______

Name (Please Print)

ACCT 5341 Examination 1

Dr. Jensen

Spring 1999

Part 1 (Multiple Choice)

  • Choose the best answer to each question when more than one answer is correct.
  • Answers are to be recorded both on the question sheet and on the answer sheet.
  • The term “earnings” does not include “comprehensive earnings.”
  1. (03 Points) What contract below is not eligible for hedge accounting under SFAS 133?
    a. Embedded call option
    b. Forward rate agreement
    c. Covered call [XXXXX Para 399]
    d. Interest rate futures
  2. (03 Points) The price of a block of 10,000 options may be different than the price of a single option if all 10,000 are sold in a block. SFAS 133 requires a fair market value blockage adjustment as follows:
    a. Upward
    b. Downward
    c. Both answers a and b above
    d. Neither answers a or b above [XXXXX Para 315]
  3. (03 Points) Suppose that a change in the price of a lumber inventory forecasted purchase (as opposed to a firm commitment) is hedged by a forward contract designated in advance as a cash flow hedge. The hedge may result in which of the following outcomes, relative to having no hedge, in periods prior to the purchase of the inventory?
    a. The hedge may reduce reported earnings prior to the transaction
    b. The hedge may increase reported earnings prior to the transaction
    c. Both answers a and b are possible depending upon the direction of the price movements
    d. None of the above since this hedge does not affect reported earnings prior to the purchase transaction or dedesignation. [XXXXX Para 152]
  4. (03 Points) Suppose that a change in the price of a lumber inventory forecasted purchase (as opposed to a firm commitment) is hedged by a forward contract designated in advance as a cash flow hedge. An ineffective hedge may result in which of the following outcomes relative to an effective hedge in periods prior to the purchase of the inventory?
    a. Ineffectiveness may reduce reported earnings prior to the transaction
    b. Ineffectiveness may increase reported earnings prior to the transaction
    c. Both answers a and b are possible depending upon the direction of the hedge’s ineffectiveness
    d. None of the above since ineffectiveness does not affect reported earnings prior to the purchase [XXXXX]
  5. (03 Points) Suppose that a change in the price of a lumber inventory forecasted sale is hedged by a forward contract designated in advance as a cash flow hedge. The hedge may result in which of the following outcomes relative to having no hedge in periods prior to the sale of the inventory?
    (Assume the inventory is on hand and that the sales price of the inventory always exceeds the original purchase price.)
    a. The hedge may reduce reported earnings prior to the transaction
    b. The hedge may increase reported earnings prior to the transaction
    c. Both answers a and b are possible depending upon the direction of the price movements
    d. None of the above since this hedge does not affect reported earnings prior to the sale transaction [XXXXX Para 129]
  6. (03 Points) Suppose that a change in the price of a lumber inventory forecasted sale is hedged by a forward contract designated in advance as a cash flow hedge. An ineffective hedge will result in which of the following outcomes relative to an effective hedge in periods prior to the sale of the inventory?
    (Assume the inventory is on hand and that the sales price of the inventory always exceeds the original purchase price.)
    a. Ineffectiveness may reduce reported earnings prior to the transaction
    b. Ineffectiveness may increase reported earnings prior to the transaction
    c. Both answers a and b are possible depending upon the direction of the hedge’s ineffectiveness
    d. None of the above since ineffectiveness does not affect reported earnings prior to the sale transaction [XXXXX]
  7. (03 Points) Suppose that a change in the price of a lumber inventory forecasted sale is hedged by a forward contract designated in advance as a fair value hedge. The hedge may result in which of the following outcomes relative to an effective hedge in periods prior to the sale of the inventory?
    (Assume the inventory is on hand and that the sales price of the inventory always exceeds the original purchase price.)
    a. The hedge may reduce reported earnings prior to the transaction
    b. The hedge may increase reported earnings prior to the transaction
    c. Both answers a and b are possible depending upon the direction of the price movements [XXXXX Para 107 and Para 109 ]
    d. None of the above since this hedge does not affect reported earnings prior to the sale transaction
  8. (03 Points) Suppose that a change in the price of a lumber inventory forecasted sale is hedged by a forward contract designated in advance as a fair value hedge. An ineffective hedge will result in which of the following outcomes relative to an effective hedge in periods prior to the sale of the inventory?
    (Assume the inventory is on hand and that the sales price of the inventory always exceeds the original purchase price.)
    a. Ineffectiveness may reduce reported earnings prior to the transaction
    b. Ineffectiveness may increase reported earnings prior to the transaction
    c. Both answers a and b are possible depending upon the direction of the hedge’s ineffectiveness movements [XXXXX Para 107 and Para 109 ]
    d. None of the above since ineffectiveness does not affect reported earnings prior to the sale transaction
  9. (03 Points) Suppose a forward contract is used as a fair value foreign currency hedge of an asset denominated in Mexican pesos. Hedge effectiveness is judged by comparing changes in the fair value of the forward contract with changes in the fair value of the U.S. dollar vis-à-vis the peso. What will be the impact of hedge ineffectiveness?
    a. No impact since only cash flow hedges are subject to hedge accounting that may be judged ineffective.
    b. No impact if the asset is an available-for-sale security denominated in pesos.
    c. No impact if the asset is a firm commitment at a future date rather than an available-for–sale asset. [XXXXX Para 125 on Page 68]
    d. None of the above answers are correct.
  10. (03 Points) Suppose a company enters into an interest rate swap as a cash flow hedge of variable interest rate debt. Present value of each swap settlement is computed according to which of the following answers assuming an upward sloping yield curve?
    a. Use a constant discount rate computed as a weighted average of the yield rates.
    b. Use a constant discount rate equal to the simple average of the yield rates.
    c. Use a constant discount rate equal to the final period’s yield rate.
    d. None of the above answers are correct. [XXXXX Para 137 on Page 74]
  11. (03 Points) SFAS 133 limits hedge accounting to which of the following relationships?
    a. Only cash flow hedges of derivative financial instruments.
    b. Cash flow hedges of derivative financial instruments and certain fair value foreign-currency-denominated nonderivative instruments. [XXXXX Para 246 on Page 131]
    c. Cash flow hedges and fair value hedges that reduce market risk exposures.
    d. Any derivative or nonderivative financial instrument for which there is no credit risk.
  12. (03 Points) The FASB’s stated long-term objective of having all derivative and nonderivative financial instruments booked at fair value on any reporting date would have what impact on hedge accounting?
    a. This would eliminate all hedge accounting treatments for financial instruments. [XXXXX Para 247 on Page 132]
    b. This would have no impact on SFAS 133 hedge accounting rules unless the FASB changed SFAS 133.
    c. This would eliminate cash flow hedges but not foreign currency hedge accounting.
    d. Irrespective of possible answers above, the FASB has never declared that its long-term objective is to require fair value reporting of all financial instruments.
  13. (03 Points) Which of the following restrictions apply to an underlying of a derivative financial instrument?
    a. The underlying must always be a market price or an interest rate derived from financial markets.
    b. The underlying may be most any external index including official rainfall on a given day or the outcome of a NFL game between the Green Bay Packers versus the Minnesota Vikings.
    c. The underlying may be most any index that is stated in monetary terms (thereby excluding rainfall amounts or sports scores). [XXXXX Para 10e on Page 6 and Para 252 on Page 134]
    d. None of the above answers are correct.
  14. (03 Points) Which of the following cannot be an underlying according to SFAS 133?
    a. Sales revenue attained by one of the contracting parties.
    b. Independent appraisal of a building owned by one of the contracting parties.
    c. Both of the above answers are correct. [XXXX Para 253 on Page 134]
    d. None of the above answers are correct.
  15. (03 Points) SFAS 133 net settlement provisions call for settlement to be in cash or in assets easily converted into cash. Which of the following does not meet the net price settlement test to qualify as a derivative financial instrument in contract between Intel Corporation and General Electric?
    a. Corn prices on the Chicago Board of Trade exchange.
    b. The price of a common stock of Microsoft Corporation.
    c. The price of the common stock of Intel Corporation. [XXXXX Paragraph 286]
    d. All of the above prices qualify since they are easily converted into cash in an organized market exchange.
  16. (03 Points) Which of the following embedded derivatives serves to disqualify the derivative from SFAS 133 accounting rules?
    a. A prepayment option of a mortgage loan.
    b. An interest-only strip embedded derivative.
    c. A principal-only strip embedded derivative.
    d. All of the above answers are correct. [XXXXX Para 293 on Page 146, Para 310 on Page 152, and Paragraph 10 on Page ]
  17. (03 Points) Which of the following types of contracts are generally excluded from SFAS 133 accounting rules (including fair market value adjustment rules)?
    a. A sales contract by Intel Corporation for microprocessors manufactured by Intel.
    b. A purchase contract by Dell Corporation for microprocessors to be used in Dell computers.
    c. A “regular-way” securities trade contract.
    d. All of the above answers are correct. [XXXXX Paragraph 10 on Page 5]
  18. (03 Points) The FASB’s Exposure Draft 162-B required that both the host contract and its embedded derivatives be accounted for as a derivative contract. What happened to this provision in SFAS 133?
    a. The provision remains the same in SFAS 133.
    b. The provision is changed in SFAS 133 to allow for separate treatments of derivative versus nonderivative components. [XXXXX Para 299 on Page 148]
    c. Nonderivative components are never allowed to be accounted for as hedges under SFAS 133.
    d. Both Answers c and d above are correct.
  19. (03 Points) The “clearly-and-closely related” provisions of SFAS 133 apply mainly to which of the following?
    a. A decision as to whether an embedded derivative is subject to SFAS 133 accounting rules.
    b. A decision as to whether an embedded derivative will be accounted for separately from its host contract. [XXXXX Para 304 on Page 150]
    c. The degree of ineffectiveness of an interest rate swap contract.
    d. The degree of ineffectiveness of a foreign currency hedging contract.
  20. (03 Points) For purposes of fair value measurement, SFAS 133 relies most heavily upon which prior standard?
    a. SFAS 105
    b. SFAS 107 [ XXXXX Para 313 on Page 153]
    c. SFAS 115
    d. SFAS 131
  21. (03 Points) SFAS 133 hedge accounting rules for fair value hedges arise primarily because of?
    a. Lobbying pressure by constituents (e.g., banks) to defer some derivative gains and losses in comprehensive income rather than having to book such fluctuations in earnings over the hedging period.
    b. Pressures by the SEC to bring SFAS 133 rules more in line with existing international standards.
    c. FASB intentions to incrementally move towards fair value accounting for all financial instruments, but the FASB feels that it is too much of a shock for constituents to abruptly shift to fair value accounting for all such instruments. . [XXXXX Para 247 on Page 132, Para 331 on Page 159, Para 335 on Page 160, and Para 321 on Page 156]
    d. None of the above.
  22. (03 Points) The FASB feels that differences between forecasted transactions and firm commitments are which of the following?
    a. inconsequential and have no bearing on differences between accounting for forecasted transactions versus firm commitments since neither appear in traditional financial statements.
    b. important only in foreign currency hedge accounting differences arising from firm commitments versus forecasted transactions.
    c. important with respect to market price accounting differences arising from firm commitments versus forecasted transactions. [XXXXX Firm commitments do not need cash flow hedges. See Cash Flow Hedge in Bob Jensen’s SFAS 133 Glossary. Also see KPMG Example 21 on Page 229.]
    d. None of the above are correct.
  23. (03 Points) Under Paragraph 29c of SFAS 133, a forecasted transaction between a parent company and its subsidiary can be accounted for as a cash flow hedge under the conditions that:
    a. Less than 100% of the voting shares of the subsidiary are owned by the parent.
    b. Both parties can enter into a similar transaction with a non-related entity if it is beneficial to the consolidated entities as a whole.
    c. The transaction meets certain tests as a foreign currency hedge. [XXXXX Para 40 on Pagers 25-26.]
    d. There are no conditions in which transactions between related parties can be accounted for as a hedge under SFAS 133.
  24. (03 Points) Suppose General Electric uses the U.S. dollar as its functional currency and has a Mexican peso debt requiring peso interest payments. Which statement below is the most correct?
    a. The foreign exchange risk in pesos cannot be designated as a cash flow hedge, because the peso debt obligation should be remeasured at current spot rates on each reporting date with changes in those spot rates being recognized as current earnings.
    b. The interest rate risk can be designated as a cash flow hedge, because the interest rate risk is not remeasured each period.
    c. Both answers above. [XXXXX KMPG example in Para 40.08 on Page 254 of Handbook, which in turn is related to Para 29d of SFAS 133]
    d. None of the answers above.
  25. (03 Points) ABC loans $10 million to an oil company under terms where the bonds guarantee a coupon payment of 10% and repayment of all principal. In addition, however, the bonds make a knock-in added payment of 1% for each period’s average daily crude oil price in excess of $15 per barrel. The coupon payments thus have both a 10% bond coupon payment and an embedded derivative for the knock-in payments. Does the embedded derivative meet the clearly-and-closely related tests to be accounted with the bonds or must this derivative be accounted for separately from its host contract?
    a. The embedded derivative meets the closely and clearly related tests, but since the amounts are speculative, the derivative cannot be viewed as a hedge.
    b. The embedded derivative meets the closely and clearly related tests and can be viewed as a fair value hedge.
    c. The embedded derivative meets the closely and clearly related tests and can be viewed as a cash flow hedge.
    d. None of the above answers is a correct answer. [XXXXX Paragraph 61i on Page 43 of SFAS 133. Also see KPMG on Page 51]
  26. (03 Points) Creditor C loans Borrower B $10 million with an option to convert each bond into 20 shares of Borrower B’s common stock. Assume that those shares, if acquired, would be available-for-sale and not trading securities. Answer the following according to SFAS 133 revisions of SFAS 115 rules.
    a. Creditor C has an embedded derivative that is clearly-and-closely related to the loan and the bonds receivable and the derivative are not accounted for separately.
    b. Creditor C has an embedded derivative that is not clearly-and-closely related to the loan and the bonds receivable and the derivative are not accounted for separately. [XXXXX Paragraph 61k on Page 43 of SFAS 133. Also see Paragraphs 304-311 beginning on Page 150 of SFAS 133. Also see KPMG Page 51.]
    c. Creditor C has an embedded derivative that is clearly-and-closely related to the loan and the bonds receivable and the derivative are accounted for separately.
    d. None of the above.
  27. (03 Points) Creditor C loans Borrower B $10 million with an option to convert each bond into 20 shares of Borrower B’s common stock. Assume that those shares, if acquired, would be available-for-sale and not trading securities. Answer the following according to SFAS 133 revisions of SFAS 115 rules..
    a. Borrower B has an embedded derivative that is clearly-and-closely related to the loan and the bonds payable and the derivative are notaccounted for separately.
    b. Borrower B has an embedded derivative that is not clearly-and-closely related to the loan and the bonds payable and the derivative are not accounted for separately.
    c. Borrower B has an embedded derivative that is clearly-and-closely related to the loan and the bonds payable and the derivative are accounted for separately.
    d. None of the above. [XXXXX Borrower B is the option writer. Written options are not derivative instruments according to Paragraph 28c, 91, and 396-401 of SFAS 133. Also see Paragraph 61k on Page 43 and KPMG Page 51.]
  28. (03 Points) Creditor C loans Borrower B $10 million with interest to be paid periodically at a fixed rate in European Euros. The interest may thus vary when converted into U.S. dollars. Answer the following according to SFAS 133 revisions of SFAS 52 rules.
    a. Creditor C has an embedded derivative that is subject to SFAS 52 rules and the bonds receivable and the derivative are notaccounted for separately. . [XXXXX Paragraph 15 on Page 8 of SFAS 133. Also see KPMG Page 53]
    b. Creditor C has an embedded derivative thatis notsubject to SFAS 52 rules and the bonds receivable and the derivative are not accounted for separately.