Reference no: EM13518229

1.Assume the same facts in the above question, except now assume that the option holders are Putter Corporation employees rather than the Caller Corporation.  Assume the options were issued as part of a compensation plan and that employees may either receive actual shares at $2 per share or a cash settlement for the difference between market price and the $2 strike price.

a. Yes, because there is no premium on a derivative having a  notional of 100,000 shares, an underlying of the price of the shares when the option is exercised, and net cash settlement provisions in lieu of delivering actual shares.  

b.  No, because the option can be settled by issuing previously authorized but unissued shares and, thereby,  does not require either cash settlement or the issuance of treasury shares that the Putter Corporation purchased on the open market.

c.  No, because SFAS 133 declares that stock-based compensation contracts are to be accounted for by SFAS 123 rather than SFAS 133.

d.  No since Putter Corporation is the option writer and written options are not accounted for as derivatives under SFAS 133 rules

2.   ABC Company issued long-term bonds paying 2% for the first 10 years and a variable rate of LIBOR plus 200 basis points thereafter.  The variable portion is to be viewed as a “fixed-to-floating” embedded derivative.  Can this derivative be accounted for apart from its host contract?

a.  Yes, because the contract can be viewed has having two independent parts, namely the fixed-rate part and the variable rate part.

b.  No, because Paragraph 13 states that a fixed-to-floating rate embedded derivative is “clearly-and-closely related” and, therefore does cannot be accounted for separately.

c.  No, because Paragraph 13b makes an exception to the “clearly-and-closely related” criterion if the embedded derivative can at least double the investor’s initial rate of return.  In the above example, the low 2% interest rate can easily be more than doubled.

d.  No because the contract cannot be viewed has having two independent parts, namely the fixed-rate part and the variable rate part.  There is no embedded derivative.

3. Suppose a bond receivable has a fixed coupon rate plus commodity options that add to the payments for rising prices of a commodity.  Will the derivatives be accounted for separately if the commodity is gold versus a rare metal that is not traded in an active market exchange?

a.  No, neither type of commodity in this case requires that the derivatives be accounted for separately.

b.  No, both types of commodities in this case require that the derivatives be accounted for separately.

c.  Yes, only the gold-based derivatives will be accounted for separately.

d.  Yes, only the rare metal derivatives will be accounted for separately.

4.  Suppose a bond receivable has a fixed coupon rate plus  options that add to the payments for rising prices of a  market-traded item.  Will the derivatives be accounted for separately if the item is gold versus an equity index Dow Jones Industrial Average stock index?

a.  No, neither type of item in this case requires that the derivatives be accounted for separately.

b.  No, both types of items in this case require that the derivatives be accounted for separately.

c.  Yes, only the gold-based derivatives will be accounted for separately. 

d.  Yes, only the equity-indexed derivatives will be accounted for separately

5.   Suppose a U.S. bank loans GE Sub $10 at 10% interest to be paid in GE Sub’s U.S. dollar functional currency.  However, suppose that the note stipulates that the principal can be repaid after one year with $10 or with 6.10 million Pounds Sterling.  How is the option to repay in Pounds Sterling accounted for under SFAS 133?

a.  The option is an embedded derivative that must be accounted for separately under SFAS 133.

b.  The option is an embedded derivative that is clearly-and-closely related to a point where the derivative  cannot be separated from the host note contract.

c.  The option is not an embedded derivative but it can be accounted for separately under SFAS 133.

d.  The Option is not an embedded derivative and it cannot be accounted for separately from the note.

6.   Company ABC holds 10,000 shares of Microsoft Corporation in a  portfolio that is deemed available-for-sale under SFAS 115.  To lock in a gain on the Microsoft Shares, the company enteres into a forward contract for Microsoft shares.  Is this forward contract required to be accounted for separately as a derivative under SFAS 133?

a.  It depends upon whether Company ABC’s own share prices are highly correlated with Microsoft share prices.

b.  Yes because SFAS 133 requires separate accounting for most equity-indexed derivatives.

c.  No, because SFAS 133 excludes derivatives that are equity-indexed.

d.  No, because the derivative is a forward contract rather than an exchange-traded futures contract whose value can be estimated using arms-length market prices.

7.   ABC Company enters an interest rate swap that swaps fixed-interest payments into LIBOR-based variable payments.  In addition, embedded into the contract is another derivative for an index-amortizing swap having a beginning notional of $10 million.  If LIBOR rises above 8% the notional rises to $12 million.  Is this embedded derivative swap within a swap required by SFAS 133 to be accounted for separately?  Note that the 

a.  No, because embedded derivatives within other embedded derivatives cannot be accounted for separately under  SFAS 133 coverage since they normally meet clearly-and-closely related criteria.

b.  No, because changes in the notional cannot be viewed as derivative instruments.

c.  Yes, because embedded derivatives within other embedded derivatives or nonderivatives may be accounted for separately under  SFAS 133 coverage.

d.  Yes, because changes in the notional must be viewed as derivative instruments.

8.  Shortline Company is due to acquire 10,000 shares of Microsoft Corporation in a court settlement of a bad debt. .  Assume that those shares, when acquired, will be available-for-sale and not trading securities.  Since the actual bankruptcy court settlement may take up to six months, Shortline hedges against a decline in Microsoft’s share prices by selling 10,000 shares short.  This is not entirely a naked short sale since the court has declared an eventual 10,000 share settlement.   Can this short position qualify as a fair value hedge under SFAS 133?

a.  Yes, because it hedges the fair value no matter whether the court settlement is viewed as a forecasted transaction or firm commitment.

b.  No, because all short sales are precluded from being fair value hedges.

c.  Maybe depending upon the unmentioned investment in the short sale and the firmness of the court settlement.  Shortline will never have to purchase the 10,000 shares whose value is being protected.  Hence there is no initial investment or commitment to purchase the shares themselves.  There may be unmentioned initial costs such as the legal costs.  The court settlement seems to be firm according to the wording of the question.  Hence, treating the short position as a fair value hedge appears to be a judgment call that is not explicitly covered in SFAS 133.

d.  No, because Shortline is the option writer in this case and written options cannot be hedges under SFAS 133 criteria for hedges.

9. Shortline Company purchases, an available-for-sale securities under SFAS 115,  1 million shares of Xerox Corporation and is restricted in the purchase contract from selling those shares for six months.   Shortline hedges against a decline in Xerox’s share prices by borrowing and equal number of shares of Xerox from a bank and immediately sells the borrowed shares at market price.   Can this short position qualify as a fair value hedge under SFAS 133?

a.  No, because Shortline made a huge initial investment in the short position by agreeing initially to return the borrowed shares.  Those shares must be eventually purchased or Shortline must pass along the 1 million shares previously purchased. 

b.  No, because all short sales are precluded from being fair value hedges.

c.  Maybe depending upon whether Shortline intends to purchase 10,000 additional shares to repay the loan or whether Shortline will use the 1 million Xerox shares that are already owned and in the vault.  Whether the short position is a fair value hedge appears to be a judgment call that is not explicitly covered in SFAS 133. 

d.  No, because Shortline is the option writer in this case and written options cannot be hedges under SFAS 133 criteria for hedges.

10.Swapline Corporation’s written swaption is designated as hedging a recognized asset or liability, the combination of the hedged item and the written option provides at least as much potential for

gais as a result of a favorable change in the fair value of the combined instruments as exposure to losses from an unfavorable change in their combined fair value. Will the test as a fair value hedge be met if all possible percentage favorable changes in the underlying (from zero percent to 100 percent) would provide at least as much gain as the loss that would be incurred from an unfavorable change in the underlying of the same percentage?

a.  Yes since a written option can be combined with any other nonopton derivative.

b.  No, swaptions cannot be cash flow hedges but not fair value hedges.

c.  No, swaptions cannot be any type of SFAS 133 hedge.

d.  No, since only the effective portion of the hedge can be posted to other comprehensive income.

11.  PutEmUp Corporation owns 25% of the shares of a company whose shares are actively traded over the counter.  The shares are accounted for by PutEmUp as an equity-method investment even though they constitute less than one percent of the outstanding shares.  To protect the value of this investment, PutEmUp purchase a put option   Can this option be a fair value hedge under SFAS 133?

a.  No, SFAS 133 explicitly disallows hedged items from being equity method security investments.

b.  Yes, SFAS 133 allows hedged items to be equity method investments if the shares are traded on stock exchanges or over-the-counter markets.

c.  No, Yes, SFAS 133 allows hedged items to be equity method investments if the shares are traded on stock exchanges but not over-the-counter markets.

d.  No, the eventual ownership must be 100% of the shares without any minority-interest ownership.

12. PutEmUp Corporation owns 55% of the shares of a company whose shares are actively traded over the counter.  In a scheduled estate auction, PutEmUp intends to purchase at a large block of shares that will raise its stake to 70% of the shares outstanding.  Assume that the price will be the current market rate on the date of the auction.  To hedge against price increase, PutEmUp negotiates a call option with the same number of shares.  Can this option be a cash flow hedge under SFAS 133?

a.  No, SFAS 133 explicitly disallows hedged items related-party contracts.  Since PutEmUp has more than 50% of the voting shares, the forecasted transaction cannot be a hedged item in this case.

b.  Yes, SFAS 133 allows hedged items to be equity method investments if the shares are traded on stock exchanges or over-the-counter markets.

c.  No, Yes, SFAS 133 allows hedged items to be equity method investments if the shares are traded on stock exchanges but not over-the-counter markets.

d.  No, the eventual ownership must be 100% of the shares without any minority-interest ownership.

13.  Home Oil Delivery, Inc. has a contract to purchase 100,000 gallons of home heating oil to be delivered in 30 days.  The price is to be the spot rate on the date of delivery.  Does this satisfy the SFAS criteria for a firm commitment?

a.  Yes as long as the contract cannot be easily broken without having to pay damages.

b.  No because SFAS 133 requires that the firm commitment be a recorded asset or liability.  The purchase contract for 100,000 gallons of fuel oil is not booked until the date of delivery and hence cannot be viewed as a firm commitment.  Traditional GAAP in the United States does not allow that such purchase contracts be booked as assets and liabilities.  

c.  No if this type of purchase is part of normal operations of this company.  Normal purchase and sale contracts cannot be firm commitments

d  No since the settlement price is not fixed at a given amount in the contract. 

14.  Can hedges against unrecognized (not booked as assets or liabilities) firm commitments be accounted for as hedges under SFAS 133?

a.  No for cash flow and no fair value hedges because the firm commitment is not booked as an asset or liability.

b.  Yes for cash flow hedges but no for fair value hedges because the firm commitment is not booked as an asset or liability

c.  No for cash flow hedges and yes for fair value hedges.

d.  Yes for cash flow hedges and yes for fair value hedges

15.  CostMe Corporation owns 10,000 shares of Private Busines Corporation (PBC).  Assume that PBC has 1,200,000 outstanding shares that are not actively traded in securities markets.  Such a small stake in a privately-held company allows CostMe to carry the investment at cost rather than equity under rules of APB 18.  Is this investment eligible for a fair value hedge using some type of derivative financial instrument?

a.  Yes but only if it is carried at cost and is not accounted for under the equity method.

b.  No as long as the accounting basis is cost rather than value.

c.  No irrespective of whether the cost or equity method is used for the 10,000 shares.

d.  None of the above.

16.  Does fair value remeasuring of assets and liabilities negate their ability to host a fair value hedge under SFA 133.  Let LCM depict lower-of-cost-or-market revaluations?  Let FV depict remeasurement above pr below historical cost.

a.  Yes for the case of  remeasurement downward under LCM and yes for  both ways under FV.

b.  Yes for the case of  remeasurement downward under LCM and no for both ways under FV.

c.  No for the case of  remeasurement downward under LCM and yes for  both ways under FV.

d.  No for the case of  remeasurement downward under LCM and no for  both ways under FV.

17.  CallEmUp Corporation paid $10,000 to acquire  futures contracts used as a cash flow hedge of a forecasted transaction.  Can a forward contract be used as a cash flow hedge and is this $10,000 to be used in measuring ineffectiveness of the hedge under SFAS 133 rules?

a.  Yes the futures contracts can be used for the cash flow hedge and yes the premium is included in measuring effectiveness.

b.  Yes the futures contracts can be used for the cash flow hedge and no the premium is included in measuring effectiveness.

c.  No the futures contracts can be used for the cash flow hedge and yes the premium is included in measuring effectiveness.

d.  No the futures contracts can be used for the cash flow hedge and no the premium is included in measuring effectiveness.

18.  WeSwappedEm Company used a swap to hedge cash flow risk of interest payments on a $1 million commercial note receivable.  The Company was forced at a later time to take lower payments reducing the note’s present value, under SFAS 114 impairment tests, to $800,000.   Should both the value of the note and the interest rate swap be remeasured?

a.  The note should be written down;  The interest rate swap should be written down.

b.  The note should be written down;  The interest rate swap should not be written down.

c.  The note should not be written down;  The interest rate swap should be written down.

d.  The note should not be written down;  The interest rate swap should not be written down.

19.  Wheatery Flour Company is uncertain about both the price of wheat and how many bags of flour will be sold each month over the next six months for forecasted sales at $5 per bag.  This company enters into a futures contract in wheat to hedge the forecasted flour sales.  Is this a cash flow hedge under SFAS 133 rules?

a.  No, because any futures contract does not qualify as a derivative instrument under SFAS 133.  

b.  No, because any futures contract does not qualify for cash flow hedging under SFAS 133.  Futures contracts may only be used for fair value hedging.

c.  Yes, because this contract meets both the derivative and cash flow tests of SFAS 133.

d.  No, because the uncertainty in sales volume makes the contract too uncertain to qualify as a forecasted transaction.

20.  Which statement below is the most correct in terms of a cash flow hedge under SFAS 133?  Assume that the writer of the option within a swaption is termed the writer of the swaption.

a.  A swaption can be a cash flow hedge without regard to who wrote the swaption.

b.  A written swaption cannot be a cash flow hedge, but a swaption might be a cash flow hedge if the company is not the writer of the swaption.

c.  A company must be the writer of a swaption in order for that swaption to be a cash flow hedge.

d.  A written swaption may be a cash flow hedge but is subject to added constraints that it must provide at least as much potential for favorable cash flows as exposure to unfavorable cash flows.