Derivative Instruments and Hedging Activities Paper 2
Which of the following statements is(are) true regarding
derivative financial instruments?
I. Derivative financial instruments should be measured at fair
value and reported in the balance sheet as assets or liabilities.
II. Gains and losses on derivative instruments not designated
as hedging activities should be reported and recognized in
earnings in the period of the change in fair value.
(c) Derivative instruments meet the definition of assets
and liabilities. As such they should be reported on the entity’s
financial statements. The most relevant measure for reporting
financial instruments is fair value. Thus, statement I is true. If a
derivative instrument does not qualify as a hedging instrument,
then its gains or losses must be reported and recognized in current
earnings. Thus, statement II is also true.
Which of the following is an underlying, according to ASC
(d) All of the above meet the basic definition of an
underlying, which is any financial or physical variable that has
either observable changes or objectively verifiable changes.
If the price of the underlying is greater than the strike or
exercise price of the underlying, the call option is
(b) A call option is in the money if the price of the
underlying is greater than the strike or exercise price of the underlying.
An at-the-money option is one in which the price of the
underlying is equal to the strike or exercise price. A call option is
out of the money if the strike or exercise price is greater than the
price of the underlying.
Which of the following is not a distinguishing characteristic
of a derivative instrument?
(b) Derivative instruments contain
1. One or more underlyings and one or more notional
2. No initial net investment or smaller net investment than
required for contracts with an expected similar response
to market changes, and
3. Terms that require or permit net settlement, net settlement
by means outside the contract, and delivery of an
asset that is substantially the same as net settlement.
An example of a notional amount is
(a) Notional amounts are the referenced associated
asset or liability that are commonly a number of units such as
barrels of oil. Answers (b) and (d) are incorrect because they are
examples of underlyings. Answer (c) is incorrect because it is an
example of a derivative instrument.
Disclosures related to financial instruments, both derivative
and nonderivative, used as hedging instruments must include
(d) Disclosures related to financial instruments that are
used as hedging instruments must include the following information:
1. Objectives and strategies for achieving them.
2. Context to understand the instrument.
3. Risk management policies.
4. A list of hedged instruments.
Disclosure of the maximum potential accounting loss is only
required for financial instruments with concentrations of credit
Which of the following financial instruments or other contracts
is not specifically excluded from the definition of derivative
instruments in ASC Topic 815?
(b) Only call (put) options are included in the definition
of derivative financial instruments. Leases are excluded
because they require a payment equal to the value of the right to
use the property. Equity securities and adjustable rate loans are
excluded because they require an initial net investment equivalent
to the fair value.
Which of the following is not a derivative instrument?
(d) Futures contracts, credit indexed contracts, and
interest rate swaps are all included in derivative instruments.
Which of the following criteria must be met for bifurcation
(a) The hybrid instrument is not recorded at fair value.
Economic characteristics and risks of the embedded instrument
are not “clearly and closely” related to those of the host contract.
The embedded derivative must meet the definition of a derivative
Financial instruments sometimes contain features that
separately meet the definition of a derivative instrument. These
features are classified as
(c) An embedded derivative is a feature of a financial
instrument or other contract, which if the feature stood alone,
would meet the definition of a derivative.