(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.
(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.
(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.
(b) Derivative instruments contain 1. One or more underlyings and one or more notional amounts 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.
(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.
(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 risk.
(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.
(d) Futures contracts, credit indexed contracts, and interest rate swaps are all included in derivative instruments.
(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 instrument.
(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.
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