The aim of this case study is to illustrate the accounting treatment of hedges of highly expected future issuance of fixed rate debt with a forward starting interest rate swap. A forward starting swap is just a swap that starts sometime in the future. With this type of hedge the entity takes advantage of low interest rates prior to issuing the debt and/or does not want to take the risk of higher rates at issuance date.

7.9.1 Background Information

On 1 January 20X0, ABC (an entity with the EUR as functional currency) expected to issue a fixed rate bond on 15 July 20X0 with the following characteristics:

Bond terms
Expected issue date 15 July 20X0
Issuer ABC
Issue proceeds EUR 100 million (100% of notional)
Expected maturity 3 years (15 July 20X3)
Notional EUR 100 million
Coupon Fixed, to be paid annually (30/360 basis)The coupon is expected to be set on the issue date at the EUR 3-year swap rate plus a 100 bps credit spread

ABC was exposed to upward movements in the 3-year swap rate and to a widening of its own credit spread. ABC wanted to protect itself against potential increases in the 3-year interest rate until issuance date, by locking in the future coupon payment at 5.61% (assuming a spread of 100 basis points). Accordingly, on 1 January 20X0 ABC entered into a forward starting receive-fixed pay-floating interest rate swap with XYZ Bank with the following terms:

Interest ...

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