Risk management policies, Risk Management

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 On 1 October 2010, a company issued at par $30 million (par value) of fixed rate 6% debenture loans to the market at par. Interest on the debenture loans is paid quarterly on the last day of each calendar quarter (i.e. 1.5% per quarter). The debenture loans will be redeemed on a future specified date at par.

To comply with the company's risk management policies, it entered into a receive-fixed, pay - variable interest rate swap agreement at market rates on $30 million to hedge the fair value of its debt. The terms of the swap are to pay the agreed variable rate established and fixed at the beginning of each quarter and receive 5.25% per annum fixed rate in return. The swap has a maturity date the same as that of the debentures.

The variable interest rate applicable to the swap for the 3 months to 31 December 2010 determined on 1 October 2010 was 4.72% per annum.

As a result of a rise in market interest rates, the fair value of the company's debenture loans fell to $29,762,240 by the company's year end, 31 December 2010.

The net fair value of the swap at the 31 December 2010 was $238,236 (loss).

No transaction costs were incurred on issue of the debentures loans or on entering into the swap agreement. All necessary documentation to treat the swap as a hedge was set up on 1 October 2010.

Explain the accounting treatment of the above transaction in accordance with IAS 39, including relevant calculations and journal entries (insofar as the information provided permits).


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