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Sunday, January 24, 2010

Hedge Exposures - Derivatives - IAS 39

Derivatives are an integral tool utilized by corporations to hedge exposures of price fluctuations of the underlying assets.  The exposures mitigated could be:  future price of raw materials, foreign currency, or interest rates.  Financial understanding is needed to evaluate the financial statement value.

Derivatives are made up of four types or a combination of more than one.

  • Forward Contracts - An Over the Counter (OTC) contract between two parties.
  • Futures Contracts - Future contracts are forward contracts that trade on regulated markets.  The advantage is liquidity.  The disadvantage is the terms of the contract have to be standardized.
  • Swaps - Swaps are portfolios of forward contracts.  
  • Options - Option represents the right, not obligation, to buy (call) or sell (put) an asset at a prearranged price.
IAS 39 Financial Instruments is the core standard under IFRS for derivatives. IFRS 9 to replace IAS 39 by 2013 with early adoption permitted in 2009. All derivatives are measured at fair value in accordance with IAS 39.
“The best way to predict the future is to create it.” ~ Peter Drucker

Reference-Deloitte
Financial Instruments Standards: A Guide on IAS 32, IAS 39 and IFRS 7
Financial Accounting: The Impact on Decision Makers (with 2009 IFRS Update)