Help please
cornflower
Registered Posts: 129 ? ? ?
I have just passed ACCA P2 and my boyfriend has asked me for help on this question as he is studying MSC in Accounting but I'm totally baffled by it. It's on hedge accounting and whether a hedge is effective or not. If anyone can help I'd be most grateful. Here is the question:
Entity A has a C1000 debt at 10% fixed rate with a 2 year term. Interest payments are made annually. In order to hedge against future changes in interest rates it enters into a 2 year C1000 notional interest rate swap requiring interest payments at 1 year LIBOR in exchange for the receipt of fixed interest at 10%. At inception LIBOR is expected to be 10% for the following 2 years but at the end of year 1 it is expected to be 5% for the 2nd year.
Perform a hedge effectiveness test at the end of year 1 in accordance with IAS39 principles.
Entity A has a C1000 debt at 10% fixed rate with a 2 year term. Interest payments are made annually. In order to hedge against future changes in interest rates it enters into a 2 year C1000 notional interest rate swap requiring interest payments at 1 year LIBOR in exchange for the receipt of fixed interest at 10%. At inception LIBOR is expected to be 10% for the following 2 years but at the end of year 1 it is expected to be 5% for the 2nd year.
Perform a hedge effectiveness test at the end of year 1 in accordance with IAS39 principles.
0
Comments

Sorry but I have posted in wrong forum as well.0

Hi,
It's been a while since I did a hedge calculation, but here goes!
At the end of year 1 your retrospective test would be as follows:
Hedged item:
Fair value at inception.....................................1,000
Fair value at end of year 1:
C1,000 x 1.10/1.05.........................................1,048
Change in fair value...........................................(48)
Hedging instrument:
Fair value at inception..........................................0
Fair value at end of year 1 = C50 / 1.05................48
Change in fair value............................................48
The C50 is the difference in anticipated swap cash flows (C1,000 x (10%  5%))
Offset test at the end of year 1
Change in fair value of heding instrument / change in fair value of hedged item, so:
48 / 48 = 1.
The hedge is currently 100% effective.
The chances are that if there had been a contractual diff, or a delay in the timing of cash flows (either on the debt or the swap), or if hedge effectiveness is tested at a date other than the swap repricing date then there would undoubtedly be some hedge ineffectiveness. In your Q also there is no mention of any credit risk in the swap payments and such credit risk also has the potential of introducing some ineffectiveness.
Hope that helps.
Steve0 
Thanks so much Steve0
Categories
 All Categories
 1.2K Books to buy and sell
 2.3K General discussion
 18.9K For AAT students
 248 NEW! Qualifications 2022
 138 General Qualifications 2022 discussion
 8 AAT Level 2 Certificate in Accounting
 33 AAT Level 3 Diploma in Accounting
 59 AAT Level 4 Diploma in Professional Accounting
 8.9K For accounting professionals
 23 coronavirus (Covid19)
 274 VAT
 92 Software
 274 Tax
 136 Bookkeeping
 7.3K General accounting discussion
 193 AAT member discussion (AATQB, MAAT, FMAAT and AAT Licensed Accountants and Bookkeepers)
 3.8K For everyone
 39 AAT news and announcements
 352 Feedback for AAT
 2.8K Chat and offtopic discussion
 589 Job postings
 17 Who can benefit from AAT?
 36 Where can AAT take me?
 44 Getting started with AAT
 26 Finding an AAT training provider
 48 Distance learning and other ways to study AAT
 25 Apprenticeships
 65 AAT membership