If a put option as a hedge for “Available for Sale” security, where should the unrealized gain/loss be reflected? Assume that the value of the equity has declined over the accouting period and there is a commensurate increase in the value of the put option. If unrealized gain is reported in NI as per Los 29©? then is there not a mismatch, since the unrealized loss on the “Available for sale” security is not reflected in NI? ref. q 90, bk1, exam 2PM. Thanks for you input folks.
I think it depends on whether is a fair value hedge (income statement) or deemed some other type of hedge.
This sounds like a fair value hedge which is an option on an asset. This is reported on the income statement. The other hedges (cash flow and ???) are reported under equity.
Has to be a fair value hedge. Sound like the OP is saying it shouldn’t go in NI because the unrealized loss on the AFS security is going right to the BS by way of comp income.
Just a clarification: we are dealing with only ‘unrealized’ gain / loss. ie.the put option has not been exercised/sold nor have the hedged shares been sold. thepinkman: that is exactly the mismatch I am talking about. As per your statement the NI would be higher by x dollars due to the unrealized gain of the put option but the matching decline in the value of the shares would not hit the NI… Somehow this does not seem right to me. Any FSA gurus care to comment?
To be honest sarthak I think you are going too deep for the exam. I could be wrong (and I am interested in the answer), but I wouldn’t sweat it with 8 days left.
lol, I am but barely scratching the surface i feel. I have been accused of trying to “scam” the exam! God knows this is true, with no finance background and less than 200hrs I know it will be a miracle if i pass. my strategy is to do all exams of bk6&7 and hope for the best! Thanks for the encouragement though…
& more importantly, understand the rationale behind all the “correct” answers
I know i need the “good luck” I am averaging 70% in the schweser exams and hope to hit 80%+ before I am done with the exams. we’ll see… keeping my fingers crossed. The damn tension is giving me “heartburn” and acidity though. Maybe i’ll go buy some tums before i head home from work today. I can’t believe it friday night 11:00 pm and i am still at work.
i am just thinking guys, if it is fully hedged then the unrealized loss is when the asset is below fair value, unrealized loss (which is the premium paid for the put option), be listed in the income statement.
under IAS 39 (and i’m fairly sure that its the same under US GAAP) the movement in fair value of the put option is reported in the income statement. the movement in fair value of the afs security (assuming it is not a permanent impairment) gets firstly posted to comprehensive income. the key part of the hedge accounting rules is this: the effectively hedged part of the movement on the AFS security is then posted from comprehensive income to the income statement to match the movement of the put option. so if the hedge is 100% effective the movements on the afs security and the put option will offset. if it is not 100% effective, the difference between the effective portion (amount posted from comp income to income statement) and the movement in the value of the put option will leave the ineffective portion in the income statement. hope this helps.
glendale, Thanks for your clarification. This definitely helps. The part about moving the effective part of the hedge from comp. income to income statement. Is there a specific pg. # reference in the curriculum or online where that is clearly stated. good first post and welcome to the forum glendale.
Thanks glendale for your post and thanks sarthak for your question! Yes, the answer goes beyond the CFAI curriculum - I haven’t seen it mentionned in the study notes - but I like understanding the reason to better remember the mechanism. So it helps!
it isnt included in the curriculum. if you get a copy of ias 39 its easy enough to find (just look at section on fair value hedges). should be easy enough to get a copy of the standard on the internet.