for wishing to not disclose the degree of market risk are somewhat taken out of hand, and a standard that calls for a more indepth disclosure of market risk should not be overlooked or considered unreasonable. Furthermore, a standard on market risk disclosure would enhance the primary quality of relevance in the coverage of financial derivatives. The disclosed information would be timely since it would be generated continuously by a value-at-risk model. The disclosure of market risk would also provide feedback and predictive value as the changes in market risk exposure would confirm or negate past market predictions and would help external decision makers make predictions about the outcome of coming market changes. Therefore, through the adoption of value-at-risk as the market risk measurement model and through the disclosure of this risk in the financials, all four qualitative characteristics that are required in Statement of Financial Accounting Concepts No. 2 would be met. CURRENT METHODS OF DISCLOSING MARKET RISK As mentioned before, the lack of a defined standard for the disclosure of market risk has left many companies and financial reporters without guidance as to how to disclose their level of market risk. As such, many companies make little to no reference to derivative market risk or methods of market risk in the notes to their financials. A select study of the 1993, 1994, and 1995 annual reports of eight American-based companies was performed, and only one of the eight, Dow Chemical, made an indepth reference to its market risk and risk management measures. The 1995 annual report states in Note J, The Company's risk management program for both foreign currency and interest rate risk is based on fundamental, mathematical and technical models that take into account the implicit cost of hedging. Risks created by derivative instruments and the mark-to-market valuations of positions are strictly monitored at all times. The Company uses value at risk and stress tests to monitor risk. (37) Three other companies briefly mentioned their risk management strategies and their exposure to market risks as a result of their use of derivative instruments. The 1994 Disney report states, "The Company does not expect interest rate movements to significantly affect its liquidity or operating results in the foreseeable future" (47), the 1993 AT&T report states, "By their nature, all such instruments involve risk, and our maximum potential loss may exceed the amount recognized in our balance sheet....we believe that our reserves for losses are adequate" (42), and the McDonald's 1994 annual report states, "The Company does not use derivatives with a level of complexity or with a risk higher than the exposures to be hedged" (23). The remaining four companies, MCI, Owens Corning, Procter & Gamble, and Burlington Industries, made no clear reference to market risk or to market risk management. This survey provides a clear example of how little guidance companies receive in relation to market risk disclosure. It is evident that some companies try to disclose more information while others try to avoid the subject altogether. In order to uphold the comparability of financial statements and disclosure notes, this degree of confusion in market risk disclosure cannot continue. A REVISED STANDARD FOR THE DISCLOSURE OF MARKET RISK Keeping the needs and wants of stakeholders in mind, a standardized method of disclosing derivative-related market risk can be derived. This disclosure method would specifically state that a market risk management and measurement system (namely value-at-risk, as is proposed above) is utilized to monitor the market risk exposure to which the entity is susceptible. The disclosure would also include the potential amount of losses within a standardized confidence level that was calculated by the VAR model on the balance sheet date. It could easily be clarified in the disclosure note that this VAR measurement is of potential rather than realized or recognized losses, so as to avoid any confusion on the part of financial statement users. In keeping with SFAS Nos. 105 and 119, the credit risks and quantitative information by major derivative type, such as maturity and fair values, should still be included, for this information also provides the stakeholder with knowledge of the company's investment risks. However, from the point of view of the financial statement user, such information as the accounting method used by the company for derivatives and a detailed explanation of why derivatives are used should be deleted. This information appears superfluous in the eyes of the user, is often times not understood completely, and does not provide them with a comprehensive idea of what risks the company has been and is currently facing with future changes in market rates. Although the revised disclosure note will delete some of the information that has previously been included in financial instrument disclosures, it will provide the financial statement users with the necessary information he or she needs to understand the risks a company has taken with the use of derivative instruments and will also supply an explanation of the risk management controls in place. Regardless of whether a company invests heavily or lightly in derivative instruments, this risk information is of great interest to the financial investors and creditors of today and should be included in the financials of any company that invests in any type of derivative instrument. A sample disclosure note discussing the value-at-risk and implemented risk management program follows. Let it again be noted that these statements would still be preceded by the charts or other layouts that disclose the credit risks and the maturity and fair values of the derivatives by major type. The Company's risk management program for market risks, including both foreign currency and interest rate risk, is based on the fundamental and statistical value-at-risk model that computes the amount of potential derivative losses, within a standardized confidence level, that the company may incur with the expected future changes in market rates. This model is used not only to calculate the value-at-risk, but is also used to strictly monitor the amount of derivative-related market risk to which the company exposes itself. As of December 31, 19XX (the balance sheet date), the Company carried a value-at-risk amount of $xxx,xxx based upon a xx percent confidence level. CONCLUSION In order to uphold the reliability, relevance, comparability, and consistency of derivative instrument disclosures, standards must be adopted that provide guidance on the most effective way of measuring and disclosing an inherent derivative risk, market risk. The above proposals, which call for the standardization of the value-at-risk measurement and management model and for the disclosure of its results, will greatly enhance the qualitative characteristics of derivative-related information. While it is argued that the disclosure of market risk will provide unreliable and misleading information due to the uncontrollable and often unpredictable nature of market rates, the value-at-risk models have been proven to be highly reliable and accurate, and as such will provide financial statement users reliable, relevant, comparable, and consistent disclosure information with which to make their decisions. REFERENCES July-August 1995, 57-58. McDonald's 1994 Annual Report. Minehan, Cathy E. and Katerina Simons. "Managing Risk in the '90s: What Should Y bb``*?KSzЋFN* 0 B3;Thpf~x1< «! q֫|BK19!)(``@(D)``)L*``V*+&++``++,-/.0.::./N/_2bi24v4D5N588CC|PƬPldڬyd4g:ghhii>n Hnu Bx{*{{tuvwЋxyz{*| }~0BTfx«֫꫋:NbvƬڬ*&t%n)& ; ; .'?;t #+/0!nj@!n @!;+?o #+V!8;+?i #+V!!;+:;+?I #F@!; #+:>,%$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = 26--  > 12-- % = * - 12 -- 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = u%n)& ; ; <.'?;t #+/0!nj@!n @!;+?o #+V!8;+?i #+V!!;+:;+?I #F@!; #+:>,%$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = 60--  > 12-- % = * - 12 -- 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = ωv҉͋%n)& ; ; r.'?;t #+/0!nj@!n @!;+?o #+V!8;+?i #+V!!;+:;+?I #F@!; #+:>,%$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = 114--  > 12-- & = + - 12 -- 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = wߍ%n)& ; ; .'?;t #+/0!nj@!n @!;+?o #+V!8;+?i #+V!!;+:;+?I #F@!; #+:>,%$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = 188--  > 12-- & = + - 12 -- 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = x%n)& ; ; .'?;t #+/0!nj@!n @!;+?o #+V!8;+?i #+V!!;+:;+?I #F@!; #+:>,%$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = 253--  > 12-- & = + - 12 -- 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = y%n)& ; ; N.'?;t #+/0!nj@!n @!;+?o #+V!8;+?i #+V!!;+:;+?I #F@!; #+:>,%$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = 334--  > 12-- & = + - 12 -- 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = z%n)& ; ; o.'?;t #+/0!nj@!n @!;+?o #+V!8;+?i #+V!!;+:;+?I #F@!; #+:>,%$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = 367--  > 12-- & = + - 12 -- 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = ){,'%n)& ; ; .'?;t #+/0!nj@!n @!;+?o #+V!8;+?i #+V!!;+:;+?I #F@!; #+:>,%$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = 409--  > 12-- & = + - 12 -- 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = ;>%nnJb)&; ; r;#+7r!'f0Pemberton ReferencesbuttonClick/buttonClick "Pemberton References"' | %n)& ; ; <.'?;t #+/0!nj@!n @!;+?o #+V!8;+?i #+V!!;+:;+?I #F@!; #+:>,%$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = 60--  > 12-- % = * - 12 -- 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" =  "n)& ; ; b.&?;t #+.0!nj@!n @!;+>o #+U!8;+>i #+U!!;+9;+>I #F@!; #+9>,$$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = 98--  > 12-- % = * - 12 -- 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = /}2-%n)& ; ; r.'?;t #+/0!nj@!n @!;+?o #+V!8;+?i #+V!!;+:;+?I #F@!; #+:>,%$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = 114--  > 12-- & = + - 12 -- 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = A~D?%n)& ; ; .'?;t #+/0!nj@!n @!;+?o #+V!8;+?i #+V!!;+:;+?I #F@!; #+:>,%$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = 140--  > 12-- & = + - 12 -- 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = SVQ%n)& ; ; .'?;t #+/0!nj@!n @!;+?o #+V!8;+?i #+V!!;+:;+?I #F@!; #+:>,%$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = 163--  > 12-- & = + - 12 -- 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = ehc%n)& ; ; .'?;t #+/0!nj@!n @!;+?o #+V!8;+?i #+V!!;+:;+?I #F@!; #+:>,%$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = 168--  > 12-- & = + - 12 -- 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = wzu"n)& ; ; .&?;t #+.0!nj@!n @!;+>o #+U!8;+>i #+U!!;+9;+>I #F@!; #+9>,$$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = 207--  > 12-- & = + - 12 -- 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = %n)& ; ; .'?;t #+/0!nj@!n @!;+?o #+V!8;+?i #+V!!;+:;+?I #F@!; #+:>,%$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = 237--  > 12-- & = + - 12 -- 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = "n)& ; ; .&?;t #+.0!nj@!n @!;+>o #+U!8;+>i #+U!!;+9;+>I #F@!; #+9>,$$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = 226--  > 12-- & = + - 12 -- 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = %n)& ; ; N.'?;t #+/0!nj@!n @!;+?o #+V!8;+?i #+V!!;+:;+?I #F@!; #+:>,%$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = 334--  > 12-- & = + - 12 -- 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = ӫ#7K_sì׬';i sl< 9%#n)& ; ; .'?J >,"">,"J Y!EV?;t #+/0!nj@!n @!;+?o #+V!8;+?i #+V!!;+:;+?I #F@!; #+:>,%$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = 0  > 12 = % - 12 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = ˿ Pemberton's Table of Contentsׯ گG"%nnJb)&; ; r;#+7r!'f0Pemberton ReferencesbuttonClick/buttonClick "Pemberton References"'>Pemberton's Referencesݰ %$ }!zShowGlossarywi" S7J)&; ; ;&#+U!8'f$glossarybuttonUp} glossary}Glossarys 2{? xtField~ NM$ Z K%yUo)&; ; 5"z-<"!&<+F !!9 <+V!8!9"!}5!y:*!!<+V!!@#+V!8; #+/0!n@!n @!;o #+/04!;@#+V!8;+?X #+V!!;+?\ #+V!!;, #+:$@!"!}jB#:$'ftextauthorHide Menu BarSystemSmallFontsstatusbardefaultenterPage+TO HANDLE --{entering fshort } $= , = default d statusbar > 'P$ d 9 } 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 0syslockScreen నsvASYM_TpID! 9504021118513691351731203655 p $e"P!#2 arrows#&!#2!2W }Zh: $e"P! "eNext Page`" JAA)&; ; >;#+5!'f$buttonUp} Ӑt} ":W!)"`) {&,: $e"P!7Next Pageo|& o!!!t"Qr!t"!Q $ P!Kv JBackGg" QLH)&; ; !!:M'f+buttonUp} d .}_bKv (` $ P!Next Page%g" QLH)&; ; !!:M'f+buttonUp} d .}]oh!``m`  \ $rnSmallFonts  5$n!Show Menu Bar" l}c)&; ; !9!;+> #+U!8+U!!'f8Hide Menu BarbuttonUp5} d B"Hide Menu Bar" / }Show Menu Bar  D$P$ Hide Menu Bar " l}c)&; ; !!;+> #+U!8+U!!'f8Show Menu BarbuttonUp5} d B"Show Menu Bar" / } Hide Menu Bar   K$bn!  Table of Contents "knG_)&; ; r;#+6r!'f0Table of ContentsbuttonClick+buttonClick "Table Contents"" Table of Contents   > $nB  LargeFonts? @" *!)& ; ; ; #$@"-$?J >,!">,!J Y!HV?~;t #+.0!n@!n@!;+>h #+U!!;+>h #+U!8;+9;+>S #F@!; #+9>,$$@!'ftextAxsvScrollNumberlargeFontsArialsmallFontsbuttonUp}4svScrollNumber = ߈""  > 12 ' = , + 12 捈"" W= "Arial" W= 16 Hide B"largeFonts" / Show B"smallFonts" / = B"/-- g1 "" ߈ "" = }W Increase Font Size {|:}&b( pD".n")& ; ; ; #$@"-$?J >,!">,!J Y!EV?;t #+.0!nj@!n @!;+>o #+U!8;+>i #+U!!;+9;+>I #F@!; #+9>,$$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = ߈""  > 12 ' = , - 12 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = Decrease Font Size|!ePemberton Referencesh Ms|X trueASYM_BeenHerev|H  b&Button; p->HHH2CF@Pemberton References and Footnotes r#T (HH3V text Auto_Scroll%tbk_wid_name- 0  Scroll to view more text ---------> Click Here to Return to Heather Pemberton's Paper REFERENCES AT&T 1993 Annual Report. Carey, David. "Getting risk's number" Institutional Investor. February 1995, 59-64. Dow Chemical Company 1995 Annual Report. Estrella, Arturo, Darryll Hendricks, John Kambhu, Soo Shin, and Stefan Walter. "The Price Risk of Options Positions: Measurement and Capital Requirements" Federal Reserve Bank of New York Quarterly Review. Summer-Fall 1994, 27-43. GAO. Financial Derivatives: Actions Needed to Protect the Financial System. May 1994. Goldberg, Stephen R., Charles A. Tritschler, and Joseph H. Godwin. "Financial Reporting for Foreign Exchange Derivatives" Accounting Horizons. June 1995, 1-16. Kearney, A. John. "What the regulators have in mind" Financial Executive. July-August 1995, 57-58. McDonald's 1994 Annual Report. Minehan, Cathy E. and Katerina Simons. "Managing Risk in the '90s: What Should You Be Asking about Derivatives?" New England Economic Review. September-October 1995, 3-25. Smith, John T. Workshop on Derivative Financial Instruments presented to the American Accounting Association as taped by Professor Robert E. Jensen. August 13, 1995, 1-14. Statement of Financial Accounting Standards No. 105. Walt Disney Company 1994 Annual Report. Zecher, Joshua. "Banamex cuts the risk designer-style" Wall Street & Technology Magazine. March 1994, 46-50. REFERENCES CONSULTED Burlington Industries 1995 Annual Report. Dyckman, Thomas R., Roland E. Dukes, and Charles J. Davis. Intermediate Accounting, Revised Edition. Boston: Richard D. Irwin, Inc., 1992. Financial Accounting Standards Board Prospectus No. 151-B. "Disclosure Effectiveness" July 31, 1995. MCI 1994 Annual Report. Owens Corning 1994 Annual Report. Procter & Gamble 1995 Annual Report. Statement of Financial Accounting Standards No. 52. Statement of Financial Accounting Standards No. 80. Statement of Financial Accounting Standards No. 107. Statement of Financial Accounting Standards No. 119. S 2` cq((( (Q] Ma(  K(^(.((((] s` q st E "znVn)&; ; r;#+6r!'f0Pemberton Project on Market RiskbuttonClick;buttonClick "Pemberton Project on Market Risk"3s tv !!JG"znVn)&; ; r;#+6r!'f0Pemberton Project on Market RiskbuttonClick;buttonClick "Pemberton Project on Market Risk"3Click Here to Return to Heather Permberton's Paper u%$ }!JShowGlossaryGi" S7J)&; ; ;&#+U!8'f$glossarybuttonUp} glossary}UGlossary} prs` tH uvu4truel1{@ xtField~ NM$ lZ K"yUo)&; ; 5"z-<"!&<+E !!9 <+U!8!9"!}5!y:*!!<+U!!@#+U!8; #+.0!n@!n @!;o #+.04!;@#+U!8;+>X #+U!!;+>\ #+U!!;, #+9$@!"!} @#:$'ftextauthorHide Menu BarSystemSmallFontsstatusbardefaultenterPage+TO HANDLE --{entering fshort } $= , = default d statusbar > 'P$ d 9 } 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 0syslockScreen నsvASYM_TpID! 9504021118513691351731203655l p $e"P!#2 arrows#&!#2!2W }Zh: $e"P! "eNext Page`" JAA)&; ; >;#+5!'f$buttonUp} Ӑt} ":W!)"`) {&,: $e"P!7Next Pageo|& o!!!t"Qr!t"!Q $ P!Kv JBackGg" QLH)&; ; !!:M'f+buttonUp} d .}_bKv (` $ P!Next Page%g" QLH)&; ; !!:M'f+buttonUp} d .}]oh!``m`  \ $rnSmallFonts  5$n!Show Menu Bar" l}c)&; ; !9!;+> #+U!8+U!!'f8Hide Menu BarbuttonUp5} d B"Hide Menu Bar" / }Show Menu Bar  D$P$ Hide Menu Bar " l}c)&; ; !!;+> #+U!8+U!!'f8Show Menu BarbuttonUp5} d B"Show Menu Bar" / } Hide Menu Bar   K$bn!  Table of Contents "knG_)&; ; r;#+6r!'f0Table of ContentsbuttonClick+buttonClick "Table Contents"" Table of Contents  > $nB  LargeFonts? @" *!)& ; ; ; #$@"-$?J >,!">,!J Y!HV?~;t #+.0!n@!n@!;+>h #+U!!;+>h #+U!8;+9;+>S #F@!; #+9>,$$@!'ftextAxsvScrollNumberlargeFontsArialsmallFontsbuttonUp}4svScrollNumber = ߈""  > 12 ' = , + 12 捈"" W= "Arial" W= 16 Hide B"largeFonts" / Show B"smallFonts" / = B"/-- g1 "" ߈ "" = }W Increase Font Size {|:}&b( pD".n")& ; ; ; #$@"-$?J >,!">,!J Y!EV?;t #+.0!nj@!n @!;+>o #+U!8;+>i #+U!!;+9;+>I #F@!; #+9>,$$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = ߈""  > 12 ' = , - 12 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = Decrease Font Size\ eWorld Wide Web Sitesrencesh Mls\v p@rs0 t\@0 u4trueASYM_BeenHere1 4b=&Button} pB <^+HHH2 World Wide Web Sites r#T JHH3text"85 Auto_ScrollGtbk_wid_nameO R c Scroll to view more text ---------> FASB: I:\Data\Fasbdata\Projdata\Hedging\Boardmem\1996\NEW'APP5.DOC 4/5/96 Ira Lukyanenko: http://www.newswire.ca/releases/October 1995/03/c0205.html http://198.252.177.253/prodrn.html http://198.252.177.253/idf/prodidf.html http://www.jpmorgan.com/MarketDataInd/RiskMetrics.html http://www.clark.net/pub/gen/fas/sysrisk/ http://www.florin.com/v4/alore4f.html http://www.rpsi.com/ http://www.numa.com/derivs/ref/c-risk/cr-over.htm http://gsb-www.stanford.edu/~wfsharpe/mia_prob2.htm http://www.colybrand.com/industry/finserv/garpsumm.html Hunter Bass: http://www.cob.ohio-state.edu (arya, fellingham, tomassini, young) http://www.cob.asu.edu (jacpbm, atjab, idre) http://www.bc.edu (wright) http://www.excite.com http://www.hk.super.net http://www.londonmail.co.uk http://www.wellsfargo.com http://anet.scu.edu.au http://www.sys.uea.ac.uk Doug Parker: http://www.cme.com http://www.aib.ie http://www.cbot.com http://www.uwm.edu/~ewing/htm Morgan Matson: http://remus.rutge...jburns/deriv.html (Casino Capitalism) Patrick Litonjua: http://www.cica.ca/cica/ps/01440.htm http://www.ernsty.uk/ernsty/rd/rd2.htm http://www.cica.ca/cica/ps/01460.htm http://www.ey.com.us/aa/frb495.htm#eitf http://www.cica.ca/cica/ps/02290.htm Alexa Winchell: http://www-leland.stanford.edu/group/sjlbf/onetwo.html http://datacover.com/financials/95/note13.html http://www.inect.co.uk/int0006.html http://www.euro.net/innovation/FinanceHP.html http://nestegg.iddis.com/nyifcat/bk3719.html http://www.netresource.com/wsn http://cnnfn.com Zoe Scales: http://www/ey.com.us/aa/frb495.htm http://Finance.Wat.aPapers/paper2.htm Stephen Ciavano: http://serv.tech.com.com/re/acct.html http://www.lainet.com/dmg/ http://www.bloomberg.com http://www.numa.com/derivs/links/links/htm http://www.investorama.com/futures.html http://www.newspage.com/NEWSPAGE/cgi-bin/walk.cgi/NEWSPAGE/info/d10/d71 Jamie Turner: http://www.cme.com/market/insstutional/bibliographies/der-bibl.html http://www.numa.com/derivs/srives.htm http://www.amex.com/options/options http://networth.galt.com/www.home/info/ http://rutgers.edu/Accounting/raw/aicpa/chap3-4.htm Aaron Wiggins: http://www/clev.frb.org/bsr/dialogue/v2i7p1.htm http://www.window.state.tx.us/localinf/debtguide/chr.8.html http://www.vb.edu:10021/business/finance.dmc/DRU/v1n38.txt http??www.eight.com -  -6y  [ s^ p %$ }! m ShowGlossary i" S7J)&; ; ;&#+U!8'f$glossarybuttonUp} glossary}Glossary trueL1{E xtField~ NM$ LZ K"yUo)&; ; 5"z-<"!&<+E !!9 <+U!8!9"!}5!y:*!!<+U!!@#+U!8; #+.0!n@!n @!;o #+.04!;@#+U!8;+>X #+U!!;+>\ #+U!!;, #+9$@!"!} @#:$'ftextauthorHide Menu BarSystemSmallFontsstatusbardefaultenterPage+TO HANDLE --{entering fshort } $= , = default d statusbar > 'P$ d 9 } 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 0syslockScreen నsvASYM_TpID! 9504021118513691351731203655L p $e"P!#2 arrows#&!#2!2W }Zh: $e"P! "eNext Page`" JAA)&; ; >;#+5!'f$buttonUp} Ӑt} ":W!)"`) {&,: $e"P!7Next Pageo|& o!!!t"Qr!t"!Q $ P!Kv JBackGg" QLH)&; ; !!:M'f+buttonUp} d .}_bKv (` $ P!Next Page%g" QLH)&; ; !!:M'f+buttonUp} d .}]oh!``m`  \ $rnSmallFonts  5$n!Show Menu Bar" l}c)&; ; !9!;+> #+U!8+U!!'f8Hide Menu BarbuttonUp5} d B"Hide Menu Bar" / }Show Menu Bar  D$P$ Hide Menu Bar " l}c)&; ; !!;+> #+U!8+U!!'f8Show Menu BarbuttonUp5} d B"Show Menu Bar" / } Hide Menu Bar   K$bn!  Table of Contents "knG_)&; ; r;#+6r!'f0Table of ContentsbuttonClick+buttonClick "Table Contents"" Table of Contents  > $nB  LargeFonts? @" *!)& ; ; ; #$@"-$?J >,!">,!J Y!HV?~;t #+.0!n@!n@!;+>h #+U!!;+>h #+U!8;+9;+>S #F@!; #+9>,$$@!'ftextAxsvScrollNumberlargeFontsArialsmallFontsbuttonUp}4svScrollNumber = ߈""  > 12 ' = , + 12 捈"" W= "Arial" W= 16 Hide B"largeFonts" / Show B"smallFonts" / = B"/-- g1 "" ߈ "" = }W Increase Font Size {|:}&b( pD".n")& ; ; ; #$@"-$?J >,!">,!J Y!EV?;t #+.0!nj@!n @!;+>o #+U!8;+>i #+U!!;+9;+>I #F@!; #+9>,$$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = ߈""  > 12 ' = , - 12 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = Decrease Font Size British Petroleum Annual Report and Accounts 1995 Note 20 Derivative financial instruments In the normal course of business the group is a party to derivative financial instruments (derivatives) with off-balance sheet risk, primarily to manage its exposure to fluctuations in foreign currency exchange rates and interest rates, and some movements in oil prices. The underlying economic currency of the group's cash flows is mainly US dollars: significant non-dollar cash flow exposures are hedged. Accordingly, most of our borrowings are in US dollars or swapped into dollars where this achieves a lower cost of financing. We also manage the balance between floating rate and fixed rate debt. As a secondary and limited activity, and in conjunction with risk management, we trade certain derivatives. These derivatives involve, to varying degrees, credit and market risk. With regard to credit risk, the group may be exposed to loss in the event of non-performance by a counterparty. The group controls credit risk by entering into derivative contracts only with highly credit rated counterparties and through credit approvals, limits and monitoring procedures and does not usually require collateral or other security. The group has not experienced material non-performance by any counterparty. Market risk is the possibility that a change in interest rates, currency exchange rates or oil prices will cause the value of a financial instrument to decrease or its obligations to become more costly to settle. When derivatives are used for the purpose of risk management they do not expose the group to market risk because gains and losses on the derivatives offset losses and gains on the asset, liability or transaction being hedged. When derivatives are traded, the exposure of the group to market risk is limited to changes in their fair (market) values rather than the contract amounts. The following table shows the "gross contract amount" of derivatives, to align with US reporting requirements. For traded derivatives, most of these positions have been neutralised, with trading initiatives being concluded by taking opposite positions to fix a gain or loss, thereby achieving a zero net market risk. Under "unmatched contract amount" these matched contracts have been eliminated. A statistically based assessment of market risk, i.e. of exposures to possible future changes in market values over a 24-hour period, is shown under "assessed market risk". In addition, the table shows the "net fair value" and "net carrying amount" of the asset or liability created by derivatives. These amounts represent, respectively, the net market value at the balance sheet date and the net book value, i.e. market value when acquired or later marked to market. -------------------------------------------------------------------------------------------------------------------------------------------------- Pound million Risk management 1 - interest rate contracts 2 - foreign exchange contracts 3 - oil price contracts Trading 4 - interest rate contracts 5 - foreign exchange contracts 6 - oil price contracts 1995: 1 2 3 4 5 6 Gross contract amount 3,967 6,018 2,212 413 2,156 1,095 Unmatched contract amount n/a n/a n/a 208 274 392 Assessed market risk n/a n/a n/a -- (2) (1) Net fair value asset (liability) (75) 171 (15) -- (1) 5 Net carrying amount asset (liability) (49) 86 (15) -- (1) 5 1994: Gross contract amount 3,873 5,523 756 429 4,244 635 Net carrying amount asset (liability) (60) 69 (1) -- 7 10 ______________________________________________________________________ Interest rate contracts include futures contracts and swap agreements. Foreign exchange contracts include forward and futures contracts, swap agreements and options. Oil price contracts are those which require settlement in cash and include futures contracts, swap agreements and options. 635 10 _____________________________________________________________________________________________________________________ Interest rate contracts include futures contracts and swap agreements. Foreign exchange contracts include forward and futures contracts, swap agreements and options. Oil price contracts are those which require settlement in cash and include futures contracts, swap agreements and options. cts, swap agreements and options. (49) 171 86 (15) (15) -- -- (1) (1) 5 5 n/a n/a n/a -- (2) (1) Gross Net carrying contract amount amount asset (liability) (60) 69 (1) -- 7 10 3.873 5,523 756 429 4,244 635 ``+JKLnKs v{e"!LShowGlossaryIi" S7J)&; ; ;&#+U!8'f$glossarybuttonUp} glossary}Show Glossaryor,1{A xtField~ NM$ ,Z K"yUo)&; ; 5"z-<"!&<+E !!9 <+U!8!9"!}5!y:*!!<+U!!@#+U!8; #+.0!n@!n @!;o #+.04!;@#+U!8;+>X #+U!!;+>\ #+U!!;, #+9$@!"!} @#:$'ftextauthorHide Menu BarSystemSmallFontsstatusbardefaultenterPage+TO HANDLE --{entering fshort } $= , = default d statusbar > 'P$ d 9 } 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 0syslockScreen నsvASYM_TpID! 9504021118513691351731203655, p $e"P!#2 arrows#&!#2!2W }Zh: $e"P! "eNext Page`" JAA)&; ; >;#+5!'f$buttonUp} Ӑt} ":W!)"`) {&,: $e"P!7Next Pageo|& o!!!t"Qr!t"!Q $ P!Kv JBackGg" QLH)&; ; !!:M'f+buttonUp} d .}_bKv (` $ P!Next Page%g" QLH)&; ; !!:M'f+buttonUp} d .}]oh!``m`  \ $rnSmallFonts  5$n!Show Menu Bar" l}c)&; ; !9!;+> #+U!8+U!!'f8Hide Menu BarbuttonUp5} d B"Hide Menu Bar" / }Show Menu Bar  D$P$ Hide Menu Bar " l}c)&; ; !!;+> #+U!8+U!!'f8Show Menu BarbuttonUp5} d B"Show Menu Bar" / } Hide Menu Bar   K$bn!  Table of Contents "knG_)&; ; r;#+6r!'f0Table of ContentsbuttonClick+buttonClick "Table Contents"" Table of Contents  > $nB  LargeFonts? @" *!)& ; ; ; #$@"-$?J >,!">,!J Y!HV?~;t #+.0!n@!n@!;+>h #+U!!;+>h #+U!8;+9;+>S #F@!; #+9>,$$@!'ftextAxsvScrollNumberlargeFontsArialsmallFontsbuttonUp}4svScrollNumber = ߈""  > 12 ' = , + 12 捈"" W= "Arial" W= 16 Hide B"largeFonts" / Show B"smallFonts" / = B"/-- g1 "" ߈ "" = }W Increase Font Size {|:}&b( pD".n")& ; ; ; #$@"-$?J >,!">,!J Y!EV?;t #+.0!nj@!n @!;+>o #+U!8;+>i #+U!!;+9;+>I #F@!; #+9>,$$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = ߈""  > 12 ' = , - 12 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = Decrease Font Sizef_eExamples: Banks Hedge Risksh M,svst@uvw@bu4trueASYM_BeenHere1 s4b=&Button} tk <#+HHH2 Motivations for Use u$ JHHH2text"85 Auto_ScrollGtbk_wid_nameOR` Scroll to view more text ---------> Currency Newsletter from Grant Thornton Vol. 7, No. 3 FALL 1994, pp. 1-2 "Community Banks Consider Derivatives for Hedging Risk" Financial derivatives have been a topic of intense discussion in banking circles these days, as stories of large industrial companies losing millions of dollars in these instruments make the rounds. The banking regulators are making noises about more regulation of these instruments, congress is talking about legislation, and the accounting profession and the Securities and Exchange Commission (SEC) are requiring more disclosure of their use. The result of this attention has been a sort of "derivative frenzy," which has obscured the real benefit of these instruments to companies --- and to community banks. "Most community banks don't use uncollateralized or other 'risky' types of derivatives," says M. Scott Reed, managing partner of Grant Thornton's California Central Valley Area offices and chairman of the firm's National Financial Institutions Committee. "But it's important for bankers to understand how derivatives work and what they can do. In particular, they need to understand their risks." In the Public Eye A derivative is any financial instrument whose value or income stream changes based on changes in some other asset or index. For example, stock options, foreign exchange contracts, collateralized mortgage obligations (CMOs), and commodities futures are all derivatives. Derivatives became popular over the last 15 years as interest rates, commodity prices, and foreign exchange rates became more volatile. Business and large banks used these instruments to hedge risk. But others have lost considerable amounts of money with them. Now a "red alert" on using these instruments seems to have been broadcast across the nation. Congress, for one, has taken a great interest in them. "It's too late for legislation this year, but we expect bills to be reintroduced and hearings held on derivatives next year," says Ann Grochala, director of bank operations for the Independent Bankers Association of America (IBAA), Washington, D.C. Banking regulators are also upset about derivatives. In July, the Office of the Comptroller of the Currency (OCC) issued an advisory letter warning community banks about the risks of investing in structured notes. These notes are debt securities primarily issued by various government agencies, including the Federal National Mortgage Association (FNMA). Their cash flow depends on one or more indices or contain embedded options or forwards. The result of the OCC's action has been to throw a broad blanket of doubt over all derivatives --- including CMOs --- and regardless of risk, says C.J. Pickering, president and chief executive officer of IBAA Securities Corp., a wholly owned subsidiary of the IBAA in Memphis, Tenn. "The regulatory stand on derivatives right now is very confused," he says. "But the derivatives talked about in the newspapers and by the OCC are the wildest and most risky types of these instruments. They are not talking about the kinds of mortgage-backed securities that most community banks hold in their portfolios." Using Federal Deposit Insurance Corp. call-report data, Pickering estimates that only 156 community banks own the risky types of derivatives that are getting the bad press. FASB Moves To further increase attention on derivatives, the Financial Accounting Standards Board (FASB) is in the process of issuing a final statement on the disclosure of derivatives in financial statements. Entitled "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments," the statement is expected out this fall. Derivatives are so complicated that FASB is still studying how they should be treated for accounting purposes. The new statement will merely require companies and banks to disclose more quantitative and qualitative information about their derivatives --- however they account for them. Unfortunately, the SEC is not happy with the amount of quantitative information the new statement will require. "We want to see more quantitative information about derivatives, supplemented with clear qualitative disclosures that describe how derivatives are used," says Stephen Swad, professional accounting fellow at the SEC. "Our chairman has stated publicly that the SEC will be considering rule-making after the FASB final statement comes out." This call for extra disclosure has alarmed bankers. They want to see disclosure of derivatives in bank financial statements, but fear too much disclosure will give the impression that they are taking more risks than they are. "It is quite possible that a bank that is using derivatives is bearing far less risk than one that is not," says Donna Fisher, director of tax and accounting for the American Bankers Association, Washington, D.C. "Yet the financial statements could end up giving the opposite impression. "Large banks are the primary users of derivatives now, but more and more smaller banks will be using them. Disclosure will be a big issue." Using Derivatives Clearly, this is a big year for arguing about, accounting for, and regulating derivatives. But there are derivatives --- and there are derivatives. And some of these instruments appear to show great potential for use by community banks, in particular some of the simplest derivatives, which can be used to hedge interest-rate risk. "Community banks should consider derivatives just another tool available to them for asset and liability management," says Charles W. Smithson, senior vice president-risk management research, Chase Manhattan Bank, New York. The most useful derivative for a community bank would be the standard interest rate swap, Smithson says. An interest rate swap is a simple way to adjust the interest-rate sensitivity of a portfolio. By nature, banks are always short-funded: Assets are longer-lived than liabilities. Consequently, when interest rates rise, the bank is damaged. To reduce this risk, a bank would normally sell off assets. But with an interest rate swap, the bank enters into an agreement with another party --- in this case, a money-center bank --- to swap cash flows. For example, if a community bank has made a five-year loan with a fixed-rate cash flow, it can swap that cash flow for a five-year floating-rate cash flow tied to the prime rate. It has thus protected itself from interest-rate risk, should interest rates climb. "With an interest rate swap, the bank has balanced its portfolio without lending money or selling an asset," says Smithson. "The banks owe each other nothing. They merely are swapping interest streams based on some fixed amount on money."  -13(;rb l Sd v{e"!PShowGlossaryMi" S7J)&; ; ;&#+U!8'f$glossarybuttonUp} glossary}_Show Glossary true 1{B xtField~ NM$  Z K"yUo)&; ; 5"z-<"!&<+E !!9 <+U!8!9"!}5!y:*!!<+U!!@#+U!8; #+.0!n@!n @!;o #+.04!;@#+U!8;+>X #+U!!;+>\ #+U!!;, #+9$@!"!} @#:$'ftextauthorHide Menu BarSystemSmallFontsstatusbardefaultenterPage+TO HANDLE --{entering fshort } $= , = default d statusbar > 'P$ d 9 } 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 0syslockScreen నsvASYM_TpID! 9504021118513691351731203655  p $e"P!#2 arrows#&!#2!2W }Zh: $e"P! "eNext Page`" JAA)&; ; >;#+5!'f$buttonUp} Ӑt} ":W!)"`) {&,: $e"P!7Next Pageo|& o!!!t"Qr!t"!Q $ P!Kv JBackGg" QLH)&; ; !!:M'f+buttonUp} d .}_bKv (` $ P!Next Page%g" QLH)&; ; !!:M'f+buttonUp} d .}]oh!``m`  \ $rnSmallFonts  5$n!Show Menu Bar" l}c)&; ; !9!;+> #+U!8+U!!'f8Hide Menu BarbuttonUp5} d B"Hide Menu Bar" / }Show Menu Bar  D$P$ Hide Menu Bar " l}c)&; ; !!;+> #+U!8+U!!'f8Show Menu BarbuttonUp5} d B"Show Menu Bar" / } Hide Menu Bar   K$bn!  Table of Contents "knG_)&; ; r;#+6r!'f0Table of ContentsbuttonClick+buttonClick "Table Contents"" Table of Contents  > $nB  LargeFonts? @" *!)& ; ; ; #$@"-$?J >,!">,!J Y!HV?~;t #+.0!n@!n@!;+>h #+U!!;+>h #+U!8;+9;+>S #F@!; #+9>,$$@!'ftextAxsvScrollNumberlargeFontsArialsmallFontsbuttonUp}4svScrollNumber = ߈""  > 12 ' = , + 12 捈"" W= "Arial" W= 16 Hide B"largeFonts" / Show B"smallFonts" / = B"/-- g1 "" ߈ "" = }W Increase Font Size {|:}&b( pD".n")& ; ; ; #$@"-$?J >,!">,!J Y!EV?;t #+.0!nj@!n @!;+>o #+U!8;+>i #+U!!;+9;+>I #F@!; #+9>,$$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = ߈""  > 12 ' = , - 12 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = Decrease Font Size[ [h=L{_rwnW7@;_XtRLX7@+Y7@;&Z7@[7@ 1S?\7@?Ur~_[GVv%o]7@ :Bb$/Ais^7@@t5@i5_4AF\ _7@ _k|p4?  !d"ZJ~H$~6Ȏcz{{HxzeExample 2 Quiz Part 2h0M6"Ur )&  ; ; "!};@#+U!!; #+U!8;  #+>N #+9$@!;: #+.0!n@!n @!; #+.04!;@#+U!8;+> #+U!!;+> #+U!!; #+9$@!.&?#h<"'.&?J#+hr#+h3#hg<"'.&?=#+hy#+h'ftext3svQuiz5PermissionLincolnSorry! You did not give the correct password. Try again.Sorry! You did not give the correct password. No more tries.Hide Menu BarSystemstartupThat is the magic password.What is the password to view the answers?SmallFontsenterPage>?)&; ; ;@#+U!!'f"leavePage= P } startup ߈"" "" = 0 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 0 4svQuiz5Permission = 0 ("What the view answers?" IT = Lincoln I = 1 "That 8magic ." > "Sorry!You did xgive hcorrect .Try ." ("‰„Ɓ IT = z = 1 "ur." > "mixc`.No more tries."  }RQhXi}j/~25$2&16:5; @: ADJ@EGEIINJNO.OH!"$&\)+.OQRSTUVWWXZO^Y[[\]^_R__X`bcdefPff^` g Ri Rj Rk RlRmRnnn\gvppovvvxLyq$25:J@EHZOX^`\govvvxLy ~ K-$CK-$C,)startupUX-MK$j/ r#C&1Zr@ C h-MHHHCR Example 2 Quiz Part 2 i  K$ b HHBRY\! text7 : P M  Auto_Scroll_ tbk_wid_nameg rj o Scroll to view more text ---------> ______________________ Name (Print Clearly) Acct. 370 Quiz #5 Part 2 Dr. Jensen Administered in Class #08 10. Unlike John Smiths Example 2, suppose that, instead of entering into Swap 2, the Client negotiated a Swap 1a with the Counter Party 1 in Swap 1. After negotiations, Counter-Party 1 agreed to pay the LIBOR =4% APR for (1/4) year between January 1 and April 1 as an up-front cash payment for Swap 1a. Swap 1a terminates at the same date as Swap 1. Assume he Client's journal entry to record this payment is as follows: Client (when LIBOR = 4.0% APR) Year 1 Debit Credit April 01 Cash 1,000,000 Deferred swap gain 1,000,000 Under EITF 84-36, the client will amortize the gain at $100,000 every six months. What are the December 31, Year 1 Client journal entries assuming Swap 1 and Swap 1a cash flows are netted out against one another? At that time, LIBOR = 6.4%. Explain your answer and show calculations. a. Journal entry to pay the interest on note payable with a $100 million principal: Client (when LIBOR = 6.4% APR) Year 1 Debit Credit Dec. 31 Click Here to View Answer b. Journal entry to show the net cash paid or received under Swaps 1 and 1a with a $100 million notional (Swaps 1 and 1a cash flows are to be netted against one another): Client (when LIBOR = 6.4% APR) Year 1 Debit Credit Dec. 31 Click Here to View Answer 11. Draw a graph of the net interest expense as a function of LIBOR/2. The ordinate (y-axis) is to be interest expense on the note payable before any swaps compared with Swaps 1 and 2 and compared with Swaps 1 and 1a combined. Thus there will be three graphs compared at each value of LIBOR/2. The abscissa should show the possible values of LIBOR ranging from 0 to 0.10 semi-annual rates equal to LIBOR/2. Click Here to View Answer Net Interest Expense | | | | | | | | | | | | |--------------|---------------|---------------|--------------|---------------|-------------->LIBOR/2 0.00 0.02 0.04 0.06 0.08 0.10 12. Under EITF 84-36, what are the Client's journal entries on December 31 of Year 5 to terminate the loan payable and Swap 1 and Swap 1a? Explain your answer and show calculations. a. What is the Client's entry to pay off the loan with $100 million in principal at a variable interest rate? Client (when LIBOR = 10% APR) Year 5 Debit Credit Dec. 31 Click Here to View Answer b. What is the Client's entry to terminate Swaps 1 and 1a with $100 million notional and net settlement accounting? Remember that $1million up-front cost is being amortized at $100,000 every six months. Client (when LIBOR = 10% APR) Year 5 Debit Credit Dec. 31 Click Here to View Answer 13. Click Here to View the Remaining Quiz Questions | |---------|----------|----------|---------|----------|---------|---------|----------|----------|-------> 01 02 03 04 05 06 07 08 09 10 Swap May Cash Flow Payments Over 10 Semi-Annual Periods c. John Smith indicates that his firm made the Client defer and amortize Swap April, Swap May, and Swap June over the remaining life of the original loan that terminates on December 31 of Year 5. What is the Payment 1 journal entry on November 30 of Year 1 for Swap May? Click Here to View Answer Client (when LIBOR = 4.50% APR) Year 1 Debit Credit Nov. 30 16. Instead of the LIBOR rate pattern given in the question above, suggest another LIBOR pattern that would have made Swap May an excellent economic decision rather than a suspected front-loading of income. Why is it possible that John Smith is wrong about Example 2 being an illustration of front-loading of income? Click Here to View Answer 17. In the graph below, provide a graphical depiction of your answers to the question above. Click Here to View Answer Swap May Cash Flows | | | | $0 Cash|------------------------------------------------------------------------------------------------------ $0 Cash Flow | | | | | | | | | |---------|----------|----------|---------|----------|---------|---------|----------|----------|-------> 01 02 03 04 05 06 07 08 09 10 Swap May Cash Flow Payments Over 10 Semi-Annual Periods 18. In Example 2, what clues make John Smith extremely suspicious that the Client was front-loading income rather than making reasonable econonomic decisions? Click Here to View Answer Y!CA -1rv(((),~(((!("(')(/D"$] &/|  (  (  (  \) b e   ( & (+ - (3 H +a o p .  A A !!"$&\)+.!!$"ynm)& ; ; "!};@#+U!!; #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+9$@!; #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.largeFontsstartupAnswer10asmallFontsbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / HIde B"smallFonts" / g1 "" ߈"" = 27 Answer10a3$6$&"ynm)& ; ; "!};@#+U!!; #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+9"$@!; #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.largeFontsstartupsmallFontsAnswer10bbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / HIde B"smallFonts" / g1 "" ߈"" = 34 Answer10b&&Y)"xnl)& ; ; "!};@#+U!!;  #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+9.$@!; #+U!8'ftextAnswer113svQuiz5PermissionYou did not give the correct password when you entered this page.largeFontsstartupsmallFontsbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / Hide B"smallFonts" / g1 "" ߈"" = 46 Answer11m)p)+"ynm)& ; ; "!};@#+U!!;  #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+9L$@!;m #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.Answer12alargeFontsstartupsmallFontsbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / Hide B"smallFonts" / g1 "" ߈"" = 76 Answer12a ,,."ynm)& ; ; "!};@#+U!!; #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+9Y$@!; #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.largeFontsstartupAnswer12bsmallFontsbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / Hide B"smallFonts" / g1 "" ߈"" = 89 Answer12b..g/"onKc)&; ; r;#+6r!'f0Example 2 Quiz Part 3buttonClick0buttonClick "Example 2 Quiz Part 3"(/ }/ r#C00"n)&; ; r;S#+6r!;?#@#+U!!;,#+>.&,  #+U!8;* #+U!8'foInterest Rate Swaps Part 1viewbuttonClickzbuttonClick "Interest Rate Swaps Part 1" }""s  Group 3 "8s (-- B"view" /"" B"r#1Click Here to Return to Interest Rate Swap Example 2 PageQ1 T1Zr@ C22~"hnG\)&; ; r;#+6r!'f0Example 2 QuizbuttonClick+buttonClick "Example 2 Quiz" #R!2Return to Questions 1-12nU2 X2f2x#-7#2c2Answer132\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick 22r7#5<'w73 $2T#-!h :3KKKHS?3*5B3'5Counter Party 1, under Swaps 1 and 1a combined, receives $250,000 every six months for five years. The up-front cost was only $1m that averages ($1m+$0)/5 = $0.2m per year. The ROI is ($0.5m-$0.2m) /$0.2m = 150% average annual ROI. More importantly, there is absolutely no market risk in this 150% average annual return on investment since it is independent of LIBOR Furthermore, the credit risk is nill due to the right of offset of the interest swaps in case of default.}5`!5 $2x 55Hide Answer5 567#7#|65Answer14ay6\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick 66r7#: EE6 5r7#!h 6KKKAS6969Swap 1 hedged the note such that the Client owes $3.25 million every six months independent of LIBOR fluctuations. This sums to $32.5 million over 10 payment periods. Swap 2 reverses Swap 1 with a cash penalty of $250,000 each period, which sums to a total penalty of $2.5 million. The semi-annual penalty is (0.060-0.065)/2 times a $100 million notional. Any future outcomes where the note interest based upon LIBOR plus the Swap 2 penalty sum to less than $35.0m = ($32.5m+$2.5m) makes Swap 2 a good deal (ignoring time value of money). In any period, Swap 2 is a good deal if (LIBOR / 2) + 0.25% penalty for reversing Swap 1 sum to less than 3.25% . Client entered into Swap 2 because of a fear that LIBOR was not going to keep on increasing...: y````````: 5 EE::Hide Answer: :;7#7#;;Answer14b;\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick ;;r7# @6; :r7#!h ;KKKAS;j?;g?o Swap 1 hedged the note such that the Client owes $3.25 million every six months independent of LIBOR fluctuations. This sums to $32.5 million over 10 payment periods. Swap 1a reverses Swap 1 with a cash penalty of $250,000 each period, which sums to a total penalty of $2.5 million. This penalty equals (0.060-0.065)/2 times the $100 million notional. However, Swap 1a provides an up-front $1 million, making the net total penalty equal to $1.5 million. Any future outcomes where the note interest based upon LIBOR plus the Swap 1a penalty sum to less than $34.0m = ($32.5m+$1.5m) makes Swap 1a a good deal (ignoring time value of money). In any period, Swap 1a is a good deal if (LIBOR / 2) + 0.15% penalty for reversing Swap 1 sum to less than 3.25% . This makes Swap 1a a somewhat better deal than Swap 2, although both swaps bring back LIBOR rate risk. @ ~````1HJK``nn7@ :6:@G@Hide Answer{@ ~@@7#7#A@Answer15aA\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick A Ar7#D EE]A J@r7#!h `AKKKASeADhAD   Client did not enter into Swap May and Swap June to reverse any hedges that we know about. We can only assume these are speculative investments. As such, they are questionable because on May 1 and June 1 of Year 1, the LIBOR APR is a relatively low 4.0%. This means that the Client almost certainly will face increases in LIBOR that increase future Swap May and Swap June payments. We suspect that the client expects the LIBOR to stay very close to 4.0% in the near future. If this is the case, net income is positively enhanced by the net cash inflows of Swap May and Swap June.. If LIBOR rises above 6.0% in later years, the Client will have net cash outflows. Thus, there is a type of "front-loading" of income only if the client expects future losses to offset any near-future gains. D``D J@ EEDDHide Answer3E 6EDEQ #Q #EAEAnswer15cE\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick EEjQ #GLVF EjQ #!FHHHARFG FG`0 darned if I know! There's no reported Swap May up-front payment to amortize! In Swap 1a, it would make sense to force the Client to amortize the $1 million up-front payment. However, there is no such up-front payment mentioned by John Smith in the three Example 2 swaps of April, May, and June....................G( h Yh ```h G ELVH HHide AnswerAH DHRH "TW!IHOHAnswer15bH\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick  II )v SIX INJW!NV(qO5'.O 5^ KI Hk 49!^ !NIHHHBRSIVIIEx-post it appears that the Client either made a bad estimate of future interest rates or was trying to front-load cash flows for 3 payments)J H!T,JKJClick Here to Hide This GraphJH "9:JN ``iݜ*o?H6A^BbzbO/(fvEE>j(9jJ2 """)))000___UUUMMMBBB999 ```( +9%I;/]E:IS+!!lYQGj2ga1aS {Cg..&YQFh.IRj#SjJu3lJA7e ,N, QdoV YC6r3w_GqC-}zn#&s[ Rp$L 6n{DuqVJ4H2Aph6B"}3%6Z\H"BMXR ӕ$sVo<gX .YLg:}ߚ=VCq8SeFMjLZc"LeN?Pppiiiwwwfxю7Tvpxd?2}Dx#$_`,19م>w؁V!0ȳypQit|NH3 c| !+OH2 B !WOH @ ! !O Oi"~ P #.OOAnswer12aOO6_ #.W_  WP  X  P ZO"~ !h PKKKB[Q PPPPNote payable 100,000,000 Interest expense 5,000,000 Cash 105,000,000 Q Q 'R:=SMhT~UVQQRSTUVQOQR"P7E)&; ; ; #+U!8'f$12amouseEnter;7E)&; ; ; #+U!!'f$12amouseLeave) "12a" "12a"RORS"P7E)&; ; ; #+U!8'f$12amouseEnter;7E)&; ; ; #+U!!'f$12amouseLeave) "12a" "12a"SOST"P7E)&; ; ; #+U!8'f$12amouseEnter;7E)&; ; ; #+U!!'f$12amouseLeave) "12a" "12a"TOTU"P7E)&; ; ; #+U!8'f$12amouseEnter;7E)&; ; ; #+U!!'f$12amouseLeave) "12a" "12a"UOUV"P7E)&; ; ; #+U!8'f$12amouseEnter;7E)&; ; ; #+U!!'f$12amouseLeave) "12a" "12a"VOVW"P7E)&; ; ; #+U!8'f$12amouseEnter;7E)&; ; ; #+U!!'f$12amouseLeave) "12a" "12a"WZO !  XZO3 ! 3 GX ZOJXi$ XXm"Wn=K)&; ; ; #+U!!'f$answer12abuttonClick!buttonClick answer12aXHide Answer!Y $Y(# (# 2Y/YAnswer12b[Y^Y(# _YY" R_@ _ c1 Y X(# !h YKKKASZYnZYkZDeferred swap gain 100,000 Interest expense 150,000 Cash 250,000 Z [:<[Lh\o|]^[[[\]^[^Y+[^Y.[\"P7E)&; ; ; #+U!8'f$12bmouseEnter;7E)&; ; ; #+U!!'f$12bmouseLeave) "12b" "12b"+\^Y.\]"P7E)&; ; ; #+U!8'f$12bmouseEnter;7E)&; ; ; #+U!!'f$12bmouseLeave) "12b" "12b"+]^Y.]^"P7E)&; ; ; #+U!8'f$12bmouseEnter;7E)&; ; ; #+U!!'f$12bmouseLeave) "12b" "12b"+^^Y.^_"P7E)&; ; ; #+U!8'f$12bmouseEnter;7E)&; ; ; #+U!!'f$12bmouseLeave) "12b" "12b"O_XYY" ! YY" _X@ ! @ _ X_ c1 N`K`m"Wn=K)&; ; ; #+U!!'f$answer12bbuttonClick!buttonClick answer12b[`Hide Answer` `"a"a``Answer10a``"af%PfAAf% a ^`"a!h aKKKBSaaaaadInterest expense 3,200,000 Cash 3.200,000 ab-c6CdISe\bbcde)b`,bc"P7E)&; ; ; #+U!8'f$10amouseEnter;7E)&; ; ; #+U!!'f$10amouseLeave) "10a" "10a")c`,cd"P7E)&; ; ; #+U!8'f$10amouseEnter;7E)&; ; ; #+U!!'f$10amouseLeave) "10a" "10a")d`,de"P7E)&; ; ; #+U!8'f$10amouseEnter;7E)&; ; ; #+U!!'f$10amouseLeave) "10a" "10a")e`,ef"P7E)&; ; ; #+U!8'f$10amouseEnter;7E)&; ; ; #+U!!'f$10amouseLeave) "10a" "10a"Mf^`%! %f^`AA! AAf ^`f%LgIgm"Wn=K)&; ; ; #+U!!'f$answer10abuttonClick!buttonClick answer10aYgHide Answerg gt" t" ggAnswer10bggt" RnYY@ nO n c" h \gt" !h hKKK&BS0ihhhhDeferred swap gain 100,000 Interest expense 150,000 Cash 250,000 -i Ri<>RjNeRklyRlRmOi Ri Rj Rk RlRmci gfiOj"P7E)&; ; ; #+U!8'f$10bmouseEnter;7E)&; ; ; #+U!!'f$10bmouseLeave) "10b" "10b"cj gfjOk"P7E)&; ; ; #+U!8'f$10bmouseEnter;7E)&; ; ; #+U!!'f$10bmouseLeave) "10b" "10b"ck gfkOl"P7E)&; ; ; #+U!8'f$10bmouseEnter;7E)&; ; ; #+U!!'f$10bmouseLeave) "10b" "10b"cl gflOm"P7E)&; ; ; #+U!8'f$10bmouseEnter;7E)&; ; ; #+U!!'f$10bmouseLeave) "10b" "10b"cmgfmOn"P7E)&; ; ; #+U!8'f$10bmouseEnter;7E)&; ; ; #+U!!'f$10bmouseLeave) "10b" "10b"n\gYY@ ! YY@ n\gO ! O n \gn c" oom"Wn=K)&; ; ; #+U!!'f$answer10bbuttonClick!buttonClick answer10boHide Answero oog'#%g'#%TpoAnswer11Qp\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick spvpgr#%pb uqv's#p ogr#%ppClick Here to Hide This Graphq ob u!qKKK.BR qqqnNote how Swap 2 adds $250,000 every six months, whereas Swap 1a only adds $150,000 to the no swap alternative.hs...qov's# ,E0:Iqv ``iݜ*o?H6A^BbzbO/(fvEE>j(9jJ2 """)))000___UUUMMMBBB999 ```( +9%I;/]E:IS+!!lYQGj2ga1aS {Cg..&YQFh.IRj#SjJu3lJA7e ,N, QdoV YC6r3w_GqC-}zn#&s[ Rp$L 6n{DuqVJ4H2Aph6B"}3%6Z\H"BMXR ӕ$sVo<gX .YLg:}ߚ=VCq8SeFMjLZc"LeN?Pppiiiwwwfxю7Tvpxd?2}Dx#$_`,19م>w؁V!0ȳypQit|[v ^vx~ "h$fvKKK~DRcv12akvvnvv`QLIBOR = 0.100 APR - $5,000,000 = ($100 million)(0.100)(0.5 Year)v% 1w 4w #d$X #+U!!;+>\ #+U!!;, #+9$@!"!} @#:$'ftextauthorHide Menu BarSystemSmallFontsstatusbardefaultenterPage2TO HANDLE --{entering fshort } $= , = default d statusbar > 'P$= P d @ } 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 0syslockScreen నY \{j|}:      ,)! 95040211185136913517312036557ASYM_TpIDk n$e"P!#2zwarrows!#2!2 }:: $e"P! "RNext PageO`" JAA)&; ; >;#+5!'f$buttonUp} Ӑt}gj "W!)"` {: $e"P!Next Page| o!!!t"Q!t"!Q :",$ P!Kv )Backg" QLH)&; ; !!:M'f+buttonUp} d .}Kv `  $ P!Next Pageg" QLH)&; ; !!:M'f+buttonUp} d .}oh!``  5$n!Show Menu Bar" l}c)&; ; !9!;+> #+U!8+U!!'f8Hide Menu BarbuttonUp5} d B"Hide Menu Bar" / }Show Menu Bar  . D$P$ + Hide Menu Bar " l}c)&; ; !!;+> #+U!8+U!!'f8Show Menu BarbuttonUp5} d B"Show Menu Bar" / } Hide Menu Bar+ . D K$bn! A Table of Contents "knG_)&; ; r;#+6r!'f0Table of ContentsbuttonClick+buttonClick "Table Contents"" Table of Contents9 < L M $n I LargeFonts " j)&; ; ;@#+U!!;+> #+U!8;m #+.0!nv@!n@!;+>M #+U!!;+>U #+U!8;( #+.04!; #+9$@!'ftextlargeFontsstartupArialsmallFontsbuttonUp} } "startup" 捈"" W= "Arial" W= 16 Hide B"largeFonts" / Show B"smallFonts" / g1 "" ߈"" = 0 } Increase Font Size? B R M c_O SmallFonts" i)&; ; ;@#+U!!;+> #+U!8;m #+.0!nc@!n @!;+>T #+U!8;+>V #+U!!;( #+.04!; #+9$@!'ftextSystemlargeFontsstartupsmallFontsbuttonUp} } startup 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / g1 "" ߈"" = 0 }Decrease Font SizeG J^$ n![Show Calculators"]nPQ)&; ; !;&#+U!8'f)CalculatorbuttonClick+buttonClick d "Calculator""Calculator:   <÷eExample 2 Quizh  X M ="#Ur )&  ; ; "!}"!};@#+U!!; #+U!8;  #+>N #+9$@!;: #+.0!n@!n @!; #+.04!;@#+U!8;+> #+U!!;+> #+U!!; #+9$@!.&?#h<"'.&?J#+hr#+h3#hg<"'.&?=#+hy#+h'ftext3svQuiz5PermissionLincolnSorry! You did not give the correct password. Try again.Sorry! You did not give the correct password. No more tries.Hide Menu BarSystemstartupThat is the magic password.What is the password to view the answers?SmallFontsenterPage>?)&; ; ;@#+U!!'f"leavePage= P= P } startup ߈"" "" = 0 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 04svQuiz5Permission = 0 ("What the view answers?" IT = Lincoln I = 1 "That 8magic ." > "Sorry!You did xgive hcorrect .Try ." ("‰„Ɓ IT = z = 1 "ur." > "mixc`.No more tries."  }ۢ s t" u v9wY[lkDq|qPnrHpTmLo\stuvwxy z>t qXz*{n|}~|ZΈ؉:2*"RZژJ0ޗ`ʝƞŸ.ΜԢP~zv&"dKLM NV:XY\fbjckAmֽnopxqz^stu$vawyz|}|~xˀˁ^ÂƃDŽ  U Dfgikr\s>t*{|؉Z0P&\$^}  s b &Button  K<$pK<$p startup "  <{+ K$di#p_ t  <{+b HHHCRg j Example 2 Quiz Part 1 u K$ , HHvC~9 text     Auto_Scroll) tbk_wid_name1 04 0`%K Scroll to view more text ---------> ______________________ Name (Print Clearly) Acct. 370 Quiz #5 Part 1 Dr. Jensen Administered in Class #07 1. Assume that the Client has a variable-rate loan of $100 million with the interest payable semi-annually for five years based upon the LIBOR at the each interest rate payment date. The LIBOR is expressed as an APR (Annual Percentage Rate) even though only half that rate is used to calculate the interest rate payment on the note. On January 1, Year 1 when there are 60 months remaining on the loan principal, the Client anticipates a steady rise in LIBOR. To hedge against this rise, the Client enters into a vanilla Swap 1 with Counter-Party 1. The Client will receive a variable LIBOR rate semi-annually on a $100 million notional amount. Counter-Party 1 will receive in exchange a 6.5% fixed rate payable semi-annually. Assume that the date of closing the books is December 31 of each year. Also assume the loan interest and Swap 1 settlements are on December 31 and June 30 each year. What is the Client's journal entry at the date of Swap 1 assuming traditional accounting for such a swap? Assume the $100 million loan is already recorded in the ledger. Client (when LIBOR = 5% APR) Year 1 Debit Credit Jan. 01 Click Here to View Answer 2. Under Swap 1, what are the Client's journal entries on June 30 if the first net settlement arises in cash.? Assume the LIBOR = 8.5% APR on that date. Explain your answer and show calculations. a. Journal entry to pay the interest on note payable with a $100 million principal: Client (when LIBOR = 8.5% APR) Year 1 Debit Credit June 30 Click Here to View Answer b. Journal entry to show the net cash paid or received under Swap 1 with a $100 million notional: Client (when LIBOR = 8.5% APR) Year 1 Debit Credit June 30 Click Here to View Answer c. What is the impact of Swap 1 on semi-annual interest expense of the $100 million loan? Click Here to View Answer 3. In Swap 1, what are the Client's journal entries on June 30 if the first net settlement arises in cash? Assume the LIBOR = 4.5% APR on that date. Explain your answer and show calculations. a. Journal entry to pay the interest on note payable with a $100 million principal: Client (when LIBOR = 4.5% APR) Year 1 Debit Credit June 30 Click Here to View Answer b. Journal entry to show the net cash paid or received under Swap 1 with a $100 million notional: Client (when LIBOR = 4.5% APR) Year 1 Debit Credit June 30 Click Here to View Answer 4. Draw a graph of the net interest expense as a function of LIBOR. The ordinate (y-axis) is to be interest expense on the note payable before and after a hedging adjustment for Swap 1. The abscissa should show the possible values of LIBOR/2 ranging from 0 to 0.10 semi-annual rates. Click Here to View Answer Net Interest Expense | | | | | | | | | | | | |--------------|---------------|---------------|--------------|---------------|-------------->LIBOR/2 0.00 0.02 0.04 0.06 0.08 0.10 5. Suppose that instead, the interest rate declined so precipitously by April 1 that the Client wants to negate the variable interest rate risk in Swap 1. Suppose the Client enters into Swap 2 on April 1, Year 1 when LIBOR = 4.0% APR. Client negotiates to receive a fixed 6.0% APR for 57 months payable on the same dates as Swap 1. In exchange, Counter-Party 2 will receive a variable interest payment based upon LIBOR. What is Client's journal entry to record Swap 2(April) under traditional accounting for such swaps? Explain your answer and show calculations. Client (when LIBOR = 4.0% APR) Year 1 Debit Credit April 01 Click Here to View Answer 6. Since LIBOR is relatively low, it is almost certain that the Client will receive more interest in the first year of Swap 2 than it pays out (which is sometimes referred to by John Smith as cash up front). In this case why is the Swaps Yield Curve a clue as to why Counter-Party 2 would agree to Swap 2? Explain your answer and show calculations. Click Here to View Answer 7. Under Swap 2, what is the Client's journal entry on September 30 assuming LIBOR = 4.4% and interest payments due every September 30 and March 31? Assume a net settlement accounting of interest rate swaps in Swap 2. Explain your answer and show calculations. Journal entry to show the net cash paid or received under Swap 2 with a $100 million notional: Client (when LIBOR = 4.4% APR) Year 1 Debit Credit Sept 30 Click Here to View Answer 8. Draw a graph of the net interest expense as a function of LIBOR/2. The ordinate (y-axis) is to be interest expense on the note payable with no swaps versus with Swaps 1 and 2 combined. The abscissa should show the possible values of LIBOR ranging from 0 to 0.10 semi-annual rates equal to LIBOR/2. In this graph ignore the three-month time difference between Swap 1 and Swap 2 starting times. Click Here to View Answer Net Interest Expense | | | | | | | | | | | | |--------------|---------------|---------------|--------------|---------------|-------------->LIBOR/2 0.00 0.02 0.04 0.06 0.08 0.10 9. Under EITF 84-36, what are the Client's journal entries on December 31 of Year 5 to terminate the loan payable and Swap 1? Also show the Swap 2 termination December 31 of Year 5. a. What is the Client's entry to pay off the loan with $100 million in principal at a variable interest rate? Explain your answer and show calculations. Client (when LIBOR = 10% APR) Year 5 Debit Credit Dec. 31 Click Here to View Answer b. What is the Client's entry to terminate Swap 1 with $100 million notional and net settlement accounting? Explain your answer and show calculations. Client (when LIBOR = 10% APR) Year 5 Debit Credit Dec. 31 Click Here to View Answer c. What is the Client's entry to terminate Swap 2 with $100 million notional and net settlement accounting? Explain your answer and show calculations. Client (when LIBOR = 10% APR) Year 5 Debit Credit Dec. 31 Click Here to View Answer d. What has been the impact of Swaps 1 and 2 on the original $ 100 million dollar loan interest expense? You can answer this question in general without knowing the entire history of LIBOR over the five-year span. Click Here to View Answer e. Suppose that, instead of carrying Swap 2 to the end of Year 5, Client terminates Swap 2 on December 31 of Year 1 by paying out $500,000 to Counter-Party 2 plus interest for LIBOR = 8.5% APR for the six-month period in the last half of Year 1. What is the combined journal entry for this termination and interest? Note that Swap 2 qualifies as a hedge against Swap 1. Assume Swap 1 is not terminated until Year 5. Explain your answer and show calculations. Client (when LIBOR = 8.5% APR) Year 1 Debit Credit Dec. 31 Click Here to View Answer 10. Click Here to View the Remaining Quiz Questions r Swaps 1 and 1a with a $100 million notional (Swaps 1 and 1a cash flows are to be netted against one another): Client (when LIBOR = 6.4% APR) Year 1 Debit Credit Dec. 31 Click Here to View Answer 11. Draw a graph of the net interest expense as a function of LIBOR. The ordinate (y-axis) is to be interest expense on the note payable after a hedging adjustment for Swaps 1 and 1a. The abscissa should show the possible values of LIBOR ranging from 0 to 0.10 semi-annual rates equal to LIBOR/2. Click Here to View Answer Net Interest Expense | | | | | | | | | | | | |--------------|---------------|---------------|--------------|---------------|-------------->LIBOR/2 0.00 0.02 0.04 0.06 0.08 0.10 12. Under EITF 84-36, what are the Client's journal entries on December 31 of Year 5 to terminate the loan payable and Swap 1, and Swap 1a? Explain your answer and show calculations. a. What is the Client's entry to pay off the loan with $100 million in principal at a variable interest rate? Client (when LIBOR = 10% APR) Year 5 Debit Credit Dec. 31 Click Here to View Answer b. What is the Client's entry to terminate Swaps 1 and 1a with $100 million notional and net settlement accounting? Remember that $1million up-front cost is being amortized at $50,000 every six months. Client (when LIBOR = 10% APR) Year 5 Debit Credit Dec. 31 Click Here to View Answer 13. Click Here to View the Remaining Quiz Questions {9 -1rv``*``+/N(T[(`b(h~9((((<)(((?A (   (  (  ( 1 ZDJ   (  (  (  F7  `` a l I 8``(((0L5Nor?`(fm(rt(zhQGRTk( ((/VH"((/(46(<Q>Yj"B(HO(TV(\q[rvz^x(((ac*/ #"#((#/#(4#6#(<#Q#j###~$$($$($$($$$$$)%)%)%$$$$$$$$$$$$$$$$$$$$$$$9v9wY[jckAqz^va9v 9<"wnk)& ; ; "!};@#+U!!;  #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+9 $@!; #+U!8'ftextAnswer13svQuiz5PermissionYou did not give the correct password when you entered this page.largeFontsstartupsmallFontsbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / HIde B"smallFonts" / g1 "" ߈"" = 12 Answer1<w <?"xnl)& ; ; "!};@#+U!!; #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+9#$@!; #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.largeFontsstartupsmallFontsAnswer2abuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / HIde B"smallFonts" / g1 "" ߈"" = 35 Answer2a/?x 2?A"xnl)& ; ; "!};@#+U!!; #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+9,$@!; #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.largeFontsstartupAnswer2bsmallFontsbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / HIde B"smallFonts" / g1 "" ߈"" = 44 Answer2bAk AWD"xnl)& ; ; "!};@#+U!!; #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+97$@!; #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.largeFontsstartupAnswer2csmallFontsbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / HIde B"smallFonts" / g1 "" ߈"" = 55 Answer2ckDy nDF"xnl)& ; ; "!};@#+U!!; #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+9>$@!; #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.largeFontsstartupsmallFontsAnswer3abuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / HIde B"smallFonts" / g1 "" ߈"" =62 Answer3aGz GI"xnl)& ; ; "!};@#+U!!;  #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+9G$@!;m #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.Answer3blargeFontsstartupsmallFontsbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / HIde B"smallFonts" / g1 "" ߈"" = 71 Answer3bI{ I-L"wnk)& ; ; "!};@#+U!!; #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+9S$@!; #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.largeFontsstartupsmallFontsAnswer4buttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / HIde B"smallFonts" / g1 "" ߈"" = 83 Answer4AL| DLN"wnk)& ; ; "!};@#+U!!;  #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+9i$@!;m #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.Answer5largeFontsstartupsmallFontsbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / HIde B"smallFonts" / g1 "" ߈"" = 105 Answer5N} NeQ"wnk)& ; ; "!};@#+U!!; #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+9x$@!; #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.largeFontsstartupAnswer6smallFontsbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / HIde B"smallFonts" / g1 "" ߈"" = 120 Answer6yQ~ |QT"wnk)& ; ; "!};@#+U!!; #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+9$@!; #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.largeFontsstartupAnswer7smallFontsbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / HIde B"smallFonts" / g1 "" ߈"" = 130 Answer7T TV"wnk)& ; ; "!};@#+U!!;  #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+9$@!;m #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.Answer8largeFontsstartupsmallFontsbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / HIde B"smallFonts" / g1 "" ߈"" = 146 Answer8V V;Y"xnl)& ; ; "!};@#+U!!;  #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+9$@!;m #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.Answer9alargeFontsstartupsmallFontsbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / HIde B"smallFonts" / g1 "" ߈"" = 173 Answer9aOY RY["xnl)& ; ; "!};@#+U!!; #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+9$@!; #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.largeFontsstartupAnswer9bsmallFontsbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / HIde B"smallFonts" / g1 "" ߈"" = 183 Answer9b[ [w^"xnl)& ; ; "!};@#+U!!; #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+9$@!; #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.largeFontsstartupAnswer9csmallFontsbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / HIde B"smallFonts" / g1 "" ߈"" = 193 Answer9c^q ^a"xnl)& ; ; "!};@#+U!!; #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+9$@!; #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.largeFontsstartupAnswer9dsmallFontsbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / HIde B"smallFonts" / g1 "" ߈"" = 206 Answer9d)av ,ac"xnl)& ; ; "!};@#+U!!; #+U!8"!}>,!J"#+Y;+> #+U!8;+> #+U!!;7 #+.04!;# #+9$@!; #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.largeFontsstartupAnswer9esmallFontsbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > Show B"largeFonts" / HIde B"smallFonts" / g1 "" ߈"" = 213 Answer9ecj cd"onKc)&; ; r;#+6r!'f0Example 2 Quiz Part 2buttonClick0buttonClick "Example 2 Quiz Part 2"(d " di#pff"n)&; ; r;S#+6r!;?#@#+U!!;,#+>.&,  #+U!8;* #+U!8'foInterest Rate Swaps Part 1viewbuttonClickzbuttonClick "Interest Rate Swaps Part 1" }""s  Group 3 "8s (-- B"view" /"" B"rAfClick Here to Return to Interest Rate Swap Example 2 Pageof rfH8"gg"n)&; ; r;S#+6r!;?#@#+U!!;,#+>.&,  #+U!8;* #+U!8'foInterest Rate Swaps Part 1viewbuttonClickzbuttonClick "Interest Rate Swaps Part 1" }""s  Group 3 "8s (-- B"view" /"" B"rgReturn to Interest Rate Swap Example 2h "h.hV"e"h+hAnswer1h\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick hhce"iVEh gTV"!h iKKK~CSiri ioi`YNo entry under treaditional swap accounting unless there is a cash exchange at this time.ii gu6iiHide Answeri ij| V".n e" jjAnswer5}j\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick jjcn e" \k E j iT| V".!h jKKKCSjHkjEk`YNo entry under treaditional swap accounting unless there is a cash exchange at this time.Ykk i 6 kkHide Answerk k"ao "0 kkAnswer2all~ "0 Dqw~ w |q2o 2 q  El k"a!h HlKKKCS8mMllPlldInterest expense 4,250,000 Cash 4,250,000 5mTm-Pn6CLoISHp\QmPnHpTmLoemlhmMn"O6D)&; ; ; #+U!8'f$2amouseEnter:6D)&; ; ; #+U!!'f$2amouseLeave' "2a" "2a"anldnIo"O6D)&; ; ; #+U!8'f$2amouseEnter:6D)&; ; ; #+U!!'f$2amouseLeave' "2a" "2a"]ol`oEp"O6D)&; ; ; #+U!8'f$2amouseEnter:6D)&; ; ; #+U!!'f$2amouseLeave' "2a" "2a"Ypl\pAq"O6D)&; ; ; #+U!8'f$2amouseEnter:6D)&; ; ; #+U!!'f$2amouseLeave' "2a" "2a"yqk%! %qkAA! AAq kq%vrsrl"Vn<J)&; ; ; #+U!!'f$answer2abuttonClick buttonClick answer2arHide Answerr r"x$rKKKCRr2ar>sr;s`FLIBOR = 0.085 APR $4,250,000 = ($100 million)(0.085)(0.5 Year)Ys s s G"$sKKK.CRs2bstst`NLIBOR = 0.085 APR + $1,000,000 = ($100 million)(0.085-0.065)(0.5 Year);t ot rt"o "o t}tAnswer2btt"o yww3 z22$ Xzr3 t >t"o !h tKKKCSut|utyusCash 1,000,000 Interest expense 1,000,000 uu*v3@wRbxkuuvwx vt vv"O6D)&; ; ; #+U!8'f$2bmouseEnter:6D)&; ; ; #+U!!'f$2bmouseLeave' "2b" "2b"wtww"O6D)&; ; ; #+U!8'f$2bmouseEnter:6D)&; ; ; #+U!!'f$2bmouseLeave' "2b" "2b"xtxx"O6D)&; ; ; #+U!8'f$2bmouseEnter:6D)&; ; ; #+U!!'f$2bmouseLeave' "2b" "2b"xtyy"O6D)&; ; ; #+U!8'f$2bmouseEnter:6D)&; ; ; #+U!!'f$2bmouseLeave' "2b" "2b"z>tww3 ! ww3 Uz>t22$ ! 22$ z >tzr3 {{l"Vn<J)&; ; ; #+U!!'f$answer2bbuttonClick buttonClick answer2b'{Hide Answerg{ j{/ "e$r{KKK6CRo{3bw{{z{{`PLIBOR = 0.045 APR - $1,000,000 = ($100 million)(0.045-0.065)(0.5 Year){ 1| 4|_ " "P B|?|Answer3bk|n|"P  AA  | |n " !h |KKKCS}|>}|;}^Interest expense 1,000,000 Cash 1,000,000 }}'~0=CMV}}~}n|}~"O6D)&; ; ; #+U!8'f$3bmouseEnter:6D)&; ; ; #+U!!'f$3bmouseLeave' "3b" "3b"~n|~"O6D)&; ; ; #+U!8'f$3bmouseEnter:6D)&; ; ; #+U!!'f$3bmouseLeave' "3b" "3b"n|"O6D)&; ; ; #+U!8'f$3bmouseEnter:6D)&; ; ; #+U!!'f$3bmouseLeave' "3b" "3b"n|€"O6D)&; ; ; #+U!8'f$3bmouseEnter:6D)&; ; ; #+U!!'f$3bmouseLeave' "3b" "3b"߁|hn h ! hn h |#_ # ! #_ # E |H c ܂قl"Vn<J)&; ; ; #+U!!'f$answer3bbuttonClick buttonClick answer3bHide Answer  Q 8" Q 8" .+Answer3aWZE` 8" `  ΈQ   ' E` 8" !h KKKCS*'dInterest expense 2,250,000 Cash 2,250,000 -6CIS\Z"O6D)&; ; ; #+U!8'f$3amouseEnter:6D)&; ; ; #+U!!'f$3amouseLeave' "3a" "3a"Z"O6D)&; ; ; #+U!8'f$3amouseEnter:6D)&; ; ; #+U!!'f$3amouseLeave' "3a" "3a"Z"O6D)&; ; ; #+U!8'f$3amouseEnter:6D)&; ; ; #+U!!'f$3amouseLeave' "3a" "3a"Z"O6D)&; ; ; #+U!8'f$3amouseEnter:6D)&; ; ; #+U!!'f$3amouseLeave' "3a" "3a"ˈ`  ! `  Q  ! Q  1 4 ' ȉʼnl"Vn<J)&; ; ; #+U!!'f$answer3abuttonClick buttonClick answer3aՉHide Answer ? "t$ KKK>CR3a%(`FLIBOR = 0.045 APR $2,250,000 = ($100 million)(0.045)(0.5 Year)  G"$KKKFCR7da`LLIBOR = 0.044 APR + 800,000 = ($100 million)(0.060-0.044)(0.5 Year))))))) ? G"? G"‹Answer7TN G",N ,R?  '+ TN G"!h .KKKC[36qCash 800,000 Interest expense 800,000 :+22?*Qb"i7:2*"KN/"N5C)&; ; ; #+U!8'f$7mouseEnter95C)&; ; ; #+U!!'f$7mouseLeave% "7" "7"CF'"N5C)&; ; ; #+U!8'f$7mouseEnter95C)&; ; ; #+U!!'f$7mouseLeave% "7" "7";>"N5C)&; ; ; #+U!8'f$7mouseEnter95C)&; ; ; #+U!!'f$7mouseLeave% "7" "7"36"N5C)&; ; ; #+U!8'f$7mouseEnter95C)&; ; ; #+U!!'f$7mouseLeave% "7" "7"O,N ,! ,N ,? ! ?  'JGk"Un;I)&; ; ; #+U!!'f$answer7buttonClickbuttonClick answer7WHide Answer i )"$KKKVCR9b`NLIBOR = 0.100 APR + $1,750,000 = ($100 million)(0.100-0.065)(0.5 Year)- a dx)"~ i"~ roAnswer9b'"~ ژB 3 JiB ۓ 06)"~ !h ޓKKKCSΔnkdCash 1,750,000 Interest expense 1,750,000 ˔"+8JSޗ\ޗ"O6D)&; ; ; #+U!8'f$9bmouseEnter:6D)&; ; ; #+U!!'f$9bmouseLeave' "9b" "9b"ߖ"O6D)&; ; ; #+U!8'f$9bmouseEnter:6D)&; ; ; #+U!!'f$9bmouseLeave' "9b" "9b"ۗ"O6D)&; ; ; #+U!8'f$9bmouseEnter:6D)&; ; ; #+U!!'f$9bmouseLeave' "9b" "9b"ט"O6D)&; ; ; #+U!8'f$9bmouseEnter:6D)&; ; ; #+U!!'f$9bmouseLeave' "9b" "9b"0B ! B G03 ! 3 u 0xx B   l"Vn<J)&; ; ; #+U!!'f$answer9bbuttonClick buttonClick answer9bHide AnswerY \x "$dKKK^CRa9ciԚlњ`NLIBOR = 0.100 APR - $2,000,000 = ($100 million)(0.060-0.100)(0.5 Year) # &"~ "~ 41Answer9c]`E"~ B 3 .B E"~ !h KKKCS0-lInterest expense 2,000,000 Cash 2,000,000 Μ+ʝ4AƞR[Ÿd\\\˜ʝƞŸΜߜ`ǝ"O6D)&; ; ; #+U!8'f$9cmouseEnter:6D)&; ; ; #+U!!'f$9cmouseLeave' "9c" "9c"۝`ޝÞ"O6D)&; ; ; #+U!8'f$9cmouseEnter:6D)&; ; ; #+U!!'f$9cmouseLeave' "9c" "9c"מ`ڞ"O6D)&; ; ; #+U!8'f$9cmouseEnter:6D)&; ; ; #+U!!'f$9cmouseLeave' "9c" "9c"ӟ`֟"O6D)&; ; ; #+U!8'f$9cmouseEnter:6D)&; ; ; #+U!!'f$9cmouseLeave' "9c" "9c"B ! B +3 ! 3 Y \B l"Vn<J)&; ; ; #+U!!'f$answer9cbuttonClick buttonClick answer9cHide Answer1 4@G"O G"O =Answer6\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick ѢԢEG"O  "  EG"O !h KKKCSX$!The Swaps Yield Curve shows how swap interest increases with the time length of the swap. Most competitors to Counter-Party 2 are offering a 6.0% swap at this date. The client could go to a competitor if Swap 2 is out of line.Ub[_fbsfԢvo"YnBM)&; ; ;&#+U!8'f$Yield CurvebuttonClick%buttonClick "Yield Curve"= " @MHide Answer  #w$KKKfCR9a`QLIBOR = 0.100 APR - $5,000,000 = ($100 million)(0.100)(0.5 Year)#% W Z(# (# heAnswer9aE(# v$ B 殖'3 Ѧ &E(# !h ԦKKKC[f٦ħܦNote payable 100,000,000 Interest expense 5,000,000 Cash 105,000,000 c  ':=Mh~~z~z"O6D)&; ; ; #+U!8'f$9amouseEnter:6D)&; ; ; #+U!!'f$9amouseLeave' "9a" "9a""O6D)&; ; ; #+U!8'f$9amouseEnter:6D)&; ; ; #+U!!'f$9amouseLeave' "9a" "9a""O6D)&; ; ; #+U!8'f$9amouseEnter:6D)&; ; ; #+U!!'f$9amouseLeave' "9a" "9a"{"O6D)&; ; ; #+U!8'f$9amouseEnter:6D)&; ; ; #+U!!'f$9amouseLeave' "9a" "9a"w"O6D)&; ; ; #+U!8'f$9amouseEnter:6D)&; ; ; #+U!!'f$9amouseLeave' "9a" "9a"s"O6D)&; ; ; #+U!8'f$9amouseEnter:6D)&; ; ; #+U!!'f$9amouseLeave' "9a" "9a"&$ ! $ &B ! B  &'3 l"Vn<J)&; ; ; #+U!!'f$answer9abuttonClick buttonClick answer9aHide Answer N 6d# 6d#tAnswer4q\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick  [ 6d# d#Ӱ K [!ְHHHCR۰fްcwNote how Swap 1 eliminates all LIBOR market risk of interest rate fluctuations by by changing interest to $3,250,000.TݱL 6d#%C 9  ``iݜ*o?H6A^BbzbO/(fvEE>j(9jJ2 """)))000___UUUMMMBBB999 ```( +9%I;/]E:IS+!!lYQGj2ga1aS {Cg..&YQFh.IRj#SjJu3lJA7e ,N, QdoV YC6r3w_GqC-}zn#&s[ Rp$L 6n{DuqVJ4H2Aph6B"}3%6Z\H"BMXR ӕ$sVo<gX .YLg:}ߚ=VCq8SeFMjLZc"LeN?Pppiiiwwwfxю7Tvpxd?2}Dx#$_`,19م>w؁V!0ȳypQit|7 M d#:YClick Here to Hide This Graph Y $ $Answer8\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick 7:S $ x $Se V\S $hClick Here to Hide This GraphǷ X\ !ʷKKKCRϷZҷWrNote how Swap 2 returns all LIBOR market risk of interest rate fluctuations plus adding $250,000 every six months.uQѸp\ $S`&B:Ը ``iݜ*o?H6A^BbzbO/(fvEE>j(9jJ2 """)))000___UUUMMMBBB999 ```( +9%I;/]E:IS+!!lYQGj2ga1aS {Cg..&YQFh.IRj#SjJu3lJA7e ,N, QdoV YC6r3w_GqC-}zn#&s[ Rp$L 6n{DuqVJ4H2Aph6B"}3%6Z\H"BMXR ӕ$sVo<gX .YLg:}ߚ=VCq8SeFMjLZc"LeN?Pppiiiwwwfxю7Tvpxd?2}Dx#$_`,19م>w؁V!0ȳypQit|1 o4Be"e"?Answer2c\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick ӽֽce"澴rE mce"!h KKKCSSwap 1 eliminates all interest rate (LIBOR) market risk and reduces the $100 million loan to a fixed-rate loan at 3.25% interest expense every semi-annual interest payment period. nrE!Hide AnswerU uXfi)" i)" cAnswer9d߿\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick ')" i_  7 s$')" !h :KKKCS?jBg  The net penalty is the difference between 9c-9d above, which is $1,750,000-$2,000,000=-$250,000 every six months. This aggregates to -$500,000 per year added interest expense equal to ($100,000,000)(6.0%-6.5%) difference between the Swap 2 and Swap 1 fixed rates.V````` t$i_  Hide Answer% w((#%$0KKKnCZ-9e58=LIBOR = 0.085 APR - $1,750,000 = ($100 million)(0.060-0.085)(0.5 Year) + $500,000 Under EITF 87-36, the termination loss of $500,000 can be deferred and amortized at ($500,000/8) = $62,500 for the eight remaining Swap 1 semi-annual periods.Z _ "=_ "=ÝAnswer9eEn "=xn  _ ˖ ' y^En "=!h KKKCShInterest expense 1,250,000 Deferred swap loss 500,000 Cash 1,750,000 e +47Idnz|z|}|ʂƃDŽȡz"O6D)&; ; ; #+U!8'f$9emouseEnter:6D)&; ; ; #+U!!'f$9emouseLeave' "9e" "9e""O6D)&; ; ; #+U!8'f$9emouseEnter:6D)&; ; ; #+U!!'f$9emouseLeave' "9e" "9e""O6D)&; ; ; #+U!8'f$9emouseEnter:6D)&; ; ; #+U!!'f$9emouseLeave' "9e" "9e"}"O6D)&; ; ; #+U!8'f$9emouseEnter:6D)&; ; ; #+U!!'f$9emouseLeave' "9e" "9e"|y"O6D)&; ; ; #+U!8'f$9emouseEnter:6D)&; ; ; #+U!!'f$9emouseLeave' "9e" "9e"}u"O6D)&; ; ; #+U!8'f$9emouseEnter:6D)&; ; ; #+U!!'f$9emouseLeave' "9e" "9e"~^n  ! n  ^_ ! _  ^ '̀l"Vn<J)&; ; ; #+U!!'f$answer9ebuttonClick buttonClick answer9eHide Answer &W cceExample 2 Quiz Part 3h M6"Ur )&  ; ; "!};@#+U!!; #+U!8;  #+>N #+9$@!;: #+.0!n@!n @!; #+.04!;@#+U!8;+> #+U!!;+> #+U!!; #+9$@!.&?#h<"'.&?J#+hr#+h3#hg<"'.&?=#+hy#+h'ftext3svQuiz5PermissionLincolnSorry! You did not give the correct password. Try again.Sorry! You did not give the correct password. No more tries.Hide Menu BarSystemstartupThat is the magic password.What is the password to view the answers?SmallFontsenterPage>?)&; ; ;@#+U!!'f"leavePage= P } startup ߈"" "" = 0 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 0 4svQuiz5Permission = 0 ("What the view answers?" IT = Lincoln I = 1 "That 8magic ." > "Sorry!You did xgive hcorrect .Try ." ("‰„Ɓ IT = z = 1 "ur." > "mixc`.No more tries."  }74˖hi}H3~6:65v;z?:!#&D(x*,@D? FI4EJM JNNOO$PPPPM VzWWW"XNXzXXU.0^^`Z]rac`1|PX  6:?4E JPMUZ]`G ~JK-$CK-$CVSstartup-MK$H3 r#C5Zr@ C h-MHHH3R Example 2 Quiz Part 3/ i2<K$ HHn: <9textadzw Auto_Scrolltbk_wid_name+ Scroll to view more text ---------> ______________________ Name (Print Clearly) Acct. 370 Quiz #5 Part 3 Dr. Jensen Administered in Class #08 13. Although it is not common, why would Counter-Party 1 agree to pay $1 million up-front in order to enter into Swap 1a? On the otherhand, why might Counter-Party 1 refuse the Swap 1a deal? Click Here to View Answer 14. On April 1, Year 1 after Swap 1 is in effect, under what circumstances will the aggregate cash flows from termination or reversal swaps be the best decision in hindsight. Ignore time value of money and all other considerations other than aggregates cash flows. a. When compared with Swap 1 in effect, when would it be a good idea to enter into Swap 2(April)? Be specific in terms of Swap 1 contract terms. Click Here to View Answer b. When compared with Swap 1 in effect, when would it be a good idea to enter into Swap 1a(April)? Be specific in terms of Swap 1 contract terms. Click Here to View Answer 15. John Smith explained that the Client entered into a succession of Swap 2 contracts every three months. Suppose that three such swaps are entered into on April 1, May 1, and June 1 of Year 1. Refer to these as Swap 2(April), Swap 3(May), and Swap4(June). In each case assume LIBOR = 4.0% APR. Since only one such swap was needed to reverse Swap 1, the other two swaps might be speculation investments that LIBOR will on average rise above 6% over the swap contract periods. However, even if the swaps eventually lose money, according to John Smith, the Client may have entered into the three swaps to front-load income at the long-run expense of losing money on the swaps. Suppose that LIBOR remains at 4% from April 1 through June 30 and then rises by 0.10% at each month thereafter for six years (e.g., LIBOR is 4.00% on June 30 of Year 1, 4.10% on July 31 of Year 1, 4.20% on August 31 of Year 1, and so on until it reaches 11.20% on June 30 of Year 6). a. Explain how Swap 3(May) and Swap 4(June) might be entered into for the purposes of front-loading income. Click Here to View Answer b. In the graph below, graph the net cash income and net loss pattern of Swap May for its entire five year term from May 1 of Year 1 through April 30 of Year 5. Click Here to View Answer Swap May Cash Flows | | | | $0 Cash|------------------------------------------------------------------------------------------------------ $0 Cash Flow | | | | | | | | | |---------|----------|----------|---------|----------|---------|---------|----------|----------|-------> 01 02 03 04 05 06 07 08 09 10 Swap May Cash Flow Payments Over 10 Semi-Annual Periods c. John Smith indicates that his firm made the Client defer and amortize Swap 2(April), Swap 3(May), and Swap 4(June) over the remaining life of the original loan that terminates on December 31 of Year 5. What is the Payment 1 journal entry on November 30 of Year 1 for Swap May? Click Here to View Answer Client (when LIBOR = 4.50% APR) Year 1 Debit Credit Nov. 30 16. Suppose the LIBOR rate rate growth of 0.10% per month is reduced by half to 0.5% per month. Does it still appear that the Client may be front-loading income? Click Here to View Answer 17. In the graph below, provide a graphical depiction of your answers to the question above. Click Here to View Answer Swap May Cash Flows | | | | $0 Cash|------------------------------------------------------------------------------------------------------ $0 Cash Flow | | | | | | | | | |---------|----------|----------|---------|----------|---------|---------|----------|----------|-------> 01 02 03 04 05 06 07 08 09 10 Swap May Cash Flow Payments Over 10 Semi-Annual Periods 18. In this illustration, what clues make John Smith extremely suspicious that the Client was front-loading income rather than making reasonable economic decisions? Click Here to View Answer r than making reasonable econonomic decisions? Click Here to View Answer extremely suspicious that the Client was front-loading income rather than making reasonable econonomic decisions? Click Here to View Answer ons? Click Here to View Answer 9%% -1rvv!#`` &4  D(,  `  x* GH, .`v1 sv!#&D(x*,.1!V"@nw4)& ; ; "!};@#+U!!; #+U!8"!}>f,!J"p#+7;7 #+.04!;# #+9 $@!;u #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.startupAnswer13buttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > g1 "" ߈"" = 12 Answer13ȸ!!#W"Anx5)& ; ; "!};@#+U!!; #+U!8"!}>f,!J"p#+7;7 #+.04!;# #+9$@!;m #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.Answer14astartupbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > g1 "" ߈"" = 23 Answer14aȹ## &W"Anx5)& ; ; "!};@#+U!!; #+U!8"!}>f,!J"p#+7;7 #+.04!;# #+9$@!;u #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.startupAnswer14bbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > g1 "" ߈"" = 31 Answer14bȹ!&$&A(W"Anx5)& ; ; "!};@#+U!!; #+U!8"!}>f,!J"p#+7;7 #+.04!;# #+93$@!;u #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.startupAnswer15abuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > g1 "" ߈"" = 51 Answer15aȹU(X(u*W"Anx5)& ; ; "!};@#+U!!; #+U!8"!}>f,!J"p#+7;7 #+.04!;# #+9?$@!;u #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.startupAnswer15bbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > g1 "" ߈"" = 63 Answer15bȹ**,W"Anx5)& ; ; "!};@#+U!!; #+U!8"!}>p,!J"z#+7;A #+.04!;- #+9W$@!; #+U!8'fAnswer15ctext3svQuiz5PermissionYou did not give the correct password when you entered this page.startupbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > g1 "" ߈"" = 87 Answer15cȹ,,.V"@nx4)& ; ; "!};@#+U!!; #+U!8"!}>f,!J"p#+7;7 #+.04!;# #+9d$@!;m #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.Answer16startupbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > g1 "" ߈"" = 100 Answer16ȹ..1V"@nx4)& ; ; "!};@#+U!!; #+U!8"!}>f,!J"p#+7;7 #+.04!;# #+9q$@!;m #+U!8'ftext3svQuiz5PermissionYou did not give the correct password when you entered this page.Answer17startupbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > g1 "" ߈"" = 113 Answer17ȹ%1(1E3V"@nx4)& ; ; "!};@#+U!!; #+U!8"!}>o,!J"y#+7;7 #+.04!;# #+9$@!; #+U!8'ftextAnswer183svQuiz5PermissionYou did not give the correct password when you entered this page.startupbuttonClickbuttonClick= P } startup= P4svQuiz5Permission  <1 "You did xgive the correct you entered ." > g1 "" ߈"" = 137 Answer18ȹs3 }v3 r#C44"n)&; ; r;S#+6r!;?#@#+U!!;,#+>.&,  #+U!8;* #+U!8'foInterest Rate Swaps Part 1viewbuttonClickzbuttonClick "Interest Rate Swaps Part 1" }""s  Group 3 "8s (-- B"view" /"" B"r5Click Here to Return to Interest Rate Swap Example 2 Page/5 25Zr@ C55~"hnG\)&; ; r;#+6r!'f0Example 2 QuizbuttonClick+buttonClick "Example 2 Quiz" #5Return to Questions 1-1236 66D6Z"Si #%6A6Answer136\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick 66E #%:i7 66"S!h 7KKK37(: 7%:Counter-Party 1, under Swaps 1 and 1a combined, receives $250,000 every six months for five years. The up-front cost was only $1m that averages ($1m+$0)/5 = $0.2m per year. The ROI is ($0.5m-$0.2m) /$0.2m = 150% average annual ROI. More importantly, there is absolutely no market risk in this 150% average annual return on investment since it is independent of LIBOR Furthermore, the credit risk is nill due to the right of offset of the interest swaps in case of default. However, Counter-Party 1 may be able to obtain Swap 2 without having to pay the $1 million up-front by simply going to the interest rate swap market and contracting with someone other than the Client. Swap 2 is a better deal for Counter-Party 1 than the deal for Swap 2.: `!``: 6Z::Hide Answer; ;;7#7#;;Answer14a;\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick ;;r7#z? EE; :r7#!h ;KKK3;>;>Swap 1 hedged the note such that the Client owes $3.25 million every six months independent of LIBOR fluctuations. This sums to $32.5 million over 10 payment periods. Swap 2 reverses Swap 1 with a cash penalty of $250,000 each period, which sums to a total penalty of $2.5 million. The semi-annual penalty is (0.060-0.065)/2 times a $100 million notional. Any future outcomes where the note interest based upon LIBOR plus the Swap 2 penalty sum to less than $35.0m = ($32.5m+$2.5m) makes Swap 2 a good deal (ignoring time value of money). In any period, Swap 2 is a good deal if (LIBOR / 2) + 0.25% penalty for reversing Swap 1 sum to less than 3.25% . Client entered into Swap 2 because of a fear that LIBOR was not going to keep on increasing...w? y````````? : EE??Hide Answer? ??7#7#v@?Answer14bs@\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick @@r7#D6@ ?r7#!h @KKK3@^D@[Do Swap 1 hedged the note such that the Client owes $3.25 million every six months independent of LIBOR fluctuations. This sums to $32.5 million over 10 payment periods. Swap 1a reverses Swap 1 with a cash penalty of $250,000 each period, which sums to a total penalty of $2.5 million. This penalty equals (0.060-0.065)/2 times the $100 million notional. However, Swap 1a provides an up-front $1 million, making the net total penalty equal to $1.5 million. Any future outcomes where the note interest based upon LIBOR plus the Swap 1a penalty sum to less than $34.0m = ($32.5m+$1.5m) makes Swap 1a a good deal (ignoring time value of money). In any period, Swap 1a is a good deal if (LIBOR / 2) + 0.15% penalty for reversing Swap 1 sum to less than 3.25% . This makes Swap 1a a somewhat better deal than Swap 2, although both swaps bring back LIBOR rate risk.D ~````1HJK``n!E ?6$E1EHide AnswereE hEvE7#7#EsEAnswer15aE\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick F Fr7#I EEGF 4Er7#!h JFKKK3OFIRFI@+ Client did not enter into Swap 3(May) and Swap 4(June) to reverse any hedges that we know about. We can only assume these are speculative investments. As such, they are questionable because on May 1 and June 1 of Year 1, the LIBOR APR is a relatively low 4.0%. This means that the Client almost certainly will face increases in LIBOR that increase future Swap May and Swap June payments. We suspect that the client expects the LIBOR to stay very close to 4.0% in the near future. If this is the case, net income is positively enhanced by the net cash inflows of Swap 3(May) and Swap 4(June). If LIBOR rises above 6.0% in later years, the Client will have net cash outflows. Thus, there is a type of "front-loading" of income only if the client expects future losses to offset any near-future gains. I``(I 4E EEI JHide Answer=J @JNJQ #Q #JKJAnswer15cJ\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick JJjQ #MLVK  JjQ #!"KHHH2'KL*KLo darned if I know! There's no reported Swap 3(May) up-front payment to amortize! The client must have amortized each positive swap cash flow. In Swap 1a, it would make sense to force the Client to amortize the $1 million up-front payment. However, there is no such up-front payment mentioned by John Smith in the three Example 2 swaps of April, May, and June.M( h Wh `h h ``h =M  JLV@MMMHide AnswerM MM)"T)"TNMAnswer15b N\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick KNNN PO,!TO c $PaB PP ~  |P)"N PM P!NHHH2N~ON{OEx-post it appears that the Client either made a bad estimate of future interest rates or was trying to front-load cash flows for the first three payments. Note that Payment 1 is only for May and June. O`O PM,!TOOClick Here to Hide This Graph!PPM c !"ZMPPMaB !"ZyPPM ~  !"ZPPM)""@<:PU ``iݜ*o?H6A^BbzbO/(fvEE>j(9jJ2 """)))000___UUUMMMBBB999 ```( +9%I;/]E:IS+!!lYQGj2ga1aS {Cg..&YQFh.IRj#SjJu3lJA7e ,N, QdoV YC6r3w_GqC-}zn#&s[ Rp$L 6n{DuqVJ4H2Aph6B"}3%6Z\H"BMXR ӕ$sVo<gX .YLg:}ߚ=VCq8SeFMjLZc"LeN?Pppiiiwwwfxю7Tvpxd?2}Dx#$_`,19م>w؁V!0ȳypQit|5U 8UFUx!T Z!UCUAnswer17U\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick V V &9!| zWF W W3 "Xn n NX\ zX; X8XZ!U]V U W! !`VHHH2eVPWhVMWEx-post, it appears that the Client made great estimates of future interest rates. Swap 3 becomes a good deal at this low rate of LIBOR increase. Note that Payment 1 is for only May+June interest. wW``W U TWWClick Here to Hide This GraphWU .!"ZXU!"ZKXU .!"ZwXUz =!"ZXUY? .!"ZXUV\ !"Z+YUx!"wf9:.YW] ``iݜ*o?H6A^BbzbO/(fvEE>j(9jJ2 """)))000___UUUMMMBBB999 ```( +9%I;/]E:IS+!!lYQGj2ga1aS {Cg..&YQFh.IRj#SjJu3lJA7e ,N, QdoV YC6r3w_GqC-}zn#&s[ Rp$L 6n{DuqVJ4H2Aph6B"}3%6Z\H"BMXR ӕ$sVo<gX .YLg:}ߚ=VCq8SeFMjLZc"LeN?Pppiiiwwwfxю7Tvpxd?2}Dx#$_`,19م>w؁V!0ȳypQit|] ]];#;#^]Answer16^\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick -^0^#^`;[m^ Z]#!h p^KKK3u^@`x^=`Any LIBOR pattern in which the Client's net cash inflows exceed the outflows (with some added consideration for time value of money). For example, if the Client experiences the LIBOR pattern in Question 15, the net cash outflows of greatly exceed the Client's Swap 3 inflows. However, if the LIBOR increases at half that rate, the net cash inflows greatly exceed the Swap 3 inflows making this swap a good deal.lars..........[`!` Z];[``Hide Answer` ``VF#VF#Za`Answer18Wa\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick oaraVF#c 6a `VF#!h aKKK3abca_c The fact that Client entered into three successive swaps that entailed swap cash outflow payments based upon LIBOR is very suspicious when each time the LIBOR was a relatively low 4.0% annual rate. This especially makes the speculative swaps very risky and questionable long-run decisions. The possibility that management was trying to look good in the short run at the expense of the long run is very possible.cxc ` 6cHide Answer=Ǝnefishneth 0  -%Ur')&; ; 5"z-<"!<+F !!9<+V!8!95!y:*"!}!!|<+V!!;Y #+V!8;J #+?O #+V!!;1 #+?Q #+V!8"!}jB#:$'ffishnetauthorfishnet2statusbardefaultfishnet1enterPage5)&; ; ;A #+V!8;2 #+?0 #+V!!; #+?  #+V!8'fVfishnetfishnet2fishnet1leavePage $= , = default d statusbar > $= P d 9 fishnet fishnet2  fishnet1 * syslockScreen న W Rd Kq;> J `P    (TLD< h!"$4' (L)*D+,-/012 3L4x5678(9T:;<`=?BCDE F\ G HpJ!K!L!M"N`"O"P"QD#R!S$TV#Y%Z0%[$]`&^&_&a'b'cp'd(e(f$)gP)h|)i)j)k*l,*m$n#p*r>+t2,u,v,w,x$-yb-z-{-|.}H.~.../n+*/000(1T111"2N2z222"3/J/Z33X*555"6N66647z6l777848`88889d999:8::4;;(<`<<<=d====>@>@;:>\@@@hAAADBBBLCCCTDDE0E\EEEE F8FdFFFHGGGPHHIXI>l>I(JIKKLLLM\KM(N`NNNO@OxOOO PXPPPQ8QpQQQ R PR S 4TTBUUVVUVWtWTXDYpYY|d?dC EeFrfH.gKhL \ ;Iw G" \Kq CM i(N@2  `N  N w N(^ Ow@OxOz @ k O  ,O ,  PYHXP6P6P Q 8Q pQLxQmZQ~R@ +? PRjRi- eDdi9|d jdM j  ;f!&!HHH>*R `HTeacher Facilitates Student Creates Teacher Assigns Teacher EvaluatesM$  W!J!HHH~5R Fishnet Environment  ^!^  ^fBYA^f! / d DW I / 3 .T   K ; Y )d ; :      BY! 4d$!4d$4$od9 4$! < =jOR+, od!  I| !I| | # (I5 % | # !]I5 ! .`Jot..G pL.. " - |5#!- |5# |!"5#!Hu"- z!9  |!! |!<QT W!!|!J W!! / d W I / 3 .T   K ; Y )d ; :      !|!J!1 "5#!"5#4IL"5#r"""5#! I H r  g   kw La N%  N I k      r""!) !Hu"!!Hu",AD!u"!H1"y!u"!| =jOR+, !H1"!! !- z!!- z!$9< !~h- z!e  !~! - z!!.Jot..G pL.. = !14`]$! <!  +`! 4gL:DI '4g!(:!}  %*%*o <o R \ o M \  w N FY M ZM } M }    ! U%)!H%Uo (AH%Ho Uo Cy*!GC|bGC,`!-` ! ;`!  # Lx {dv#L^(5GT/ /!0!1#!I2!u3!4 !5{!6dv!%7#L^!Q85G!}9/!: ! T &o !&o &o $&o !?&o !U S&o !&o Xmp&D !5o  H$&D !&D &N c&! N j \ N  D  Bp&!ECpN ! )WHI7 W: S+ i  !  \ EFw)Dpc&!!h Hw <eKe8,h+whh eE EpN j ! H Y    FpN  !       GpD! s !W: SI$  e s 9! R$5o !5o +<Lfn+m k+ r*<Lf!+ *m !m +/,2,;,M ,0,m:$-:b-]--{g.=H.#K .,.7I.!0/g,tn+;! 3 m  j,, m m   , un+M !,vn+0! 0!-wn+m:!]KD_-xn+:!]d]bKD- yn+]!- zn+!-{n+{g! ] -. ] ] ] E.|n+=! y3.}n+#K !84, .~n+,! 3 .n+7I!Q2LLWO/ n+!0! G/ n+! {/ X*<Lf <Lf~///<Lf/m / J/<Lf%/ J/m ! m /}00;0M 0](1T1{g11/"2,N20? z2 2m:2:"300/;%3m  00 m m   0 /M %%1 /]%Q1 /%1/{g% ] 11 ] ] ] 1/% s/s y&2//%C C   K2/,%3w2 /0? % 2 / % 2/m:%]KD3/:%]d]bKDW3/0% 03 X*K[u#3 X*3;%W2!r4o4"nnRb)&; ; ; #+U!!; #+U!8'f3fishnet2fishnet1buttonClick.buttonClick fishnet2 fishnet1&4Show Hierarchical Environment4 ' !' 455,' 55," "60i  N6@ Y z6 N G l7MN G 7F  7Y < 8+  48& ~ `8 5 8n ' 8"89 d9== 9&9C : 8:"!: 0 54,' !54! 64," ! K640i  !w6 4@ Y !6 4 N G ! N G 666N G 6   47HY H< 6z6N G !17z6   !   i7z6HY H< !HY H< 74MN G !74F  !F  84Y < !Y < 184+  !]84& ~ !84 5 !84n ' !]  88]  , , ^ ^    ] %94"!: (959: : a94 !94== !== 94&!&94C !5:4 ! m:4"!!: p:}:: : :4 0 !@&  ::@  & : C !C :;;C @;P n=;:C !q; :P n! P nt;;;1  (<1= =`<' , =<, 0 =<'0 ==(P nd== (=D =k (= = (===c(>=(@> = (%<@;1  !1  ]<@;1= =!1= =<@;' , =!<@;, 0 =!<@;'0 =! <=    ==@;(P n! @=a=  =@;= (!=@;D =k (!=@; = (!>@;==c(!=>@;=(!i>@; = (!> \ ;% \ ;>>> k ;> \ [;>l> k ;!? l> \ [;!  \ [;?Y@\@ @0 .@ `[;hA  Ab } MA  MDB  MB  MB ) MLC8 S MCb } MC  MTD  MD  ME5 vP 0Ei v \E v E v E v! E: vV  Fn v 8F v dF v F v'F \ Q HG ~ G ~ G ~ PH! ~= HL ~g Iv ~ XI ~ @ > !@>0 .!&X @@&&&&XX"" "-A> `[;!&X 0AeA&&&&XX"" "A>  !A>b } M!  AA B 1  3 o !B>  M!  $BAB B 1  3 o yB>  M!  |BB B 1  3 o B>  M!  BB B 1  3 o )C> ) M!  ,CIC B 1  3 o C>8 S M!  CC B 1  3 o C>b } M!  CC B 1  3 o 1D>  M!  4DQD B 1  3 o D>  M!  DD B 1  3 o D>  M!  DE B 1  3 o -E>5 vP !YE>i v !E> v !E> v !E> v! ! F>: vV !5F>n v !aF> v !F> v !F> v'!F> \ Q !9FEG99Y;;II;YYxIxIxK}G> ~ !  GG B 1  3 o G> ~ !  GG B 1  3 o -H> ~ !  0HMH B 1  3 o H>! ~= !  HH B 1  3 o H>L ~g !  HH B 1  3 o 5I>v ~ !  8IUI B 1  3 o I> ~ !  II B 1  3 o I w G" !w G" IIIw G" (Jw G" %JIw G" !]JIw G" ! V\>`JYK\\mm<<== } }##RR%%   S S  Q Q ^ ^ 5'5CC` ` <<Tj 6 k k   C} } ` ` 0 a0 a[[ r rVVK q C!q CKKKq CK} 0qL%6L6LW6M 0 K\Kq C!1L\K} 0q!  _v4LL v  c | | '| | %| | #m _m _vL\K%6!L\K6!M\KW6!=M\K 0 !6S+@MMShSwESfSuc6)SS67t6H z  qWr eUr2 0  jZc%N  i````! i ]N @2  !@ 2 N   !  N  w !w  O (^ !^ (=O w!wuO !O z @ k !z k @ O   ,! , P  , ! , UP YH!YHP 6!6P 6!6P  ! 5Q  !  mQ  ! Q Lx!LxQ mZ!ZmR ~!~MR  @ +? !+? @ R  j`!~jR < i- e%i- eRSSi pK4Tp MT T l W- (s:^9 $6^e._ycf_6\k_$g` \p|`LN`ZDapa6awplb 1b:LcZg (f S1Tj(>    0  \  z =j Q ,bIj+QgQf(PiT Rp M@! vfF6 lTTfF6Q  TR @!6 ,E TT,E  Tg U R l ! l U?UBU l U3 LW V 0 W  tWE z wUT l !GS zUU);SHDGGU T3 LW !3 LW UUU3 W VV3 LW /VU3 W !hI2VSVhIwwVU3 LW !uVVGuRVT 0 !hd VWhd IdX:MWT  !w :sPWqW w(wFUs+F:(  WTE z ! E z W *R- (s!- (sWXX- (sDY  pY*  YC ^ k  { ^ m "  , +      ` $  Gz  M   c_-Ryc!yc_.R6\k! B __B ] s {   _/R$g! ) _`)  w  { { I`0R \p! | B L`y` |    ) N  p B B `1RLN! ]  ``  ] +l G  D   a2RZ! Rk aAa /    k  R C 6 e> e> {a3Rp! z ~aa   / z z a4R6!  e aae N , b5Rwp! `   bib{ o  ! # _  ? ^ } M _  M # # M ` o b6R 1!l  bb  l l b7R:L!N  bc    N 9c8RZg!gZqc9R0  !I*6tcc6;~T\,P**V$IIc:R* 7 ! cc y1d;R% P. ! 4dAd yd= i9! i9d>  j!j d? M j!jM e  eZP%ZP.e+efishnet1eeM DrfZ> fb2 \j rsP  sP $ s  CPe EdM D!eHHHn5Re2fe/f`DTeacher Teaches Student Studies Teacher Assigns Teacher Evaluatesof f FdZ> !fHHH.8Rfff Hierarchical Environmenttg Sdb2 !b2 g+g.gb2 Zgq4 WgHfb2 !g Rfq4 !q4 ggg i 4v li  iqi/g MZg ! g hhQ  :z  {     ! _ | P  ^  D  N E 'UiNZg 4v !I tXiiiI  tiOZg  ! iiI  iPZgq!q%jQZg/!  f (jYj ffZ      z \ j |d r! rjjj rj 'Do 'Ts 6j U\j r@@@@#k h\j '! ' k5k8k 'hkH sjek Wj '!k gjH sj!H sjk)l,lf d> |l? (jl   lH  m s \m 8z m z mV/  n  Bn  nf d n Dn/ M o/ M alYhkf d> ! 3 m  dlyl m m   l Zhk? (j!l[hk   !   m\hkH  !]KDYm]hk s !]d]bKDm ^hk 8z !m _hk z !m`hkV/  ! ] mm ] ] ] ?nahk  ! y3nbhk  !84, nchkf d ! 3 ndhk D!Q2LLWOo ehk/ M ! Ao fhk/ M ! uo z\j '  'xooo 'oH! sjo jDo '%o yDoH! sj! H! sjowpzpf d> p? (jp 8z "q z NqV/  q O q ? rf! d Hr M k trM k rH  r s s   plof d> %3m  pp m m   p mo? (j%q no 8z %Kq oo z %qpoV/  % ] qq ] ] ] qqo O % s/s y&rro ? %C C   Ersof! d %3qr to M k % r uoM k % rvoH  %]KDswo s %]d]bKDQsxo   %   s {\j 6#s}dP  ``!  P s~dP $ !$ P %t d  %  (tuu  u PuD A ! bDv( _ O y  ' ^1  Le Ҁe  (j ~gt g Fu z g| T5؃>"0p0u = i D f =us  @@! > (f @uuj(>    0  \  z =j Q ,bIj+QgQf(Pus P@! vfF6 uufF6Q  )vsD A ! b@!6 ,E ,vAv,E  Tguv s( _ O !( _ O xvvv( _ O wH xm + xv  x vDv( _ O !GS vw);SHDGGKw DvH !H NwcwfwH w wwH !hIwwhIwwww !uwxGuRSxDvm + !hd Vxxhd IdX:xDvv  !w :sxx w(wFUs+F:(  yDv ! Iy s ! Lyyy z z e F{ y { W F |@  y \| e | q } x ~} - " }O ~  p~   ~ l  y X . %zy ! k 4!(zzJ9e7(rd4 WWWuY';SjD[ k 6k 7k t=G=Gz y !1.{y e ! h' {C{hxv< .'KK}{y y ! JZ  {{ZwJ;gv {y W F ! y {|8yyUUA|y@  y ! xww D|Y|wwXx x |y e !  ' ||v*g  Ve)st''  }y q ! J}}JxW}y x ! -tWZ}{}-9,I tWtW}y - " !  <F}}< -FF~yO ! ~~6yU~y  ! \ X~m~\ G   ~y   !~~~y l ! Yh~wh:YY=y y !  @UI  y . !H99uVHHs ' @! v} EAQ A } i$ i$ ;s^1 !{ ` > > k  { ^ m "  , +      ` $  Gz  M   πs Le ! Le  se  ! B  %B ] s {   _sj ! ) b{)  w  { { sgt ! | B |    ) N  p B B sg ! ]  "C  ] +l G  D   }su ! Rk /    k  R C 6 e> e> sz ! z    / z z 9sg| !  e <Qe N , s5! `  Ճ{ o  ! # _  ? ^ } M _  M # # M ` o s>!l    l l Ys0!N  \m    N s0u!u0݄s = i !I*66;~T\,P**V$IISsD ! Vc ys !  ۅ dޅCP!%nnRb)&; ; ; #+V!8; #+V!!'f3fishnet2fishnet1buttonClick.buttonClick fishnet2 fishnet1&Show Fishnet Environment  5%c$2!%n)&; ; !;5 #+V!!;/ #+V!8;&#+:!['fQfishnetfishnet2fishnet1buttonClickPbuttonClick mmClose  fishnet2 fishnet1--  close 'HHide This Graphic Image3  RU!RU6_bRUF\|RU! *C bw1}Rs}}aC:i]2kZ"]]Q,Gk#{\!>G~Q&QXRiVQM]b[OO*E.'" b TYi9nfTInWIn9cL;>8)c]2,IW8I4/6-*IL))OzRQL>)> } ":ӊ! URx֊Xizlnlaf\U\RU[Wlaolxxuf[K|!zN[z  R!RR|\r}|^R! RU*-.Lbjl,>PVp|W48IUTb`7Rml|cl.l'\\׌^|\!\Gڌ  vv' L "%I>JE5EGZ<"0"L#\=^FJC*9 WZX^`zlgl\f/^! 2o^}|!|||m1{7textField~ NM$  K"yUo)&; ; 5"z-<"!&<+E !!9 <+U!8!9"!}5!y:*!!<+U!!@#+U!8; #+.0!n@!n @!;o #+.04!;@#+U!8;+>X #+U!!;+>\ #+U!!;, #+9$@!"!} @#:$'ftextauthorHide Menu BarSystemSmallFontsstatusbardefaultenterPage+TO HANDLE --{entering fshort } $= , = default d statusbar > 'P$ d 9 } 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 0syslockScreen నsvASYM_TpID! 9504021118513691351731203655 p $e"P!#2 arrows#&!#2!2W }Zh: $e"P! "eNext Page`" JAA)&; ; >;#+5!'f$buttonUp} Ӑt} ":W!)"`) {&,: $e"P!7Next Pageo|& o!!!t"Qr!t"!Q $ P!Kv JBackGg" QLH)&; ; !!:M'f+buttonUp} d .}_bKv (` $ P!Next Page%g" QLH)&; ; !!:M'f+buttonUp} d .}]oh!``m`  !pSmallFonts  5$n!Show Menu Bar" l}c)&; ; !9!;+> #+U!8+U!!'f8Hide Menu BarbuttonUp5} d B"Hide Menu Bar" / }Show Menu Bar  D$P$ Hide Menu Bar " l}c)&; ; !!;+> #+U!8+U!!'f8Show Menu BarbuttonUp5} d B"Show Menu Bar" / } Hide Menu Bar   K$bn!  Table of Contents "knG_)&; ; r;#+6r!'f0Table of ContentsbuttonClick+buttonClick "Table Contents"" Table of Contents  W!  LargeFonts " *)&; ; ;m #+.0!nn@!n@!;+>M #+U!!;+>M #+U!8;( #+.04!; #+9$@!'ftextlargeFontsArialsmallFontsbuttonUp} 捈"" W= "Arial" W= 16 Hide B"largeFonts" / Show B"smallFonts" / g1 "" ߈"" = 0 } Increase Font Size {|:}&b( pm" +)&; ; ;m #+.0!nc@!n @!;+>T #+U!8;+>N #+U!!;( #+.04!; #+9$@!'ftextSystemlargeFontssmallFontsbuttonUp} 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / g1 "" ߈"" = 0 }Decrease Font SizeF$B#?$eComprehensive Incomeh Msv p&rsF"th#u&F"h#B$V#u4 b#&Buttonc pfHHHNPRkn Comprehensive Income rZ# 0HHH> Stext Auto_Scroll-tbk_wid_name58 Scroll to view more text ---------> Excerpts from "Is a Second Income Statement Needed" by Dennis R. Beresford and Todd Johnson Journal of Accountancy, April 1996, pp. 69-72 Examples of Items Not Included in Traditional Income Statements: Foreign currency translation adjustments (FASB Statement no. 52, Foreign Currency Translation). Gains and losses on foreign currency transactions designated as, and effective as, economic hedges of a net investment in a foreign entity, commencing as of the designation date (Statement no. 52). Gains and losses on intercompany foreign currency transactions that are of a long-term investment nature (that is, settlement is not planned or anticipated in the foreseeable future), when the parties to the transaction are consolidated, combined or accounted for by the equity method in the reporting enterprise's financial statements (Statement no. 52). A change in the market value of a futures contract that qualifies as a hedge of an asset reported at fair value unless the events specified in paragraph 11 require earlier recognition of a gain or loss in income because there is not a high correlation (Statement no. 80, Accounting for Futures Contracts). The excess of the additional pension liability over unrecognized prior service cost--net loss not yet recognized as net periodic pension cost (Statement no. 87, Employers' Accounting for Pensions). Unrealized holding gains and losses on available-for-sale securities (Statement no. 115, Accounting for Certain Investments in Debt and Equity Securities). Unrealized holding gains and losses that result from a debt security being transferred into the available-for-sale category from the held-to-maturity category (Statement no. 115). Subsequent increases in the fair value of available-for-sale securities previously written down as impaired (Statement no. 115). Subsequent decreases in the fair value of available-for-sale securities--if not an other-than-temporary impairment--previously written down as impaired (Statement no. 115). EXECUTIVE SUMMARY THE FINANCIAL ACCOUNTING Standards Board is considering establishing a vehicle for reporting comprehensive income--all non-owner changes in equity. This so-called second income statement might also take the form of an expanded version of the traditional statement. COMPREHENSIVE INCOME INCLUDES ALL equity changes during a period except those resulting from investments by owners and distributions to owners. Reporting it may resolve some challenging financial reporting issues, particularly in the area of financial instruments. THERE ARE A VARIETY OF WAYS TO report comprehensive income. One would use a newly created income statement, while preserving the traditional statement. The information also could be combined into a single statement so an entirely new one does not have to be created. Another alternative is a three-column statement with components of traditional income in one column, other components of comprehensive income in a second column and a third column combining the first two. REGARDLESS OF WHICH OPTION IS selected, the understandability of financial statements would be enhanced because a vehicle would be provided for reporting income items that presently bypass a traditional statement and go directly to equity. DENNIS R. BERESFORD, CPA, CMA, is chairman of the Financial Accounting Standards Board in Norwalk, Connecticut. L. TODD JOHNSON, CPA, PhD, is a research manager with the FASB. CHERI L. REITHER, CPA, CMA, PhD, is an assistanr project manager with the FASB. The Financial Accounting Standards Board encourages expressions of individual views of board members and staff. The views in this article are those of the authors. Official FASB positions on accounting matters are determined only after extensive due process and deliberation. 70 JOURNAL of ACCOUNTANCY April 1996 Exhibit 2: Example of Comprehensive Income Statement On January 1, 1995, company X had cash and common stock of $50,000. At that date the company had no other asset, liability or equity balances. On January 2, company X purchased for cash $50,000 of equity securities that it classified as available-for-sale. On June 30, company X sold part of the available-for-sale portfolio, realizing a gain. Fair value of securities sold $22,000 Less: Cost of securities sold 20,000 Realized gain $ 2,000 Company X did not purchase or sell any other securities during 1995. It received $3,000 in dividends. At December 31, 1995, the remaining portfolio is Fair value $34,000 Less: Cost 30,000 Unrealized gain $ 4,000 Income Statement Year ended December 31, 1995 Revenues, expenses, etc. Dividend income $3,000 Realized gains on investments in securities 2,000 Net income $5,000 Statement of Comprehensive Income Year ended December 31, 1995 Net income 5,000 Total gains arising during period $6,000 Less: Gains realized in net income (2,000) 4,000 Comprehensive income $9,000 Statement of Changes in Shareholders Equity Year ended December 31, 1995 Accumulated other Common Retained comprehensive stock earnings income Total Beginning balance $50,000 $50,000 Add: Net income $5,000 5,000 Other $4,000 4,000 Ending balance $50,000 $5,000 $4,000 $59,000 Comparative Statement of Financial Position December 31, 1995 1/1/95 12/31/95 Assets: Cash $50,000 $25,000 Securities ______ 34,000 Total assets $50,000 $59,000 Shareholders' equity Common stock $50,000 $50,000 Retained earnings 5,000 Accumulated other comprehensive income 4,000 Total shareholders' equity $50,000 $59 000 April 1996 JOURNAL of ACCOUNTANCY C"77 -(UW<B<C/;g-4_f 4;R!Veq" st"(#!"##w"anIU)&; ; ;&#+9!['f$ComprehensiveIncomebuttonClick/buttonClick close ComprehensiveIncome'C#Click Here to Close This ViewerR#truee#ASYM_BeenHere# t##;0$#ShowGlossary-$i" S7J)&; ; ;&#+U!8'f$glossarybuttonUp} glossary}?$Show Glossary true|m1{8textField~ NM$  K"yUo)&; ; 5"z-<"!&<+E !!9 <+U!8!9"!}5!y:*!!<+U!!@#+U!8; #+.0!n@!n @!;o #+.04!;@#+U!8;+>X #+U!!;+>\ #+U!!;, #+9$@!"!} @#:$'ftextauthorHide Menu BarSystemSmallFontsstatusbardefaultenterPage+TO HANDLE --{entering fshort } $= , = default d statusbar > 'P$ d 9 } 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 0syslockScreen నsvASYM_TpID! 9504021118513691351731203655 p $e"P!#2 arrows#&!#2!2W }Zh: $e"P! "eNext Page`" JAA)&; ; >;#+5!'f$buttonUp} Ӑt} ":W!)"`) {&,: $e"P!7Next Pageo|& o!!!t"Qr!t"!Q $ P!Kv JBackGg" QLH)&; ; !!:M'f+buttonUp} d .}_bKv (` $ P!Next Page%g" QLH)&; ; !!:M'f+buttonUp} d .}]oh!``m`  \ $rnpSmallFonts  5$n!Show Menu Bar" l}c)&; ; !9!;+> #+U!8+U!!'f8Hide Menu BarbuttonUp5} d B"Hide Menu Bar" / }Show Menu Bar  D$P$ Hide Menu Bar " l}c)&; ; !!;+> #+U!8+U!!'f8Show Menu BarbuttonUp5} d B"Show Menu Bar" / } Hide Menu Bar   K$bn!  Table of Contents "knG_)&; ; r;#+6r!'f0Table of ContentsbuttonClick+buttonClick "Table Contents"" Table of Contents  > $n  LargeFonts " *)&; ; ;m #+.0!nn@!n@!;+>M #+U!!;+>M #+U!8;( #+.04!; #+9$@!'ftextlargeFontsArialsmallFontsbuttonUp} 捈"" W= "Arial" W= 16 Hide B"largeFonts" / Show B"smallFonts" / g1 "" ߈"" = 0 } Increase Font Size {|:}&b( pm" +)&; ; ;m #+.0!nc@!n @!;+>T #+U!8;+>N #+U!!;( #+.04!; #+9$@!'ftextSystemlargeFontssmallFontsbuttonUp} 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / g1 "" ߈"" = 0 }Decrease Font Size{X9eErnst and Young 1s and Hedge ACh Ms{< trueASYM_BeenHerev{.vu4  b&ButtonY p<+\HHH2ad@(E & Y - Derivatives and Hedge Accounting rZ# FHHH3text41 Auto_ScrollCtbk_wid_nameKVNS}z Scroll to view more text ---------> ERNST & YOUNG LLP, March 1995 DERIVATIVES AND HEDGE ACCOUNTING An Ernst & Young Alternative to the FASBs Tentative Model In January 1992, the FASB began a project to redefine GAAP applicable to hedging transactions. This project originally had two primary objectives: a) to reconcile the differences between conflicting guidance for similar transactions, and b) to provide GAAP that could be broadly applied to a wide range of hedging transactions. These continue to be appropriate objectives for the FASB to pursue. During the FASB's deliberations, several companies reported large losses from nontraditional derivative activities. Those losses plus the growth and innovation in the derivatives market intensified the need for new derivatives accounting guidance. Because derivatives are most frequently used as part of a hedging strategy, the FASB responded by altering its hedging project to include consideration of the financial reporting treatment of all derivative contracts. In January 1995 the FASB publicized a tentative approach to financial reporting for derivatives and hedge accounting that represents a radical departure from past practices (see Appendix A). While that approach would significantly increase the visibility of derivatives in financial statements, it also would severely limit the availability of hedge accounting. We believe that would result in financial reporting that would neither reflect management's intent in using derivative financial contracts as hedges nor provide for the determination of periodic income in a manner consistent with the economic results of many hedging activities. It would introduce volatility in equity and reported earnings even though the transactions are intended to reduce volatility. Recently, the FASB has discussed a variety of alternate approaches to its tentative hedging model, but has been unable to reach a consensus about the criteria to be included in a proposed standard. In the interest of assisting the Board in further considering these issues, we developed an alternative model for consideration that recognizes derivatives on-balance-sheet, but does not eliminate traditional hedge accounting. The specific objectives of our approach are to: . Improve the visibility of derivatives by accounting for all free-standing derivatives at fair value on the balance sheet. Changes in value would be reflected in the financial statements consistent with their intended purpose. . Preserve the matching of derivative gains and losses with the results of hedged exposures by retaining hedge accounting principles for transactions meeting specified criteria, including hedging of forecasted transactions that are probable of occurring. This will allow the financial statement presentation of the results of hedging activities to more closely reflect the actual economics of those strategies. Hedging activities usually are not part of an enterprise's major or central operations, but neither are they merely peripheral or incidental transactions. Hedges are entered into as part of a defined strategy to mitigate risk. They are transactions that through designation and economic relationships are inextricably linked to other transactions. Faithful representation of the economic events that have occurred is accomplished by accounting for the transactions on a combined basis. The hedge accounting model for traditional hedging activities has generally worked well for decades and results in financial statements that reflect the economic substance of derivative transactions engaged in as hedges and management's intent in engaging in such transactions. The hedging component of our financial reporting framework would be limited to traditional derivative hedging transactions in which the terms of the derivatives bear a clear economic relationship to the risks of the hedged items. This is typically the case when traditional derivative contracts are utilized (e.g., plain-vanilla interest rate swaps, foreign currency forwards, and options). It generally would not apply to nontraditional derivative contracts such as leveraged or exponential swaps or other nontraditional activities. And, our approach would result in recorded amounts that are compatible with the definitions of financial statement elements as described in FASB Concepts Statement No. 6, Elements of Financial Statements (see Appendix B). The proposed approach would not impose an enterprise-wide risk assessment criteria. Rather it would reflect management's risk management activities in a manner consistent with management's intent and business strategies. An enterprise risk reduction requirement is not the way many entities manage risk and is not universally practical. Our approach is practical and would result in an enterprise risk reduction requirement when risk is managed on an enterprisewide basis, but it would not artificially impose such a requirement when risk is managed on a decentralized basis. In our view the accounting model should accommodate different approaches to managing risk rather than forcing a company to adopt a single risk assessment approach. Our approach would resolve the Board's dilemma of defining risk because management's stated policy would be used to establish that definition. For example, most financial institutions could be expected to hedge cash flow risk on an enterprise-wide basis due to the nature of their businesses and the interrelationships of assets and liabilities. Multinationals that manage risk at a centralized enterprise-wide level also would be held to an enterprise-wide risk assessment requirement. However, multinational companies that have a policy encompassing hedges of both the cash flow risk of future revenues and the change in value of foreign currency denominated assets or liabilities resulting from changes in exchange rates on an individual transaction basis would account for those activities consistent with their policies. Our approach also would accommodate nonfinancial companies that use interest rate swaps or other derivatives to manage the mix of their debt between fixed and variable rate by focusing on the effectiveness of the use of derivatives to accomplish the defined objective. Our model adopts the same discipline as the entity's risk management policies impose. Companies would be required to evaluate the performance of their risk management strategies within the context of management's stated policies. If a derivative transaction does not accomplish the stated objective, the requirements for the hedging category of our model would not be met. E&Y's Alternative Model As with the FASB's tentative approach, our proposed model would specify the accounting for all free-standing derivative instruments. However, we would continue the use of hedge accounting in certain circumstances. We believe our model more closely reflects the economics of hedging transactions, the reality that one size does not fit all, and that each company's unique risk profile and approach to managing risks should be the basis for a meaningful financial statement presentation. Included would be derivative financial instruments that traditionally have been off-balance-sheet such as futures, options, forwards, and swaps. Further, like the FASB's tentative conclusions, our model includes commodity-based contracts that obligate the purchaser (seller) either to accept (make) delivery of a commodity or financial instrument (e.g., cash) at a specified date or during a specified period. Consistent with the FASB's tentative approach, this model would exclude many derivative instruments that are embedded in on-balance-sheet receivables or payables (not "free-standing") and would exclude cash instruments other than foreign currency transactions. All free-standing derivatives would be recognized on-balance-sheet and measured at fair value. Those derivatives would be classified in one of three categories: trading, risk management (hedging), or other derivatives. Any derivative instrument could be included in the trading or other derivatives categories and most derivatives could be included in the risk management (hedging) category. Different accounting would be prescribed primarily based on the purpose for which the instrument is held and designated. Derivative Categories 1. Trading derivatives : Includes derivatives that are bought and held principally for sale in the near future to benefit from short-term price differences. These derivatives would be recognized as assets or liabilities and measured at fair value with changes in value recognized in earnings in the period in which they occur (similar to the trading category in FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities) . This category is the same as the FASB's tentative approach. 2. Risk management (hedging) derivatives : Derivatives that are effective as and designated as hedges of specific assets, liabilities, or forecasted transactions would be measured at fair value and the related changes in value recognized as an adjustment of the carrying amount of the hedged item or as an asset or liability when the hedged item has not yet been recognized (i.e., forecasted transactions). Risk identification would be required consistent with the company's risk management practices (e.g., if done at the division level, enterprise-wide risk assessment would not be required), with appropriate disclosure of those practices. Cash instruments, other than foreign currency transactions as described below, nontraditional derivatives, and written options would not qualify for hedge accounting. Anticipatory hedging would be permitted if the transaction is a firm commitment or is probable of occurring. All gains and losses on hedging instruments, whether realized or unrealized, would be deferred and recognized as an adjustment of the hedged item's carrying amount. If a forecasted transaction is no longer probable of occurring, the deferred gain or loss on the hedging instrument would be recognized in earnings. Consistent with FASB Statement No. 52, Foreign Currency Translation , foreign currency transactions (e.g., the foreign exchange contract embedded in foreign currency denominated debt) would qualify as hedges of other foreign currency transactions. Interest rate, currency, or formula-based swaps that bear a close relationship to an identified exposure that are intended to synthetically alter the characteristics of an asset or liability, would qualify for this category and for the use of hedge accounting when they are used within an entity's risk management strategy. Included are interest rate swaps where the result in combination with the designated item, is an amount received or paid based on basic interest rates (e.g., prime or LIBOR) and not multiples of basic rates or similar formulas. 3. Other derivatives : Derivatives that are not trading derivatives and that are either not designated as risk management (hedging) derivatives or are not eligible for that category (e.g., nontraditional swaps and written options) would be included in the other derivatives category. This group of derivatives would be recognized at fair value with changes in fair value recorded in a separate component of equity until realized (or unless a decline is deemed other than temporary). Gains and losses would be recognized in income when realized. (This approach is similar to the available-for-sale category under Statement 115.) Under the FASB's tentative approach, a larger group of derivatives would be included in this category. The following table summarizes our proposed criteria for a derivative to qualify for risk management (hedging) accounting. Hedge Accounting Issue E & Y Alternative Model for Risk Management (Hedging) Category Nature of risks that qualify Risk would be broadly defined. Our for hedging model would provide a general description of the risks that qualify for hedge accounting. Qualifying instruments for All free-standing derivatives contracts, except written options and derivatives based on nontraditional formulas or indices would qualify. A clear economic relationship between the derivative and designated item would be required. Cash instruments (other than foreign currency transactions) and written options would not qualify for hedge accounting. Risk assessment (e.g., transaction The assessment of the nature of the risk versus enterprise risk) to be hedged would be based on the enterprise's risk management strategy. Risk reduction or risk management Risk reduction would not be required, but the selected hedging strategy must be consistent with the enterprise's risk management objective. Realized versus unrealized There would be no distinction between gains and losses the accounting for realized and unrealized gains and losses on the hedging instrument. Forecasted transactions Firm commitments and probable, but not firmly committed transactions would qualify to be hedged. There There would be no time limit on how far into the future an entity could hedge, but it is presumed that the required assessment would become more difficult the longer the hedge. Correlation/hedge effectiveness To qualify, the hedging instrument must be highly correlated to the hedged item within some parameters (e.g., 80% - 120%). Further, an ongoing evaluation of effectiveness in achieving the designated objective would be required. Cross-hedging Cross-hedging would be permitted. Designation Designation of the hedging instrument to the related exposure would be required, and thus hedge accounting would be elective. Measurement attribute All derivatives would be measured at fair value and recognized on-balance- sheet. Practical Concerns About Hedge Accounting Several concerns have been raised about existing or proposed hedge accounting models. The following chart summarizes those concerns and indicates how the FASB's tentative approach and the E&Y alternative address those concerns. Identified Concern 1. Derivatives are off-balance-sheet instruments. 2. Derivative risks are concealed. 3. Gains and losses from instruments that are not demonstrably risk reducing are excluded from earnings. 4. Correlation and linkage requirements introduce cost and complexity in applying hedge accounting. 5. A model based on linkage and correlation does not accommodate nonspecific hedge transactions. 6. Realized gains and losses related to forecasted transactions are not assets and liabilities. E & Y Alternative 1. All derivatives recorded on-balance-sheet at fair value. 2. All derivatives recorded at fair value and disclosed. FASB Statement 119 requires disclosure of those risks. 3. Certain gains and losses would be deferred based on management's intended (and disclosed) hedging strategy and execution of such strategy. 4. Linkage and correlation are currently employed and serve to operationalize strategy. It would be continued. 5. Nonspecific risk management transactions would be accommodated in the "other derivatives" category. Related realized gains and losses would be included in income. 6. Both realized and unrealized gains and losses are a component of the eventual amount of qualifying forecasted transactions. They are not assets and liabilities on their own. FASB Tentative Model 1. All derivatives recorded on-balance-sheet at fair value. 2. All derivatives recorded at fair value and disclosed. FASB Statement 119 requires disclosure of those risks. 3. All realized gains and losses included in earnings. Timing of income recognition will be solely dependent on realization rather than substance of derivative use. 4. Linkage and correlation not a component of the approach. 5. Approach treats all risk management positions the same. 6. Realized gains and losses are not recorded as assets and liabilities. Identified Concern 1. Commodity based derivatives have been excluded from hedge model. 2. Derivatives embedded in cash based instruments excluded from model. 3. Cash based instruments and embedded instruments are excluded from hedge model. 4. Risk is not possible to define. 5. Risk reduction is not practically determinable. 6. Modern derivatives are complex. E & Y Alternative 1. Derivatives based on commodities would be included. 2. Not covered. 3. Cash based instruments are utilized in fundamentally different ways and should be consistently treated in accordance with Statement 115. Cash based instruments, other than foreign currency transactions, should be excluded from the scope of a standard dealing with freestanding derivative contracts. 4. Management defines and manages risk as a part of its normal operating procedures. Linking the accounting is both practical and operational. 5. Management's definition and risk management activities, and related disclosures, are basis for special accounting. 6. Complex or innovative derivatives are not generally used by companies to manage simple, traditional risks. Our alternative only would apply to derivatives that have a clear economic relationship to the hedged items, generally traditional derivatives. FASB Tentative Model 1. Derivatives based on commodities would be included. 2. Not covered. 3. Some cash based instruments (to be defined) to be included. 4. Approach does not require identification of risk. 5. Approach does not require reduction of risk to obtain special accounting. 6. Complex or innovative derivatives would be treated the same as traditional derivatives. Disclosures Investors and shareholders have a heightened sense of concern about derivatives and are interested in the effect derivatives may have on a company's financial position. They want information about hedging strategies, the effectiveness of those strategies, and the potential financial impact of existing positions. They are now better informed about a company's risk management objectives and strategies and the use of derivatives within that context as a result of the improved disclosures about the uses of derivatives pursuant to FASB Statement No. 119, Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments. Under our approach, disclosures supplementing the balance sheet recognition of derivatives would be an important element of providing a complete picture of the entity's hedging activities, its strategy, and results of hedging, including deferred amounts. We believe that these disclosures would increase the visibility of derivatives and hedging activities. Concerns about hedge accounting should be addressed by establishing a consistent model that reflects the intent and economic substance of hedging activities in an entity's financial statements. APPENDIX A The FASB's Tentative Derivatives Model During the three years the FASB has been deliberating hedge accounting, it has considered various alternatives to the present set of inconsistent and incomplete rules, including mark-to-market hedge accounting, deferral hedge accounting, a full-effectiveness hedge accounting approach, a partial-effectiveness hedge accounting approach, and synthetic-instrument accounting. Because of recognition and measurement anomalies in the current financial accounting model, each of these approaches has limitations. The Board identified a number of issues that need to be addressed in any hedge accounting model, but while each approach addresses some issues, others could not be accommodated. Because of the difficulties and complexities associated with these various approaches, in November 1994 the FASB changed course and decided to support a derivatives accounting model that would abandon hedge accounting by specifying the accounting for free-standing derivative financial instruments. The Board acknowledged that this approach would not result in the same accounting currently afforded certain hedging transactions or provide special accounting in all circumstances identified by constituents as areas of need. However, the Board believes its approach would accommodate many of those circumstances. To the extent that organizations could select instruments that mature or could be realized in the desired periods, they would be able to achieve the objectives of recognizing gains and losses on hedged positions and hedging instruments concurrently. As described in the article, Simplifying Accounting for Derivative Instruments, including Those Used for Hedging , published in the January 1995 edition of "Highlights," the FASB's tentative derivatives model would include derivative financial instruments that traditionally have been off-balance-sheet such as futures, options, forwards, and swaps. In addition, other instruments, whose principal characteristics are similar to those off-balance-sheet derivatives would be included, even if they are recognized on the balance sheet. Further, the Board plans to expand the definition of a financial instrument to include commodity-based contracts that entitle the holder to receive either a financial instrument or a nonfinancial contract. However, many derivative instruments that are embedded in on-balance-sheet receivables or payables (and thus not free-standing) would not be addressed. All free-standing derivative instruments would be classified in one of two categories--trading or other than trading. Any derivative instrument could be used for risk management and classified as other than trading. As a result, different accounting would be prescribed based on the purpose for which the instrument is held, rather than the type of derivative instrument used. Those derivatives classified as trading would be recognized as assets or liabilities and measured at fair value, with changes in value recognized in earnings in the period in which they occur. Derivatives not classified as trading would be recognized as assets or liabilities and measured at fair value with changes in value excluded from earnings and reported in a separate component of equity until realized. All realized gains or losses would be recognized in earnings. Deferral of realized gains and losses would be prohibited even if the intent was to hedge the cost of a long-term asset acquired in a transaction that will occur in a future period. Firm commitments and forecasted transactions would effectively be excluded from hedge accounting for many transactions because realized gains and losses would be recognized immediately and not as adjustments of the hedged item's carrying amount. All hedge accounting pronouncements would be superseded. The FASB's derivatives model has several disadvantages. The primary disadvantage is that it does not faithfully portray the economic effects of hedging certain assets, liabilities, firm commitments, and forecasted transactions, because the gain or loss on the hedging instrument would not be included as an adjustment of the hedged item's carrying amount. For example, if a company hedged the foreign currency price of equipment to be purchased from a foreign manufacturer by entering into a forward contract, the financial statements would not portray the economic effect of effectively fixing the currency exchange rate, and thus the purchase price of the equipment. Rather, the financial statements would report a gain or loss on the hedging instrument when it settled, and the equipment would be recorded at the exchange rate in effect at the actual purchase date. Accordingly, the gain or loss on the hedging instrument would be recorded in one period, whereas the offsetting currency loss or gain on the equipment purchase would be recognized over time as the equipment is depreciated. The Board is currently considering alternatives to its derivatives model that could include some form of deferral hedge accounting, but none of those alternatives has garnered sufficient support. APPENDIX B The FASB's Conceptual Framework and Hedge Accounting The Ernst & Young alternative hedge accounting model would permit the deferral of certain realized gains and losses to be matched with transactions where a direct economic relationship exists and management intends the positions to be related. The model is predicated on the relationship between the transactions and the long-standing accounting principle that the cost of an item is the sum of all the applicable expenditures and charges directly or indirectly incurred in bringing it to its existing condition and location. Designated and effective hedging transactions are consistent with that principle. We believe that hedge accounting and the deferral, in certain circumstances, of realized gains and losses is compatible with the conceptual framework outlined in the FASB Concepts Statements. Although the terms hedging and hedge accounting are not mentioned in the Concepts Statements, the underlying accrual accounting model, including the concept that the cost of an asset or liability is often comprised of separate transactions, supports the basis for hedge accounting when that is the economic reality of the transaction. Accordingly, as discussed below, we believe the FASB's conceptual framework can accommodate Ernst & Young's recommended hedge accounting model. Costs as Components of Assets and Liabilities Assets often are composed of costs that in and of themselves do not meet a strict definition of an asset in FASB Statement of Concepts No. 6, Elements of Financial Statements . Consider an entity that pays a freight bill to have a machine delivered to a temporary location prior to the actual purchase of the machine (i.e., the machine is shipped F.O.B. Destination to the temporary location in December but is not delivered to the factory until January). Under present practice, the freight cost would be deferred in the enterprise's December balance sheet and ultimately included in the cost of the machine. The deferred freight cost, however, does not meet the definition of an asset because it is an incurred cost that does not provide a future economic benefit by itself. Similarly, hedging gains and losses are not assets and liabilities in and of themselves, but are related to an underlying transaction through a direct economic relationship and an enterprise's strategy to manage its risk. Paragraph 179 of Concepts Statement 6 states that although an entity normally incurs costs to acquire or use assets, costs incurred are not themselves assets. However, costs are not necessarily expenses or losses when incurred. Costs can be viewed in some circumstances as building blocks of assets. We note that paragraph 182 of Concepts Statement 6 states that "losses have no future economic benefits and cannot qualify as assets under the definition [of an asset]." We believe that the economic result of a designated hedging transaction is not, in and of itself, either a loss or an expense until the underlying item that is linked to the hedge results in an expense or a loss. We view the hedging result as a deferred cost, not a deferred expense. This is similar to the practice of recognizing production costs (e.g., overhead) as expenses in the period in which the product is sold rather than in the period in which the cost is incurred to produce output. Similarly, interest cost, although not an asset itself, can be considered part of the cost of a constructed asset. In FASB Statement No. 34, Capitalization of Interest Cost , the Board concluded that "in principle, the cost incurred in financing expenditures for an asset during a required construction or development period is itself a part of the asset's historical acquisition cost." Click Here to View the Remainder of This Report R; -A b    !z" "# ;#@( ](T+ f+..>.. c/>./#1%1aD2NeD>.wD2NvFxF>.FI>.IKdKK>. L}M>.M"Q>.I>QQT UUWW] B^hdjdkkp qq qVy vyTzzF|2B>N@BNW[N_aNzNaNj|NrNrNrNrNrNrNrNrNrNss"knJ_)&; ; r;#+6r!'f0Ernst and Young 2buttonClick,buttonClick "Ernst Young 2" $"Qq t7G"4w"anHU)&; ; ;&#+U!8'f$ComprehensiveIncomebuttonClick+buttonClick ComprehensiveIncome#Comprehensive Incomeل u܄C"n)&; ; ;a&#+U!8;A#+>0 #+U!!;*#+> #+9$@!'fWtextcontents1996 FASB Update1996FASBupdatebuttonClickjbuttonClick "1996FASBupdate" "contents" "1996 # Update" ߈"" "1996 A = 0b+1996 Proposed New Rules9 prstukeErnst and Young 2s and Hedge ACh Mskv prstku4  b&ButtonY p<+\HHHRad@(E & Y - Derivatives and Hedge Accounting rZ# FHHH Ytext41 Auto_ScrollCtbk_wid_nameKvNs  Scroll to view more text ---------> The FASB's Conceptual Framework and Hedge Accounting (continued) Paragraph 26 of Concepts Statement 6 states that assets "may be acquired at a cost..." and that "cost is the sacrifice incurred in economic activities." We believe the economic consequences of a transaction that is linked through designation and economic relationship to another transaction, should be accounted for as part of, or an offset to, the cost of the second transaction. Accordingly, events and transactions that occur prior to acquisition should adjust the recorded amount of an asset or a liability just as events or transactions after acquisition do, provided that specified criteria are met. Concepts Statement 6 provides several useful examples of other transactions that do not fit neatly into the present conceptual framework's definitions of assets and liabilities. For example, paragraph 237 states that debt issuance costs are either an expense or may be accounted for as a reduction of the related debt liability because such costs effectively reduce the net proceeds of the borrowing. Thus, debt issuance costs and the borrowing proceeds are linked although the counterparties to the transactions are different. That is, payments made to professionals and registration costs incurred to obtain financing are linked to the proceeds received from creditors because the transactions are economically related. Similarly, paragraphs 243 through 245 discuss the accounting for deferred investment tax credits noting that the deferred credit can serve to reduce the cost of an asset, much like a deferred hedging gain would reduce the cost of the hedged item in our model. Other costs are deferred and included as an adjustment of the basis of the underlying item as well, even though those costs are not themselves assets. Paragraph 247 provides several examples of these type costs. These examples, and others like them, illustrate that the carrying amount of an asset or a liability may consist of several components that in and of themselves are not assets and liabilities as defined in the Concepts Statements. Likewise, paragraphs 34 and 43 of Concepts Statement 6 note that a separate item that reduces or increases the carrying amount of an asset (liability) is sometimes found in the financial statements. These valuation accounts, although not liabilities or assets in their own right, are part of the related liabilities or assets. Hedging is Consistent with Accrual Accounting Accrual accounting is fundamental to the conceptual framework. Accrual accounting recognizes that operations of an entity during a period, as well as other events that affect entity performance, often do not coincide with cash receipts and cash payments of the period. This concept is embodied in Concepts Statement 6 (paragraph 145): Accrual accounting uses accrual, deferral, and allocation procedures whose goal is to relate revenues, expenses, gains, and losses to periods to reflect an entity's performance during a period instead of merely listing its cash receipts and outlays. Thus, recognition of revenues, expenses, gains, and losses and the related increments or decrements in assets and liabilities--including matching of costs and revenues, allocation, and amortization--is the essence of using accrual accounting to measure performance of entities. The goal of accrual accounting is to account in the periods in which they occur for the effects on an entity of transactions and other events and circumstances, to the extent that those financial effects are recognizable and measurable. Accrual accounting involves deferrals. Concepts Statement 6 describes deferral as the accounting process of recognizing a liability from a current cash receipt and an asset from a current cash payment. Recognition of revenues, expenses, gains, and losses is deferred until the obligation underlying the liability is partly or wholly satisfied or until the economic benefit underlying the asset is partly or wholly used or lost. Deferral hedge accounting is consistent with this concept. The only difference is that deferred amounts are not assets or liabilities themselves, but, as explained in the preceding section of this appendix, are one component of the cost of an asset or a liability. In certain circumstances, the deferral is the recorded component of a series of transactions and events that, temporarily, may be mostly unrecorded. We believe that not applying deferral accounting to these types of transactions not only does not reflect the economics of these transactions, but is potentially misleading. If deferral hedge accounting is not applied, an enterprise would report volatility in its financial statements even though it has entered into offsetting transactions to economically mitigate that volatility. Other Considerations Paragraph 230 of Concepts Statement 6 acknowledges that decisions about which accounting principles to adopt in practice involve not only concepts, but also practical considerations. The Board confronted this trade-off in both Statements 52 and 80. Paragraph 54 of Statement 80 observes that anticipated transactions may expose an enterprise to risk from a practical perspective [emphasis added]. In reality, companies are exposed to these economic risks and hedging activities are the process of managing those risks. Our model accommodates the practical reality that enterprises are exposed to currency, price, and interest rate risks and reflects the results of those entity's efforts to manage those risks. Finally, paragraph 170 of Concepts Statement 6 notes that the definitions of elements neither require nor presage upheavals in current practice. In our view, the Board's current tentative approach would create an upheaval in current practice when in fact the Concepts Statements do not contain any explicit prohibition for deferring hedging gains and losses. We note that FASB Statement No. 52, Foreign Currency Translation , was issued in 1981, more than a year after the issuance of FASB Concepts Statement No. 3, Elements of Financial Statements of Business Enterprises (the precursor to Concepts Statement 6), and that FASB Statement No. 80, Accounting for Futures Contracts , was issued more than three years after the conceptual framework definitions of financial statement elements were finalized. Statements 52 and 80 (although inconsistent) both recognize that the underlying economics of a transaction support the deferral of realized gains or losses in certain circumstances. Accordingly, it would appear that the Boards that issued those Statements concluded that hedge accounting was not inconsistent with the conceptual framework. Click Here to Return to the First Part of This Report  -  Z n > x NNNNNNNNNNNNNNofss"knG_)&; ; r;#+6r!'f0Ernst and Young 1buttonClick*buttonClick "Ernst Young 1"" trueASYM_BeenHere[dddeApple 1995 10Kum Annual Reporth MLs[vst@uvdw[@du4 trueASYM_BeenHere1 s4b=&Button} tHHH9R@%Apple Corporation 1995 SEC 10K Report  u#T jHHH9Btext?BXU Auto_Scrollgtbk_wid_nameozbrwb`_ Scroll to view more text ---------> Global Market Risks A large portion of the Company's revenue is derived from its international operations. As a result, the Company's operations and financial results could be significantly affected by international factors, such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which the Company distributes its products. When the U.S. dollar strengthens against other currencies, the U.S. dollar value of non-U.S. dollar-based sales decreases. When the U.S. dollar weakens, the U.S. dollar value of non-U.S. dollar-based sales increases. Correspondingly, the U.S. dollar value of non-U.S. dollar-based costs increases when the U.S. dollar weakens and decreases when the U.S. dollar strengthens. Overall, the Company is a net receiver of currencies other than the U.S. dollar and, as such, benefits from weaker dollar and is adversely affected by a stronger dollar relative to major currencies worldwide. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, may negatively affect the Company's consolidated sales and gross margins (as expressed in U.S. dollars). To mitigate the short-term impact of fluctuating currency exchange rates on the Company's non-U.S. dollar-based sales, product procurement, and operating expenses, the Company regularly hedges its non-U.S. dollar- based exposures. Specifically, the Company enters into foreign exchange forward and option contracts to hedge firmly committed transactions. Currently, hedges of firmly committed transactions do not extend beyond one year. The Company also purchases foreign exchange option contracts to hedge certain other probable, but not firmly committed transactions. Hedges of probable, but not firmly committed transactions currently do not extend beyond one year. To reduce the costs associated with these ongoing foreign exchange hedging programs, the Company also regularly sells foreign exchange option contracts and enters into certain other foreign exchange transactions. All foreign exchange forward and option contracts not accounted for as hedges, including all transactions intended to reduce the costs associated with the Company's foreign exchange hedging programs, are carried at fair value and are adjusted on each balance sheet date for changes in exchange rates. Refer to the Financial Instruments footnote on pages 26-28 of the Notes to Consolidated Financial Statements for further discussion. While the Company is exposed with respect to fluctuations in the interest rates of many of the world's leading industrialized countries, the Company's interest income and expense is most sensitive to fluctuations in the general level of U.S. interest rates. In this regard, changes in U.S. interest rates affect the interest earned on the Company's cash, cash equivalents, and short-term investments as well as interest paid on its short-term borrowings and long-term debt. To mitigate the impact of fluctuations in U.S. interest rates, the Company has entered into interest rate swap and option transactions. Certain of these swaps are intended to better match the Company's floating-rate interest income on its cash, cash equivalents, and short-term investments with the fixed-rate interest expense on its long-term debt. The Company also enters into interest rate swap and option transactions in order to diversify a portion of the Company's exposure away from fluctuations in short-term U.S. interest rates. These instruments may extend the Company's cash investment horizon up to a maximum effective duration of three years. To ensure the adequacy and effectiveness of the Company's foreign exchange and interest rate hedge positions, as well as to monitor the risks and opportunities of the nonhedge portfolios, the Company continually monitors its foreign exchange forward and option positions, and its interest rate swap and option positions on a stand-alone basis and in conjunction with its underlying foreign currency- and interest rate-related exposures, respectively, from both an accounting and an economic perspective. However, given the effective horizons of the Company's risk management activities, there can be no assurance that the aforementioned programs will offset more than a portion of the adverse financial impact resulting from unfavorable movements in either foreign exchange or interest rates. In addition, the timing of the accounting for recognition of gains and losses related to mark-to-market instruments for any given period may not coincide with the timing of gains and losses related to the underlying economic exposures, and as such, may adversely affect the Company's operating results and financial position. The Company generally does not engage in leveraged hedging. -------------------------------------------------------------------------------------------------------------------------------------------------- Liquidity and Capital Resources The Company's balance of long-term debt remained relatively constant during 1995. In 1994, $300 million aggregate principal amount of 6.5% unsecured notes were issued under an omnibus shelf registration statement filed with the Securities and Exchange Commission. This shelf registration was for the registration of debt and other securities for an aggregate offering amount of $500 million. The notes were sold at 99.925% of par, for an effective yield to maturity of 6.51%. The notes pay interest semi-annually and mature on February 15, 2004. The 6.51% fixed rate was subsequently effectively converted to a floating rate through ten-year interest rate swaps based on the three-month U.S. dollar London Interbank Offered Rate ("LIBOR"). To mitigate the credit risk associated with these ten-year swap transactions, the Company entered into margining agreements with its third-party bank counterparties. Margining under these agreements does not start until 1997. Furthermore, these agreements would require the Company to post margin only if certain credit risk thresholds were exceeded. It is anticipated that any margin the Company may be required to post in the future would not have a material adverse effect on the Company's liquidity position. -------------------------------------------------------------------------------------------------------------------------------------------------- Financial Instruments with Off-Balance-Sheet Risk In the ordinary course of business and as part of the Company's asset and liability management, the Company enters into various types of transactions that involve contracts and financial instruments with off-balance-sheet risk. These instruments are entered into in order to manage financial market risk, primarily interest rate and foreign exchange risk. The Company enters into these financial instruments with major international financial institutions utilizing over-the-counter as opposed to exchange traded instruments. The Company does not hold or transact in financial instruments for other than risk management purposes. Gains and losses on accounting hedges of existing assets or liabilities are included in the carrying amounts of those assets or liabilities and are ultimately recognized in income as part of those carrying amounts. Gains and losses related to qualifying accounting hedges of firm commitments or anticipated transactions are also deferred and are recognized in income or as adjustments of carrying amounts when the hedged transaction occurs. Realized and unrealized gains and losses on interest rate and foreign exchange contracts that do not qualify as accounting hedges are recognized quarterly as a component of interest and other income (expense), net. The Company monitors its interest rate and foreign exchange positions daily based on applicable and commonly used pricing models. The correlation between the changes in the fair value of hedging instruments and the changes in the underlying hedged items is assessed periodically over the life of the hedged instrument. In the event that it is determined that a hedge is ineffective, the Company recognizes in income the change in market value of the instrument beginning on the date it was no longer an effective hedge. Interest Rate Derivatives The Company enters into interest rate derivative transactions, including interest rate swaps and options, with financial institutions in order to better match the Company's floating-rate interest income on its cash equivalents and short-term investments with the fixed-rate interest expense of its long-term debt. These instruments are also used to diversify a portion of the Company's exposure away from fluctuations in short-term U.S. interest rates. The Company may also enter into interest rate contracts that are intended to reduce the cost of the interest rate risk management program. Foreign Currency Instruments The Company enters into foreign exchange forward and option contracts with financial institutions primarily to protect against currency exchange risks associated with certain firmly committed and certain other probable, but not firmly committed transactions. The Company's foreign exchange risk management policy requires it to hedge a majority of its existing material foreign exchange transaction exposures. However, the Company may not hedge certain foreign exchange transaction exposures that are immaterial either in terms of their minimal U.S. dollar value or in terms of their high correlation with the U.S. dollar. Probable, but not firmly committed transactions comprise sales of the Company's products in currencies other than the U.S. dollar. A majority of these non-U.S. dollar-based sales are made through the Company's subsidiaries in Europe, Asia (particularly Japan), Canada, and Australia. The Company also purchases foreign exchange option contracts to hedge certain other probable, but not firmly committed transactions. The Company also sells foreign exchange option contracts, in order to partially finance the purchase of foreign exchange option contracts used to hedge both firmly committed and certain other probable, but not firmly committed transactions. In addition, the Company enters into other foreign exchange transactions, which are intended to reduce the costs associated with its foreign exchange risk management programs. The duration of foreign exchange hedging instruments, whether for firmly committed transactions or for probable, but not firmly committed transactions, currently does not exceed one year. For further information regarding the Company's accounting treatment of its investments and other financial and derivative instruments, refer to pages 26-28 of the Notes to Consolidated Financial Statements. -------------------------------------------------------------------------------------------------------------------------------------------------- Notes to Consolidated Financial Statements Financial Instruments Investments The following table summarizes the Company's available-for-sale securities as of September 29, 1995: (In millions) Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value U.S. Treasury securities and obligations of U.S. government agencies $ 232 $ -- $ -- $ 232 U.S. corporate debt securities 140 -- -- 140 Foreign government securities 456 2(A) -- 458 Total included in cash and cash equivalents $ 828 $ 2 $ -- $ 830 U.S. corporate debt securities $ 48 $ -- $ -- $ 48 Foreign government securities 146 -- -- 146 Total included in short-term investments $ 194 $ -- $ -- $ 194 Equity securities $ 1 $ 42 $ -- $ 43 Total included in other assets $ 1 $ 42 $ -- $ 43 Total $ 1,023 $ 44 $ -- $ 1,067 (A) The $2 million represents gross unrealized gains on interest rate hedging transactions. Gross unrealized holding gains or losses on available-for-sale securities are recorded as a component of shareholders' equity, and include anyunrealized gains and losses on interest rate contracts accounted for as hedges against the underlying securities. Of the $42 million of gross unrealized gains related to equity securities, approximately $40 million relates to securities that are restricted from sale until February 1996. The gross realized gains recorded to earnings on sales of available-for-sale securities were $1.5 million in 1995. There were no gross realized losses recorded to earnings on sales of available-for-sale securities in 1995. The cost of securities sold is based on the specific identification method. Interest Rate Derivatives and Foreign Currency Instruments The table on page 27 shows the notional principal, fair value, and credit risk amounts of the Company's interest rate derivative and foreign currency instruments as of September 29, 1995, and September 30, 1994. The notional principal amounts for off-balance-sheet instruments provide one measure of the transaction volume outstanding as of year end, and do not represent the amount of the Company's exposure to credit or market loss. The credit risk amount shown in the table below represents the Company's gross exposure to potential accounting loss on these transactions if all counterparties failed to perform according to the terms of the contract, based on then-current currency exchange and interest rates at each respective date. The Company's exposure to credit loss and market risk will vary over time as a function of interest rates and currency exchange rates. The estimates of fair value are based on applicable and commonly used pricing models using prevailing financial market information as of September 29, 1995, and September 30, 1994. In certain instances where judgment is required in estimating fair value, price quotes were obtained from several of the Company's counterparty financial institutions. Although the table below reflects the notional principal, fair value, and credit risk amounts of the Company's interest rate and foreign exchange instruments, it does not reflect the gains or losses associated with the exposures and transactions that the interest rate and foreign exchange instruments are intended to hedge. The amounts ultimately realized upon settlement of these financial instruments, together with the gains and losses on the underlying exposures, will depend on actual market conditions during the remaining life of the instruments. (In millions) 1995 1994 ------------------------------------------------- ----------------------------------------- Notional Fair Credit Notional Fair Credit Principal Value Risk Principal Value Risk Amount Amount Transactions Qualifying as Accounting Hedges Interest rate instruments Swaps $ 450 $ (7) $ 2 $ 669 $ (40) -- Interest rate collars $ 105 --(A) --(A) -- -- -- Sold options $ 150 --(A) -- -- -- -- Foreign exchange instruments Spot / Forward contracts $1,211 $ 16 $ 23 $2,385 $ (23) $ 15 Purchased options $1,441 $ 32 $ 32 $1,510 $ 17 $ 21 Sold options -- -- -- $ 302 $ (1) -- Transactions Other Than Accounting Hedges Interest rate instruments Swaps $ 10 --(A) -- -- -- -- Sold options $ 100 $ (1) -- $ 148 --(A) -- Foreign exchange instruments Spot/Forward contracts -- -- -- $ 300 --(A) --(A) Purchased options $3,046 $ 134 $134 $1,600 $ 32 $ 32 Sold options $6,082 $ (83) -- $5,511 $ (45) -- (A) Fair value is less than $0.5 million. The interest rate swaps shown above generally require the Company to pay a floating interest rate based on the three- or six-month U.S. dollar LIBOR and receive a fixed rate of interest without exchanges of the underlying notional amounts. Maturity dates for interest rate swaps currently range from one to ten years. At September 29, 1995, and September 30, 1994, interest rate swaps classified as receive-fixed swaps had weighted average receive rates of 6.38% and 5.89%, respectively. Weighted average pay rates on these swaps were 5.88% and 6.52% at September 29, 1995, and September 30, 1994, respectively. Interest rate option contracts require the Company to make payments should certain interest rates either fall below or rise above predetermined levels. Interest rate collars limit the Company's exposure to fluctuations in short-term interest rates by locking in a range of interest rates. An interest rate collar is a no-cost structure that consists of a purchased option and a sold option. The Company receives a payment when the three-month LIBOR falls below predetermined levels, and makes a payment when the three-month LIBOR rises above predetermined levels. The entire structure generally qualifies as an accounting hedge. All interest rate option contracts outstanding at September 29, 1995, expire within three years. Interest rate contracts not accounted for as hedges are carried at fair value with gains and losses recorded currently in income as a component of interest and other income (expense), net. Unrealized gains and losses on interest rate contracts that are designated and effective as hedges are deferred and recognized in income in the same period as the hedged transaction. Unrealized losses on such agreements totaled approximately $9 million and $40 million at September 29, 1995, and September 30, 1994, respectively, primarily reflecting the net present value of unrealized losses on the ten-year swap contracts, which effectively convert the Company's fixed-rate ten-year debt to floating-rate debt. The foreign exchange forward contracts not accounted for as hedges are carried at fair value and are adjusted each balance sheet date for changes in exchange rates, and the adjustment is recognized in income at that time. Unrealized gains and losses on foreign exchange forward contracts that are designated and effective as hedges are deferred and recognized in income in the same period as the hedged transactions. Deferred gains and losses on such agreements at September 29, 1995, and September 30, 1994, were immaterial. All foreign exchange forward contracts expire within one year. Purchased foreign exchange option contracts that qualify for hedge accounting treatment are reported on the balance sheet at the premium cost, which is amortized over the life of the option. Unrealized gains and losses on these option contracts are deferred until the occurrence of the hedged transaction and recognized as a component of the hedged transaction. Deferred gains and losses on such agreements were immaterial at September 29, 1995, and September 30, 1994. As of September 29, 1995, maturity dates for purchased foreign exchange option contracts ranged from one to twelve months. Purchased and sold foreign exchange option contracts that do not qualify for hedge accounting treatment are carried at fair value and, as such, are adjusted each balance sheet date for changes in exchange rates. Gains and losses associated with these financial instruments are recorded currently in income. As of September 29, 1995, maturity dates for these sold option contracts ranged from one to six months. The Company monitors its interest rate and foreign exchange positions daily based on applicable and commonly used pricing models. The correlation between the changes in the fair value of hedging instruments and the changes in the underlying hedged items is assessed periodically over the life of the hedged instrument. In the event that it is determined that a hedge is ineffective, the Company recognizes in income the change in market value of the instrument beginning on the date it was no longer an effective hedge. Fair Values of Other Financial Instruments The carrying amounts and estimated fair values of the Company's other financial instruments are as follows: (In millions) 1995 1994 Carrying Fair Carrying Fair Amount Value Amount Value Cash and cash equivalents $ 756 $ 756 $ 1,203 $ 1,203 Short-term investments $ 196 $ 196 $ 55 $ 55 Short-term borrowings $ 461 $ 461 $ 292 $ 292 Long-term debt: Ten-year unsecured notes $ 300 $ 289 $ 300 $ 259 Other $ 3 $ 3 $ 5 $ 5 Short-term investments are carried at cost plus accrued interest, which approximates fair value. The carrying amount of short-term borrowings approximates their fair value due to their short-term maturities. The fair value of the ten-year unsecured notes is based on their listed market value as of September 29, 1995. d$"``+/``B````n``im``+"``D"$``$,``--``H-L-``a-7``/8WBBEEY``YN^N^9d v 'P$ d 9 } 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 0syslockScreen నsvASYM_TpID! 9504021118513691351731203655K p $e"P!#2 arrows#&!#2!2W }Zh: $e"P! "eNext Page`% JAA)&; ; >;#+6!'f$buttonUp} Ӑt} ":W!)"`) {&,: $e"P!7Next Pageo|& o!!R!t"Qr!t"!Q $ P!Kv JBackGg% QLH)&; ; !!:M'f+buttonUp} d .}_bKv (` $ P!Next Page%g% QLH)&; ; !!:M'f+buttonUp} d .}]oh!R``m`  \ $rnSmallFonts  5$n Show Menu Bar% l}c)&; ; !9!;+? #+V!8+V!!'f8Hide Menu BarbuttonUp5} d B"Hide Menu Bar" / }Show Menu Bar  D$P! Hide Menu Bar " l}c)&; ; !!;+> #+U!8+U!!'f8Show Menu BarbuttonUp5} d B"Show Menu Bar" / } Hide Menu Bar   K$bn!  Table of Contents "knG_)&; ; r;#+6r!'f0Table of ContentsbuttonClick+buttonClick "Table Contents"" Table of Contents   > $nB  LargeFonts? @% *!)& ; ; ; #$@"-%?J >,"">,"J Y!HV?~;t #+/0!n@!n@!;+?h #+V!!;+?h #+V!8;+:;+?S #F@!; #+:>,%$@!'ftextAxsvScrollNumberlargeFontsArialsmallFontsbuttonUp}4svScrollNumber = ߈""  > 12 ' = , + 12 捈"" W= "Arial" W= 16 Hide B"largeFonts" / Show B"smallFonts" / = B"/-- g1 "" ߈ "" = }W Increase Font Size {|:}&b( pD%.n")& ; ; ; #$@"-%?J >,"">,"J Y!EV?;t #+/0!nj@!n @!;+?o #+V!8;+?i #+V!!;+:;+?I #F@!; #+:>,%$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = ߈""  > 12 ' = , - 12 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = Decrease Font Size; ^e1996 FASB Updateh M .!%Ur)& ; ; 5"z-<"!T<+F !!9:<+V!8!9"!}5!y:*!!<+V!!@#+V!!; #+V!8; #+/0!n@!n @!;t #+/04!;@#+V!8;+?] #+V!!;+?i #+V!!;1 #+:>Y,%$@!"!}jB#:$'f0textauthorHide Menu BarSystemstartupSmallFontssvFASBscrollstatusbardefaultenterPageJN3|)& .'?'fsvFASBscrollleavePageoTO HANDLE --{entering fshort } $= , = default d statusbar > 'P$ d : } startup 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" /-- ߈"" = 04svFASBscroll ߈"" = syslockScreen న4< @ = 0 $!;vw2xz4{U|S}X~(PXVacdfvhhRjlmzqoDsuvxlz6|~^V^W;4PX+xu41e zh<$<$tqstartup21 <$TU(#V!!p^W<  4%|nlp)&; ; ;5 #+V!8;+:;" #+? #F@!'fBoutlinecontentsbuttonClick:buttonClick "contents" = "outline" "2Click Here to Show This Update's Table of Contents# v4&b/&Buttono w41 <rHHH^>Rwz 1996 FASB Update x4$T <HHHv5SStext*' Auto_Scroll9tbk_wid_nameAQDQII Scroll to view more text ---------> FASB Summary of the Proposed Standard on Accounting for Derivative Financial Instruments and Hedging Activities April 4, 1996 Click Here for Document Outline & Links Introduction The following is a summary of the proposed standard on accounting for derivative financial instruments and hedging activities that the Board discussed and supported at its April 4, 1996 public meeting. I. Scope of Proposed Standard The proposed standard would address both the investor's and issuer's accounting and would apply to all derivative financial instruments and other similar financial instruments that have both cash instrument and derivative characteristics. The Board has agreed on the following working definition of a derivative financial instrument: A derivative financial instrument is a financial instrument that by its terms at inception or upon the occurrence of a specified event provides the holder with the ability to participate in some or all of the price changes of a referenced financial instrument(s), commodity(ies), index of prices, or the price of any specific item(s) the underlying(s), and except as noted below, does not require the holder to own or deliver the underlying. A contract that requires ownership or delivery of the underlying is a derivative financial instrument only if the underlying is a derivative, the contract permits net cash settlement based on changes in the price of the underlying, or a mechanism exists in the market (such as an organized exchange) to enter into an offsetting contract with only a net cash settlement. Insurance contracts that are subject to FASB Statements No. 60, Accounting and Reporting by Insurance Enterprises , No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments , and No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts , are not considered derivative financial instruments. Most futures, forwards, swaps, and options would be considered derivatives because a facility exists in the market to enter into offsetting contracts with only a net cash settlement. Most loan commitments would not be considered derivatives because exercise of the commitment requires that the holder become indebted to the lender. Similarly, a financial guarantee would not be considered a derivative when the contract requires that, to collect at the time of default, the guaranteed party must own the underlying. The scope would also include any financial instrument for which some or all of its contractually required cash flows for any period will be determined by reference to changes in the price of an underlying(s) and in a manner that multiplies or otherwise exacerbates the effect of those changes. The scope is intended to include financial instruments that have both cash instrument and derivative characteristics when the embedded derivative contains implicit or explicit leverage. II. Recognition and Measurement of Derivative Financial Instruments All derivative financial instruments would be measured at fair value and recognized in the statement of financial position as assets or liabilities. Derivative financial instruments may be designated as a hedge of either (a) an existing asset, liability, or firm commitment, (b) a forecasted transaction, or (c) the foreign currency exposure of a net investment in a foreign entity. The change in fair value of a derivative financial instrument would be recognized in earnings in the period of change unless that instrument is designated as a hedge of a forecasted transaction or as a hedge of a net investment in a foreign entity, as explained in the following sections. III. Hedges of an Existing Asset, Liability, or Firm Commitment Recognition of Gains and Losses An entity must specifically identify the asset, liability, or firm commitment being hedged or the proportion (percentage) thereof. The full change in the fair value of the derivative financial instrument would be recognized in earnings in the period of change. The change in the fair value of the asset, liability, or firm commitment (or proportion thereof) being hedged would be recognized in earnings (with a corresponding adjustment of the carrying amount [basis] of the hedged item) only to the extent of offsetting changes in value of the hedging instrument subject to the constraints indicated below. Consequently, the adjustment of the carrying amount of the asset, liability, or firm commitment (or proportion thereof), being hedged would be in the same direction as the change in the fair value of that hedged item. -- If the hedged item is a firm commitment that involves both a financial instrument (such as the obligation to pay foreign currency) and a nonfinancial asset or liability (such as the right to receive a fixed asset), the subsequent measurement of the hedged firm commitment should be analyzed separately for the financial instrument and the nonfinancial asset or liability. A derivative financial instrument can be designated as a hedge of the financial instrument aspect of the firm commitment without affecting the accounting for the nonfinancial asset or liability. Criteria for Designation as a Hedge of an Asset, Liability, or Firm Commitment In order for a derivative financial instrument to qualify for designation as a hedge of an existing asset, liability, or firm commitment (other than a hedge of the net investment in a foreign enterprise), the following criteria must be met: a. The designation is made prospectively and is formally documented, the nature of the risk being hedged is identified, and the use of the derivative financial instrument is consistent with the entity's established policy for risk management. b. The hedged asset, liability, or firm commitment has a reliably measureable fair value and changes in the fair value of the derivative financial instrument are expected both at inception and on an ongoing basis to offset substantially the changes in the fair value of the hedged item that are attributable to the risk being hedged. However, if a derivative (such as a purchased option contract) provides only one-sided protection against the hedged risk, the increases in the fair value of the derivative are expected both at inception and on an ongoing basis to offset substantially the decreases in fair value of the hedged item attributable to the hedged risk. c. If an entity hedges less than 100 percent of an existing asset, liability, or firm commitment, the proportion (percentage) of the asset, liability, or firm commitment to be hedged is specifically identified. d. The hedged item is a single asset, liability, or firm commitment (or proportion thereof) or is a portfolio of similar items (or proportion thereof), such as similar assets or similar liabilities. If hedged items are aggregated and hedged as a portfolio, the hedged items must share common characteristics so that they are expected to respond to changes in market variables in a similar way. For example, the following characteristics should be considered when aggregating loans: loan type, loan size, nature and location of collateral, coupon interest rate, maturity, period of origination, prepayment history of the loans (if seasoned), level of net fees or costs, interest rate type (fixed or variable), and expected prepayment performance in varying interest rate scenarios. e. The asset, liability, or firm commitment presents an exposure to price changes that would affect reported earnings. f. The hedged item is not (1) a debt security that is classified as held-to-maturity in accordance with FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities , (2) oil or gas in the ground, unmined mineral ore, an agricultural product in process, or similar item, (3) an intangible asset, (4) a lease, as defined in FASB Statement No. 13, Accounting for Leases , or (5) a liability for insurance contracts written. However, certain forecasted transactions related to those items may qualify for hedge accounting. In addition, an entity must be able to allocate to the hedged asset, liability, or firm commitment any "general reserves" (valuation accounts), deferred fees and costs, and purchase premiums and discounts established for a group of items of which the hedged asset, liability, or firm commitment is a part. Entities would be precluded from designating a written option or a cash instrument as a hedging instrument except that entities would be permitted to designate cash instruments denominated in a foreign currency as hedges of foreign currency exposures of their firm commitments. Financial instruments that have characteristics similar to derivative financial instruments and thus are included in the scope of the standard would be accounted for like derivatives and could be designated as a hedging instrument. Treatment of Preexisting Gains and Losses of Hedged Item Upon inception of a hedge, the designated proportion of the asset, liability, or firm commitment being hedged would be measured and recognized at fair value and any preexisting gain or loss on that item would be recognized as a component of comprehensive income. The preexisting gain or loss would be recognized in earnings in a manner consistent with how such gains or losses on that hedged item would normally emerge or dissipate. Discontinuation of Hedge Accounting An entity would discontinue hedge accounting prospectively if a hedge failed to meet any of the foregoing criteria or if the derivative financial instrument is sold or extinguished. If performance under a firm commitment is no longer probable, an entity would derecognize any asset or liability previously recognized and recognize a corresponding loss or gain in earnings. Use of a Hedging Instrument with a Basis Difference Use of a derivative financial instrument with a different underlying basis from the hedged item (cross-hedging) as a hedging instrument would not be precluded as long as the use of that instrument is justified. Cost efficiency is a sufficient justification. Use of Options and Hedging Instruments A written option would not qualify as a hedge of an existing asset, liability, or firm commitment. Purchased options may qualify as hedging instruments and would be marked to market with no distinction between changes in time value and changes in intrinsic value. A combination of options, whether free-standing or embedded in a derivative financial instrument, would be considered as a net written option if a net premium will be received either at inception or over the life of the contract in cash or in the form of a favorable rate or other term. Combinations of written and purchased options referenced to two different underlyings would be treated as a net written option. Hedges of Mortgage Servicing Rights Capitalized mortgage servicing rights would be permitted to be designated as a hedged asset; however, uncapitalized mortgage servicing rights would be precluded from designation as a hedged item. In addition, if an entity hedges mortgage servicing rights, those servicing rights that are hedged must be stratified for measuring impairment based upon all risk characteristics of the underlying so that the stratification results in a portfolio of similar servicing rights. IV. Hedges of Forecasted Transactions Recognition of Gains and Losses Changes in the fair value of the derivative financial instrument that is designated as a hedge of a forecasted transaction would be reported as a component of comprehensive income and recognized in earnings on the date initially identified as that on which the forecasted transaction was expected to occur. Criteria for Designation of Forecasted Transactions In order to qualify for designation as a hedge of a forecasted transaction, the following criteria must be met: a. The designation is made prospectively and is formally documented and use of the derivative financial instrument is consistent with the entity's established policy for risk management. b. The forecasted transaction is specifically identified at the time of the designation. Depending on the characteristics of the forecasted transaction, documentation would include the expected date of the transaction, the type of commodity, asset, or liability involved, and the expected dollar amount, quantity, or quantity and price of the forecasted transaction. The current price of a forecasted transaction must also be identified to satisfy criterion (c) below. c. Both at inception and on an ongoing basis, the derivative financial instrument is expected to have cumulative cash flows that will offset substantially the changes in cash flows of the hedged forecasted transaction. In addition, the contractual maturity or repricing date of the derivative is expected to occur on or about the same date as the projected date of each forecasted transaction. If a derivative (such as a purchased option contract) provides only one-sided protection against risk, the cumulative cash inflows from the derivative are expected to offset substantially the corresponding increased cash outflows (or reduced cash inflows) of the hedged item. d. The forecasted transaction is probable, is part of an established business activity, and presents an exposure to price changes that would produce variations in cash flows and would affect reported earnings. (For example, forecasted dividends from subsidiaries would not meet this required characteristic.) e. The forecasted exposure is a transaction, that is, an external event involving an exchange with a party that is not consolidated or part of the reporting enterprise. Forecasted transactions between members of the consolidated group do not qualify as a hedgeable exposure. Hedge accounting is precluded for a forecasted transaction that, when culminated, will be measured initially and subsequently at its fair value with changes in fair value reported in earnings. Entities would be precluded from designating a written option or cash instrument as a hedging instrument of a forecasted transaction. Financial instruments that have characteristics similar to derivative financial instruments and are thus included in the scope of the standard would be accounted for like derivatives and could be designated as a hedging instrument. Discontinuation of Hedge Accounting An entity would discontinue hedge accounting propsectively if a hedge failed to meet any of the foregoing criteria or if the derivative financial instrument is sold or extinguished. The derivative gain or loss accumulated to the date of discontinuation would continue to be deferred until the date initially specified. Any future gains and losses arising from the derivative would not be deferred in comprehensive income. However, if an entity discontinues hedge accounting because the forecasted transaction is no longer expected to occur and the change in expectation results from an isolated, nonrecurring, and unusual event, * any previously deferred gain or loss would be recognized in earnings at the date the transaction is no longer expected to occur. V. Hedges of Net Investment in Foreign Enterprises An entity can designate a derivative financial instrument or a foreign currency-denominated cash instrument as a hedge of the foreign currency exposure of net foreign investments, as permitted by FASB Statement No. 52, Foreign Currency Translation . Those hedging instruments would be accounted for under Statement 52, which requires that the foreign currency transaction gain or loss on a derivative that is designated as a hedge of the foreign currency exposure of a net investment in a foreign entity be reported in the same manner as translation adjustments. The standard on derivatives and hedging would not change the accounting specified in Statement 52 for hedges of net investment. VI. Other Decisions on the Proposed Standard Hedging a Single Item Simultaneously as a Market Value and Cash Flow Exposure An entity is prohibited from simultaneously hedging an asset, liability, or firm commitment for both its exposure to changes in market value and its exposure to variability in its future cash flows. Guidance on Determining Fair Value FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments , would provide the basis for determining the fair value of financial instruments and that valuation guidance would not be modified. Additionally, differences among broker-dealers and other industries would be reconciled by requiring that when determining the fair value of a large block of securities, a "blockage factor" may not be taken into consideration (that is, a portfolio of trading units must be valued as the sum of the fair values of the individual trading units). Disclosures FASB Statements No. 105, Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk , and No. 119, Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments , would be superseded, although certain disclosures required by Statement 105, such as those related to concentrations of credit risk, would be retained. Statement 107 would be retained with possible amendments to the display provisions of that Statement to conform to the proposed standard. The Board has discussed potential disclosures to be included in the proposed standard. The details will be finalized in drafting the document. Presentation Issues Display requirements for reporting the effects of hedging transactions in the income statement would not be specified. ___________________________ * An example of a hedged forecasted transaction for which expections changed due to an isolated, nonrecurring, and unusual event is a projected foreign transaction by a branch that had been operating in a foreign country whose government has subsequently prohibited the entity from conducting business there. ___________________________ The staff has prepared this summary to present its understanding of the approach that the Board supported at its April 4, 1996 meeting. The actual proposed standard is expected to be published for public comment in June 1996. I:\Data\Fasbdata\Projdata\Hedging\Boardmem\1996\NEW'APP5.DOC 4/5/96 S++1S     $'   D  I4 uI "I Ip- -I; <I< <I= =I{? ?IA 4 #+U!!;+>8 #+U!!;4 #+U!8'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" /-- ߈"" = 0 contentsȚ U {4U(#!bV _Vr%\nFP)&; ; ;&#+:!['f$1996FASBupdatebuttonClick,buttonClick close "1996FASBupdate"$VHide 1886 FASB Update ViewerV 4VV!!pLWVShowGlossaryIWi" S7J)&; ; ;&#+U!8'f$glossarybuttonUp} glossary}[WShow GlossaryW 4W< !6X3Xw"anHU)&; ; ;&#+U!8'f$ComprehensiveIncomebuttonClick+buttonClick ComprehensiveIncome#MXComprehensive Income X Xs#s#XXcontentsXX7#4(s#X }PXX7#4XHHH)`XoutlineX^X^l Scroll to view more text ---------> Click On Any Red Hotword Below 1996 FASB Update Table of Contents Introduction I. Scope of Proposed Standard II. Recognition and Measurement of Derivative Financial Instruments III. Hedges of an Existing Asset, Liability, or Firm Commitment Recognition of Gains and Losses Criteria for Designation as a Hedge of an Asset, Liability, or Firm Commitment Treatment of Preexisting Gains and Losses of Hedged Item Discontinuation of Hedge Accounting Use of a Hedging Instrument with a Basis Difference Use of Options and Hedging Instruments Hedges of Mortgage Servicing Rights IV. Hedges of Forecasted Transactions Recognition of Gains and Losses Criteria for Designation of Forecasted Transactions Discontinuation of Hedge Accounting V. Hedges of Net Investment in Foreign Enterprises VI. Other Decisions on the Proposed Standard Hedging a Single Item Simult. as a Market Value and Cash Flow Exposure Guidance on Determining Fair Value Disclosures Presentation Issues Web Site I:\Data\Fasbdata\Projdata\Hedging\Boardmem\1996\NEW'APP5.DOC 4/5/96 `//`1Vacd#(fkpvhhRj"*lMTmozqDs u3<voxxlz6| ~bf^SaVacdfvhhRjlmzqoDsuvxlz6|~^gaXjac "nk)&; ; ; #+.0!n@!n @!;f #+.04!;@#+U!8;+>H #+U!!;+>L #+U!!;# #+9$@!;4 #+U!!'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 8 contentsȘ/cX2cd "nl)&; ; ; #+.0!n@!n @!;f #+.04!;@#+U!8;+>H #+U!!;+>L #+U!!;# #+9$@!;4 #+U!!'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 14 contentsșdXdf "nl)&; ; ; #+.0!n@!n @!;f #+.04!;@#+U!8;+>H #+U!!;+>L #+U!!;# #+99$@!;4 #+U!!'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 57 contentsșfXfsh "nl)&; ; ; #+.0!n@!n @!;f #+.04!;@#+U!8;+>H #+U!!;+>L #+U!!;# #+9F$@!;4 #+U!!'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 70 contentsșhXhXhOj "nl)&; ; ; #+.0!n@!n @!;f #+.04!;@#+U!8;+>H #+U!!;+>L #+U!!;# #+9]$@!;4 #+U!!'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 93 contentsșcjXfjl "nm)&; ; ; #+.0!n@!n @!;f #+.04!;@#+U!8;+>H #+U!!;+>L #+U!!;# #+9$@!;4 #+U!!'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 151 contentsȚ-lX0lm "nm)&; ; ; #+.0!n@!n @!;f #+.04!;@#+U!8;+>H #+U!!;+>L #+U!!;# #+9$@!;4 #+U!!'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 160 contentsȚmXmo "nm)&; ; ; #+.0!n@!n @!;f #+.04!;@#+U!8;+>H #+U!!;+>L #+U!!;# #+9$@!;4 #+U!!'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 168 contentsȚoXowq "nm)&; ; ; #+.0!n@!n @!;f #+.04!;@#+U!8;+>H #+U!!;+>L #+U!!;# #+9$@!;4 #+U!!'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 174 contentsȚqXqAs "nm)&; ; ; #+.0!n@!n @!;f #+.04!;@#+U!8;+>H #+U!!;+>L #+U!!;# #+9$@!;4 #+U!!'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 188 contentsȚUsXXs u "nm)&; ; ; #+.0!n@!n @!;f #+.04!;@#+U!8;+>H #+U!!;+>L #+U!!;# #+9$@!;4 #+U!!'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 197 contentsȚuX"uv "nm)&; ; ; #+.0!n@!n @!;f #+.04!;@#+U!8;+>H #+U!!;+>L #+U!!;# #+9$@!;4 #+U!!'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 197 contentsȚvXvx "nm)&; ; ; #+.0!n@!n @!;f #+.04!;@#+U!8;+>H #+U!!;+>L #+U!!;# #+9$@!;4 #+U!!'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 206 contentsȚxXxiz "nm)&; ; ; #+.0!n@!n @!;f #+.04!;@#+U!8;+>H #+U!!;+>L #+U!!;# #+9$@!;4 #+U!!'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 251 contentsȚ}zXz3| "nm)&; ; ; #+.0!n@!n @!;g #+.04!;@#+U!8;+>I #+U!!;+>M #+U!!;$ #+9 $@!;4 #+U!!'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 265 contentsȚG|XJ|} "nm)&; ; ; #+.0!n@!n @!;g #+.04!;@#+U!8;+>I #+U!!;+>M #+U!!;$ #+9$@!;4 #+U!!'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 277 contentsȚ~X~ "nm)&; ; ; #+.0!n@!n @!;g #+.04!;@#+U!8;+>I #+U!!;+>M #+U!!;$ #+9$@!;4 #+U!!'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 277 contentsȚX "nm)&; ; ; #+.0!n@!n @!;g #+.04!;@#+U!8;+>I #+U!!;+>M #+U!!;$ #+9$@!;4 #+U!!'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 285 contentsȚX[ "nm)&; ; ; #+.0!n@!n @!;g #+.04!;@#+U!8;+>I #+U!!;+>M #+U!!;$ #+9'$@!;4 #+U!!'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 295 contentsȚoXr% "nm)&; ; ; #+.0!n@!n @!;g #+.04!;@#+U!8;+>I #+U!!;+>M #+U!!;$ #+93$@!;4 #+U!!'ftextHide Menu BarSystemSmallFontscontentsbuttonClickbuttonClick 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 307 contentsȚS ~PXVs#!l"Vn>J)&; ; ; #+U!!'f$contentsbuttonClick"buttonClick "contents" Click Here to Hide Contents+ eRisks07teh M3 s +J*vy {+vtextu4trueASYM_BeenHere ; >bG&Buttonu tx"_i" S9J)&; ; ;&#+9!['f$EITF8407buttonUp} close EITF8407 }'Click Here to Hide This ViewerU uX$ nPM" z )& ; ; !#hP+<, !1'f<Type the word or word string to search for in the above textbuttonUp:} ("Type the gg ␤above " ⑃IT}sClick Here to Search for a Topicwiy!h)0.1 x4#m!i"Sn;G)&; ; ;&#+9!['f$risksbuttonClick!buttonClick close risksHide Picture yji+!HHH2t g@1Types of Fianancial Instruments Derivatives Risksanq xt zxd#KKK2  tJu*wvxyz true 2{< xtField~ NM;$ Z K%yUo)&; ; 5"z-<"!&<+F !!9 <+V!8!9"!}5!y:*!!<+V!!@#+V!8; #+/0!n@!n @!;o #+/04!;@#+V!8;+?X #+V!!;+?\ #+V!!;, #+:$@!"!}jB#:$'ftextauthorHide Menu BarSystemSmallFontsstatusbardefaultenterPage+TO HANDLE --{entering fshort } $= , = default d statusbar > 'P$ d 9 } 捈"" W= "System" W= 10 S1 "" }/ B"Hide Menu Bar" / B"SmallFonts" / ߈"" = 0syslockScreen నsvASYM_TpID! 9504021118513691351731203655 p $e"P!#2 arrows#&!#2!2W }Zh: $e"P! "eNext Page`" JAA)&; ; >;#+5!'f$buttonUp} Ӑt} ":W!)"`) {&,: $e"P!7Next Pageo|& o!!B!t"Qr!t"!Q $ P!Kv JBackGg" QLH)&; ; !!:M'f+buttonUp} d .}_bKv (` $ P!Next Page%g" QLH)&; ; !!:M'f+buttonUp} d .}]oh!B``m`  \ $rnSmallFonts  5$n!Show Menu Bar" l}c)&; ; !9!;+> #+U!8+U!!'f8Hide Menu BarbuttonUp5} d B"Hide Menu Bar" / }Show Menu Bar  D$P$ Hide Menu Bar " l}c)&; ; !!;+> #+U!8+U!!'f8Show Menu BarbuttonUp5} d B"Show Menu Bar" / } Hide Menu Bar   K$bn!  Table of Contents "knG_)&; ; r;#+6r!'f0Table of ContentsbuttonClick+buttonClick "Table Contents"" Table of Contents   > $nB  LargeFonts? @% *!)& ; ; ; #$@"-%?J >,"">,"J Y!HV?~;t #+/0!n@!n@!;+?h #+V!!;+?h #+V!8;+:;+?S #F@!; #+:>,%$@!'ftextAxsvScrollNumberlargeFontsArialsmallFontsbuttonUp}4svScrollNumber = ߈""  > 12 ' = , + 12 捈"" W= "Arial" W= 16 Hide B"largeFonts" / Show B"smallFonts" / = B"/-- g1 "" ߈ "" = }W Increase Font Size {|:}&b( pD".n")& ; ; ; #$@"-$?J >,!">,!J Y!EV?;t #+.0!nj@!n @!;+>o #+U!8;+>i #+U!!;+9;+>I #F@!; #+9>,$$@!'ftextSystemAxsvScrollNumberlargeFontssmallFontsbuttonClickbuttonClick4svScrollNumber = ߈""  > 12 ' = , - 12 捈"" W= "System" W= 10 Show B"largeFonts" / Hide B"smallFonts" / = B"0/-- g1 "" ߈ "" = Decrease Font Size e1996 SEC Proposalh Ms  vs$t^uv wxPy $^  u4  trueASYM_BeenHere!O sRb[&Button tTHHHER  1996 SEC PROPOSAL  u#T hHHH Sxtext=@VS Auto_Scrolletbk_wid_namem8p5 SEC PROPOSES DERIVATIVES RULE Click here for Merton Miller's Protest The Securities and Exchange Commission has proposed amendments to Regulation S-X, Regulation S-K, and other forms that are intended to clarify and expand existing requirements for financial statement footnote disclosures about accounting policies for derivative financial instruments and derivative commodity instruments. In addition, the proposed rules would: * Require disclosure outside the financial statements of qualitative and quantitative information about market risk inherent in derivative financial instruments, other financial instruments as defined, and derivative commodity instruments; and * Remind registrants that, when they provide disclosure about financial instruments, commodity positions, firm commitments, and other anticipated transactions ("reported items"), such disclosure must include disclosures about derivatives that affect directly or indirectly such reported items, to the extent the effects of such information are material and necessary to prevent the disclosure about the reported item from being misleading. Click here for Merton Miller's Protest u$KvPwxPwM"jnH^)&; ; r;#+6r!'f0MillerSECprotestbuttonClick,buttonClick "MillerSECprotest"$axd "jnH^)&; ; r;#+6r!'f0MillerSECprotestbuttonClick,buttonClick "MillerSECprotest"$C vF X V" U ShowGlossary i" S7J)&; ; ;&#+U!8'f$glossarybuttonUp} glossary}Show Glossary C  ^ ! ~D b* ^P/ Ȗ  Hz@ @4   |Zc^ NDJ'+++WeFASBProspectus3ationsh2(s--v $'()B,&#.#0$1$2%3J%4%5%6%7&8l&9&:&;'<V'='>#?V#A'C(D4)E`)F)G)H*IF*J*K*L*M +NH+O+P*(Q'R+S>"U$!Wd!X>" Page Number81 SmithText0101anizationsI Li$i$XUstartupY2Cd###Bi$f$!iS#d! Y2@@@!Advance Dialog Scroll  Cd##!{"en`Y)& ; ; ;&#+9!['f,FASBProspectus3buttonClick@buttonClick4svDialogTextViewer close FASBProspectus38Hide Dialog Viewer $# ,)HighlightDialog?Highlight Dialogs )vi$fi$f|y1$fif 'B$fHHH;1a    Financial Accounting Series/No. 151-B July 31, 1995 Scroll to view more text ---------> Financial Accounting Standards Board PROSPECTUS Part 3 Appendices Disclosure Effectiveness Appendix A DISCLOSURE IN THEORY AND PRACTICE The Board listed four major purposes for disclosure in Statement No. 105, Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk : 1. To describe recognized items and to provide relevant measures of those items other than the measure in the financial statements 2. To describe unrecognized items and to provide a useful measure of those items 3. To provide information to help investors and creditors assess risks and potentials of both recognized and unrecognized items 4. To provide important information in the interim while other accounting issues are being studied in more depth. Mary E. Barth and Christine M. Murphy examined a sample of recent financial statements and drew the following conclusions: 1. The most frequently required disclosures relate to amounts recognized in the financial statements, particularly to disaggregating them and providing relevant measures other than the measure in the financial statements---disaggregation of recognized amounts represents 26 percent of all required disclosures. 2. Six subjected---stockholders' equity, leases, pensions, income taxes, other postretirement benefits, and commitments and contingencies---account for 43 percent of all disclosures. 3. Few disclosure requirements explicitly provide information on future cash inflows or outflows. 4. Few provide measures of unrecognized items. 5. There is a clear trend of increasing disclosure requirements over time. This increase includes new purposes of disclosures and more items for some previously required purposes. Among the new purposes are those relating to providing alternative measures of recognized amounts, describing critical assumptions used in determining the amounts, and providing information to assess risks and potentials. 6. Few disclosure requirements have been eliminated. (Footnote 11) Appendix B RELATED ACTIONS AT THE SEC The SEC has expressed a strong interest in the issue of disclosure effectiveness, partly in response to the previously cited article by Ray Groves. The SEC has issued a rule proposal, "Use of Abbreviated Financial Statements in Documents Delivered to Investors Pursuant to the Securities Act of 1933 and Securities Exchange Act of 1934." The proposal would eliminate substantially all footnotes to the financial statements, the exceptions being: Significant accounting policies (APB 22) Matters materially affecting comparability -- Restatements, reclassifications, and changes in accounting estimate (APB 20) -- Business combinations (APB 16) -- Discontinued operations (APB 30) Circumstances identified in explanatory language added to the auditor's report (SAS 58) Loss contingencies (SFAS 5) Events of default under credit agreements (Reg. S-X) Subsequent events (SAS 1) Related party transactions (SFAS 57). Foreign issuers would be able to issue abbreviated statements under the SEC proposal. Foreign issuers that issue statements using accounting principles other than U.S. GAAP would include an additional footnote containing quantitative reconciling information. The SEC proposal also solicits suggestions for further streamlining reports to shareholders, including the option of rescinding the requirement for delivering annual reports to shareholders. The SEC proposal does not purport to change GAAP. Issuers would continue to file complete financial statements with footnote disclosures in Form 10-K, which would be available to investors on request. Comments on the proposed amendments must be sent to the SEC by October 10, 1995. The SEC has taken additional measures to address the concerns of foreign firms that wish to access U.S. capital markets. Some of the changes affect U.S. firms as well. The SEC has eliminated eight schedules from Regulation S-X. (Footnote 12) The Commission also extended the time periods for updating financial statements. The SEC specifically addressed the concerns of foreign registrants by dropping two previously required financial schedules, allowing more flexibility when selecting reporting currency, and simplifying reconciliation requirements for foreign registrants whose financial statements comply with certain international accounting standards. +)8>aA wy z {    r s t       & ' ( C D E :G+ (B.if4KKK;119<!!s1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100 101 102 103 104 105 106 107 108 109 110 111 112 113 114 115 116 117 118 119 120 121 122 123 124 125 126 127 128 129 130 131 132 133 134 135 136 137 138 139 140 141 142 143 144 145 146 147 148 149 150 151 152 153 154 155 156 157 158 159 160 161 162 163 164 165 166 167 168 169 170 171 172 173 174 175 176 177 178 179 180 181 182 183 184 185 186 187 188 189 190 191 192 193 194 195 196 197 198 199 200 201 202 203 204 205 206 207 208 209 210 211 212 213 214 215 216 217 218 219 220 221 222 223 224 225 226 227 228 229 230 231 232 233 234 235 236 237 238 239 240 241 242 243 244 245 246 247 248 249 250 251 252 253 254 255 256 257 258 259 260 261 262 263 264 265 266 267 268 269 270 271 272 273 274 275 276 277 278 279 280 281 282 283 284 285 286 287 288 289 290 291 292 293 294 295 296 297 298 299 300 301 302 303 304 305 306 307 308 309 310 311 312 313 314 315 316 317 318 319 320 321 322 323 324 325 326 327 328 329 330 331 332 333 334 335 336 337 338 339 340 341 342 343 344 345 346 347 348 349 350 351 352 353 354 355 356 357 358 359 360 361 362 363 364 365 366 367 368 369 370 371 372 373 374 375 376 377 378 379 380 381 382 383 384 385 386 387 388 389 390 391 392 393 394 395 396 397 398 399 400 401 402 403 404 405 406 407 408 409 410 411 412 413 414 415 416 417 418 419 4200a! UiS#KKK2! W!!!,"!ShowGlossary)"i" S7J)&; ; ;&#+U!8'f$glossarybuttonUp} glossary};"Show Glossaryo" Sr"~" "{"jensen"\"Fn2:)&; ; +U!!'fbuttonClickbuttonClick ##&#V#a'a+pS# ,>"@@@@#KK# ?>"6!a###a#r# .V#6!EE$ >V#)62!r$$$F$Gbr%EJ%%%(r%(&&7l&  &85 &'LLV'67EU'7U$0#J!!3m  $$ m m   % 1#2!G%2#5K! K5%3#5!]KD%4#`65!]d]bKD% 5#u!& 6#v!U&7#k! ] X&i& ] ] ] &8#8! y3&9#"!84, ':#J)!!3S';#?G5!Q2LLWO' <# 5!' =# 5!' Q>"6!a'''a*()r'( A'6!EE[( P'r62! )r^(((F4)Gbr`)(r)(&)7* WF* DG*)*EUTs*Us +H++E)C*(J!!3m  )1) m m   ]) D*(2!) E*(u!) F*(v!)G*(k! ] )* ] ] ] C*H*(#! s/s y&*I*(!C C   *J*(Jr!!3* K*(5J!+ L*(5K!E+M*(5!]KD+N*(`65!]d]bKD+O*(5K! K5 R>"L#EE''XeFASBProspectus4ationsh2(s--v @$'()j,.0 1 2 36!4t!5!6!7 "8X"9":";#<B#=n#>?BA#C$D %EL%Fx%G%H%I2&Jr&K&L&M&N4'Or'P$Q#R'S*UWPX@* Page Number81 = SmithText0101anizationsq ti$i$}startupz AEd#A#ji$fiS#P # @z A@@@!Advance Dialog Scroll3 @6Ed#A!{"en`Y)& ; ; ;&#+9!['f,FASBProspectus4buttonClick@buttonClick4svDialogTextViewer close FASBProspectus48Hide Dialog Viewer= $@@# TQHighlightDialoggHighlight Dialog )@i$fi$f1$fif 'j$fHHH;1a 2 /  Financial Accounting Series/No. 151-B July 31, 1995 Scroll to view more text ---------> Financial Accounting Standards Board PROSPECTUS Part 4 Footnotes Disclosure Effectiveness FOOTNOTES Footnote 1 Carolyn A. Streuly, Ph.D., CPA, "The Primary Objective of Financial Reporting: How Are We Doing?" Ohio CPA Journal (December 1994): 15-22. Footnote 2 Shelley Taylor & Associates, "Full Disclosure 1994: An International Study of Disclosure Practices" (London, 1995). A related article appeared in the Wall Street Journal on February 23, 1995, page C1, under the headline "Investors Bemoan Lack of Data on Overseas Firms." Footnote 3 "Companies Pressure Accounting Panel to Modify Demands for More Data," Wall Street Jour