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For example, gold mines are exposed to the price of gold, airlines to the price of jet fuel, borrowers to interest rates, and importers and exporters to exchange rate risks. Many financial institutions and corporate businesses (entities) use derivative financial instruments to hedge their exposure to different risks (for example interest rate ...
An example of this type of distortion occurred in late 1994 and early 1995 when Alan Greenspan raised the US Fed Funds rate from 3.00% in May 1994 to 5.25% in February 1995. Prior to these hikes, Orange County had initiated highly leveraged bets on short maturity interest rate derivative products in the hopes that interest rates would decline.
As OTC instruments, interest rate swaps (IRSs) can be customised in a number of ways and can be structured to meet the specific needs of the counterparties. For example: payment dates could be irregular, the notional of the swap could be amortized over time, reset dates (or fixing dates) of the floating rate could be irregular, mandatory break clauses may be inserted into the contract, etc.
On a technical note, when the asset swap is initiated between coupon dates, the asset swap buyer does not pay the accrued interest explicitly. Effectively, the full price of the bond is at par. At the next coupon period the asset swap buyer receives the full coupon on the bond and likewise pays the full coupon on the swap.
Statements of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, commonly known as FAS 133, is an accounting standard issued in June 1998 by the Financial Accounting Standards Board (FASB) that requires companies to measure all assets and liabilities on their balance sheet at “fair value”.
For example, a corporation borrows a large sum of money at a specific interest rate. [27] The interest rate on the loan reprices every six months. The corporation is concerned that the rate of interest may be much higher in six months. The corporation could buy a forward rate agreement (FRA), which is a contract to pay a fixed rate of interest ...
Per the IFRS 13 accounting standard, fair value is defined as "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date." [22] Accounting rules thus mandate [23] the inclusion of CVA, and DVA, in mark-to-market accounting.
Hedging-related transactions will attract their own accounting treatment, and corporates (and banks) may then require changes to systems, processes and documentation; [88] [89] see Hedge accounting, Mark-to-market accounting, Hedge relationship, Cash flow hedge, IFRS 7, IFRS 9, IFRS 13, FASB 133, IAS 39, FAS 130.