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divyagovil1
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Joined: 30 Jan 2009
Location: India
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Posted: 05 Apr 2009 at 20:09 \| IP Logged

Can someone pls explain the following question:-

Qualified derivatives may be used to hedge the cash flow associated with an/a:

Solution :- Asset and Forecasted Transaction

Reason provided :- A qualified derivative may be used (designated) to hedge exposure to variability in cash flow associated with an asset, liability or a forecasted transaction (but not a firm commitment, which would be a fair value hedge).

Specifically, I am confused about the statement in brackets - "but not a firm commitment, which would be a fair value hedge"

This question is part of the "Financial Instruments". Becker - Chapter F-1.

Thanks!

__________________
Divya - CO State

Passed using Becker Review :
FAR - 04/11/09 - 94
BEC - 05/30/09 - 86
REG - 08/29/09 - 95
AUD - 11/21/09 - 92
Ethics - 2011

Jams
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Joined: 26 Apr 2007
Location: United States
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Posts: 547

Posted: 05 Apr 2009 at 20:46 \| IP Logged

firm commitment is a "purchase commitment" for buying certain good in future, which relates to fluctuation in prices in future. As rightly mentioned would be a fair value hedge and wont be a derivative. on the other hand asset and forecasted transactions are derivatives which deals with future prices of assets or forecasted transactions like, oil prices or gold prices. hope it helps.

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jams

BEC-76
AUD-80
REG-84
FAR-81 !!!

divyagovil1
Major Contributor

Joined: 30 Jan 2009
Location: India
Online Status: Offline
Posts: 1456

Posted: 05 Apr 2009 at 20:59 \| IP Logged

Thanks, Jams!

If I am getting it correct, it's not possible to purchase any derivatives to offset the changes in prices for the purchase commitment contracts.

Isn't fair value hedge a derivative (as per page F7-5) ?

I am least familiar with the derivative instruments. So, little difficult to understand that how do the derivatives work and for which items we can purchase derivatives, that is, go for the derivative contracts...

Would certainly appreciate detailed understanding ....

__________________
Divya - CO State

Passed using Becker Review :
FAR - 04/11/09 - 94
BEC - 05/30/09 - 86
REG - 08/29/09 - 95
AUD - 11/21/09 - 92
Ethics - 2011

divyagovil1
Major Contributor

Joined: 30 Jan 2009
Location: India
Online Status: Offline
Posts: 1456

Posted: 05 Apr 2009 at 21:35 \| IP Logged

Okay, this is I understand from the cpa exam view point :-

A firm commitment to acquire an asset is treated the same as having the asset, which is why such a hedge is treated as a fair value hedge. Cash flow hedges are for expected cash flows. A firm commitment is not "expected.

__________________
Divya - CO State

Passed using Becker Review :
FAR - 04/11/09 - 94
BEC - 05/30/09 - 86
REG - 08/29/09 - 95
AUD - 11/21/09 - 92
Ethics - 2011

Jams
Major Contributor

Joined: 26 Apr 2007
Location: United States
Online Status: Offline
Posts: 547

Posted: 06 Apr 2009 at 13:26 \| IP Logged

i will be revising "derivatives" again in few days, i don't want to pass any wrong statements, so let me get back to you on this, definitely before your exam.

__________________
jams

BEC-76
AUD-80
REG-84
FAR-81 !!!

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