Derivatives and Hedging

Derivatives and Hedging

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The fundamental requirement for SFAS 133 is that an entity should recognize all derivatives as either assets or liabilities in the statement of financial position and measure those particular derivatives at fair value. It also postulates that accounting for any change in the derivative’s fair value rests on the anticipated use of the derivative as well as the subsequent description (Becker & Terrano, 2007).

Hedging is a risk management strategy aimed at controlling or offsetting likelihood of loss due to fluctuations in the prices of currencies or securities by employing various techniques such as futures contracts.

Foreign exchange forward contract allows a business to protect itself against future exchange rate fluctuations and it mitigates foreign exchange risk for the parties involved and is useful when both parties do operations in a country using a given currency. Foreign currency option is an option that provides the right but not an obligation to either purchase or sale a particular amount of foreign currency at a specified amount within a given time period (Becker & Terrano, 2007).

Foreign currency option in hedging grants businesses option to lock in an exchange rate regarding the currency being dealt with so long as the currency performs positively but also gives an option of letting the option to expire if the currency does not move in a favorable direction (Becker & Terrano, 2007).

If the foreign currency depreciates then the U.S Company will experience foreign exchange gain on their payable. However when the foreign exchange appreciates after purchasing the product then there will be a foreign exchange loss for the U.S Company. U.S Company will experience foreign exchange loss when they sell their goods and the foreign currency depreciates. Nevertheless, when foreign exchange appreciates and the U.S company sell to a foreign company then the U.S company will experience foreign exchange gain (Carmichael et al., 2012).

Responses

Response to Wendy

The fourth answer has been confused because it should be why companies would prefer foreign exchange options to foreign exchange contracts. This makes the answer to be very wrong unless the instructions are well followed. Question five has also been poorly tackled. You were too brief and you have confused the two concepts of currency depreciation and currency appreciation. Generally there is a lot of grammar errors that prevents the responses to flow in a logical manner. You may proofread your work to avoid many grammar errors. However, the first three questions have been well answered except for a few grammar errors. Your references are not as per the APA referencing style and therefore you may correct that too.

Response to Amy

Apart from measuring derivatives in fair value, you would have also indicated that the derivatives should also be reflected either as liabilities or assets in the statement of financial position. Hedging majorly reduces the price risk exposure in the underlying securities or assets but not just exposure. You should answer exposure to what? Question four has not been properly answered. Please revise it and provide the right response. Even the fact that foreign currency option is preferred by companies is not satisfactory. The last question has also not been properly answered. You should respond to each part of the question categorically. Generally the questions have not been answered very well and there are many grammar errors that you should correct.

ReferencesBecker, Howard, & Terrano, Richard J. (2007). Not-for-Profit Reporting 2008. Cch Inc.

Carmichael et al. (2012). Accountants’ Handbook, Financial Accounting and General Topics. John Wiley & Sons Inc.