Chapter 4An Introduction to Derivative Instruments

Before addressing the hedge accounting implications of the most common hedging strategies, it is helpful to examine the most common derivative instruments used in these strategies. The main characteristics of each derivative are described and, where relevant, its accounting implications under IFRS 9 are highlighted. A more detailed explanation of the accounting issues related to a specific derivative may be found in the numerous cases provided in this book.


4.1.1 Product Description

An FX forward is the most common and simplest hedging instrument in the FX market. It is a contract to exchange a fixed amount of one currency for a fixed amount of another currency on a specific future date. Suppose that on 1 January 20X5 ABC, a European company, expects to purchase a USD 100 million machine from a US supplier. The purchase is expected to be paid in USD on 30 June 20X5. As a result, ABC is exposed, from the moment it places the order until it makes the payment, to an appreciation of the USD relative to the EUR. To hedge this exposure ABC may enter into an FX forward with the following terms:

FX forward terms
Trade date 1 January 20X5
Counterparties ABC and XYZ Bank
Maturity 30 June 20X5
ABC buys USD 100 million
ABC sells EUR 80 million
Forward Rate 1.2500
Settlement Physical delivery

The FX forward locks in the exchange rate at which ABC will buy USD 100 million. In other words, ABC knows that ...

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