APPENDIX A DERIVATIVES Questions A-1 Reflective thinking A-2 Reflective thinking A-3 Analytic A-4 Reflective thinking A-5 Reflective thinking A-6 Reflective thinking A-7 Reflective thinking Exercises A-1 Reflective thinking A-2 Analytic A-3 Analytic A-4 Analytic A-5 Analytic A-6 Analytic Problems A-1 Analytic A-2 Analytic, Communications A-3 Analytic Cases A-1 A-2 A-3 A-4 QUESTIONS FOR REVIEW OF KEY TOPICS Question A-1 These instruments “derive” their values or contractually required cash flows from some other security or index. Question A-2 The FASB has taken the position that the income effects of the hedge instrument and the income effects of the item being hedged should be recognized at the same time. Question A-3 If interest rates change, the change in the debt’s fair value will be less than the change in the swap’s fair value. The gain or loss on the $500,000 notional difference will not be offset by a corresponding loss or gain on debt. Any increase or decrease in income resulting from a hedging arrangement would be a result of hedge ineffectiveness such as this. Question A-4 A futures contract is an agreement between a seller and a buyer that calls for the seller to deliver a certain commodity (such as wheat, silver, or Treasury bond) at a specific future date, at a predetermined price. Such contracts are actively traded on regulated futures exchanges. If the “commodity” is a financial instrument, such as a Treasury bill, commercial paper, or a CD, the contract is called a financial futures agreement. Question A-5 An interest rate swap exchanges fixed interest payments for floating rate payments, or vice versa, without exchanging the underlying notional amount. Question A-6 All derivatives, without exception, are reported on the balance sheet as either assets or liabilities at fair (or market) value. The rationale is that (a) derivatives create either rights or obligations