Hedging Theories

1. Companies manage their foreign currency exposures by a technique called hedging .
2. The 3categoriesof foreign currency exposures that can be managed are:

 Existing asset and liabilities
 Firm commitment
 Forecasted transactions
3. Hedging a noncancellable sales order is hedge of firm commitment anticipatory transaction
4. Hedging a budgeted export sales is a hedge of an hedge of a forecasted transaction.
5. A specific foreign currency exposure being hedged is commonly called the hedge item.
6. The financial instrument used to achieve the hedged is commonly called the hedging
instrument.
7. The 2 most commonly used hedging instrument to hedge foreign currency exposures are FX
forward and FX option.
8. FX forwards result in a two sided hedge because both downside risk and the upside potential on
the hedge item are counterbalanced.
9. FX options result in a one sided hedge because only the downside risk on the hedge item are
counterbalanced.
10. Hedge accounting is a special accounting treatment that achieve both counterbalancing and
either concurrent recognition or concurrent deferral of mark- market adjustments.
11. In an FX option , one party has the contractual right to buy or sell a specific quantity of currency
at a exchange rate during a specified period
12. An option buy is a call option. An option to sell is a put option.
13. The party having the contractual right is the option holder.
14. The party having the obligation to honor the option contract is the option writer.
15. The priced paid to acquire an option is called a premium.
16. An option worth exercising is said to be in the money
17. Split accounting is the context of options refers to accounting the time value element separately
from the intrinsic value element.
18. An FX forward is an agreement to buy or sell a foreign currency at a specified exchange rate and
at a specified future date.
19. In an FX forward each party must fulfill its obligation at the expiration date.
20. In an FX forward to buy a foreign currency, the buyer must take delivery at the expiration date.
21. FX forwards are executor in nature.
22. The difference between the spot rate and the forward rate is called a premium or discount and
is viewed as being a time value measurement.
23. Accounting for premiums and discounts separately form the intrinsic value is called split
accounting.
24. Entering into an FX forward for the purposes other than hedging is speculating.
25. Entering into an FX forward for the purpose of the delivery date would be a hedge of either a
firm commitment and forecasted transaction .
26. The three types risk associated with derivatives are :
 Market risk
 Credit risk
 Liquidity risk
27. Derivatives financial instrument are contracts that create rights and obligations that meet the
definitions of asset and liability.
28. All derivatives are valued in the balance sheet at their fair value.
29. Gains and losses on derivatives cannot be deferred and reported as asset and liabilities.
30. The four types of hedging categories that are exist are undesignated hedges , fair value hedges,
cash flow hedges, and net investment hedges.
31. In a fair value hedge, the concerned is that a loss will be incurred on an existing asset and
liabilities or a firm commitment.
32. In a cash flow hedge, the concern is that an adverse cash flow result will occur on a forecasted
transaction.
33. Hedging a firm commitment is generally a fair value hedge.
34. Hedging a forecasted transaction is generally a cash flow hedge.
35. Hedging and investment in a foreign subsidiary is net investment hedge.
36. FX gains and losses on fair value hedges are in earnings
37. FX gains and losses on cash flow hedge are reported in OCI when they arise and later reported in
earnings.
38. In a cash flow hedge amounts initially reported in OCI are reclassified to earnings when the
transaction on the hedge item is reported in earnings.
39. All FX forwards are valued using the change in the forward exchange rate.
40. Split accounting comes into play in determining how to assess hedge effectiveness.
41. Reporting earnings currently is mandatory for that portion of a derivatives FX gain that is
determined to be ineffective.
TRUE
1. Hedging a domestic company’s budgeted export sales is a hedge of forecasted transactions.
2. Not all anticipatory transactions are firm commitments.
3. An expected future sale that is not under the contract would be considered forecasted
transactions.
4. Hedging a domestic company’s budgeted import purchases to the extent of orders placed could
be hedges of firm commitments.
5. Hedging the potential of budgeted export sales because of an expected weakening of a foreign
currency would be a strategic hedge.
6. Hedging a domestic company’s budgeted export sales is a hedge of a forecasted transaction.
7. Hedge accounting is not defined as accounting for the time value elements separately from the
intrinsic value elements of the hedging instrument.
8. In a foreign currency option, the option writer has the potential loss exposure – not the option
holder.
9. An option to buy is referred to as a call.
10. An option to sell is referred to as a put.
11. Options have premiums but not discounts.
12. Options that out of the money have no intrinsic values.
13. In an FX forward, there is potential for either a gain or loss.
14. In FX forwards, each party to the contract must deliver a currency to the other party at the
expiration date.
15. FX forwards can be tailored to the exposure as both the quantity of currency and the duration of
the exposure.
16. In an FX forward to sell a foreign currency , the seller must make delivery of the foreign currency
t to the FX dealer at the expiration date.
17. Just like issuance of sales order, FX forwards are executory in nature.
18. The accounting for an importing transaction and the accounting for a related hedging
transaction using an FX forward are completely independent of each other.
19. When a domestic exporter desires of hedge a foreign currency receivable using an FX forward
the exporter will contract to sell a specified number of foreign currency units.
20. In an FX forward in which a foreign currency is being bought at less than the spot rate, a
discount exists.
21. In an FX forward in which a foreign currency is being sold at less than the spot rate, a discount
exists.
22. In an FX forward that hedges a foreign currency receivable, the accrual of a discount would
result in a debit being made to earnings.
23. In an FX forward that hedges a foreign currency payable, the accrual of a discount would result
in a credit being made to earnings.
24. In an FX forward that hedges a foreign currency payable, the accrual of a premium would result
in a debit being made to earnings.
25. FX gains and losses resulting from speculating using FX forward cannot be deferred.
26. Derivative financial instruments are contracts that create both rights and obligations.
27. All derivatives are valued in the balance sheet at their fair value.
28. In a fair value hedge, the concern is always that a loss will be incurred on an existing asset or
existing liability or a firm commitment
29. In a cash flow hedge , the concern is that an adverse cash flow result will occur forecasted
transaction.
30. Hedging existing inventory carried at FIFO cost is a fair value hedge.
31. Hedging a forecasted transaction is a cash flow hedge.
32. FX gains and losses on cash flow hedges are initially reported in OCI when they arise.
33. All FX forwards are valued using the change in forward rate.
34. Split accounting encompasses both the manner of valuing a derivative and the manner of
reporting the change in a derivative value.
35. Any portion of derivatives FX gain that is determined to be ineffective be reported currently in
earnings.

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1. Companies manage their foreign currency exposures by a technique called hedging .

2. The 3categoriesof foreign currency exposures that can be managed are:

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