Question 1

Derivatives are sometimes called "secondary" financial instruments:

Accepted Answer

Derivatives are called secondary financial instruments because their value is derived from the value of an underlying asset, such as a stock, bond, currency, or commodity. They are not assets in themselves, but rather represent a "bet" on the future price movement of the underlying asset.

Question 2

A key characteristic of a financial instrument is that it involves the ultimate transfer of an equity instrument:

Accepted Answer

A financial instrument refers to a contract between two parties that involves the exchange of cash or another financial asset. It does not necessarily involve the transfer of an equity instrument. Financial instruments can include stocks, bonds, options, futures, and more.

Question 3

AASB 132 does not apply to obligations arising under insurance contracts:

Accepted Answer

AASB 132 specifically excludes insurance contracts from its scope of application. The accounting treatment for insurance contracts is governed by AASB 17 Insurance Contracts.

Question 4

Once a financial instrument has been classified as a liability in the balance sheet, under AASB 132 the reporting entity is not permitted to reclassify it unless a specific transaction or other specific action by the holder or issuer of the instrument alters the substance of the financial instrument:

Accepted Answer

Under AASB 132, once a financial instrument has been classified as a liability, it cannot be reclassified unless there is a specific transaction or action that alters its substance.

Question 5

In a convertible note, the embedded option to convert the liability into the equity of the issuer has a fair value of zero on initial recognition when the option is out of the money.

Accepted Answer

On initial recognition, even if the option to convert the liability into equity (embedded in a convertible note) is out of the money, it does not necessarily have a fair value of zero. The fair value is determined based on the potential for the option to become valuable over time, considering factors like volatility, the term of the note, and the likelihood of the underlying equity's value increasing.

Question 6

A change in classification of a financial instrument may occur as a result of "revised probabilities" of, for example, conversion:

Accepted Answer

The answer of A change in classification of a financial...

Question 7

Derivative instruments generally result in a transfer of the underlying primary financial instrument on maturity of the contract.

Accepted Answer

Derivative instruments do not generally result in a transfer of the underlying primary financial instrument on maturity of the contract, but rather a settlement based on the contract terms. The underlying instrument is only transferred if specified in the contract terms.

Question 8

An entity that holds a well diversified portfolio of shares and wishes to use futures to protect its investments for possible downturns should enter into a sell position in a futures contract.

Accepted Answer

By entering into a sell position in a futures contract, the entity can hedge against potential losses in the value of their portfolio. If the market experiences a downturn, the losses in the portfolio can be offset by gains in the futures contract. This strategy is often referred to as a "short hedge."

Question 9

Companies may be motivated to enter into a foreign currency swap in order to hedge receivables held in the currency of the loan, the obligations of which they will undertake in the swap:

Accepted Answer

A foreign currency swap allows companies to exchange one currency for another at an agreed upon exchange rate, and can be used as a hedging tool for receivables held in a foreign currency. By entering into a swap, the company can protect themselves against potential losses if the foreign currency depreciates, as they will have locked in a fixed exchange rate. Additionally, by undertaking the obligations of the swap, the company can effectively offset their foreign currency receivables with an equal amount of foreign currency debt, reducing the risk of currency fluctuations.

Question 10

Compound instruments contain both a financial liability and equity component but exclude convertible notes:

Accepted Answer

Compound instruments, such as convertible notes, indeed contain both a financial liability and equity component, as the conversion feature is considered an equity component.

Question 11

In a convertible note, AASB 139 "Financial Instruments: Recognition and Measurement" requires the holder of such financial instrument to present the liability component and the equity component separately on the statement of financial position.

Accepted Answer

The answer of In a convertible note, AASB 139 "Financial...

Question 12

When initially recognising the liability and equity components of a compound financial instrument, gains and losses arise and must be recogniseD.

Accepted Answer

When initially recognizing the liability and equity components of a compound financial instrument, no gains or losses are recognized. The instrument is split into its liability and equity components based on their fair values at the time of issuance.

Question 13

The most commonly issued equity instrument would be a redeemable preference share:

Accepted Answer

The most commonly issued equity instrument is ordinary shares. Redeemable preference shares are a type of preference share that can be redeemed by the issuer after a certain period of time. However, they are not as common as ordinary shares.

Question 14

The former AASB 1033 did not consider the measurement and recognition of financial instruments and the introduction of AASB 139 has filled that void.

Accepted Answer

The former AASB 1033 did not deal with financial instrument measurement and recognition, which has been addressed by AASB 139.

Question 15

An entity that has taken a buy position in a futures contract on a particular item will make a gain when the price of the item decreases:

Accepted Answer

When an entity takes a buy position in a futures contract, it is expecting the price of the item to increase. Therefore, the entity will make a gain when the price of the item increases, not when it decreases.

Question 16

It has been common practice to keep derivative financial instruments 'off balance sheet':

Accepted Answer

Keeping derivative financial instruments off balance sheet has been a common practice in the past, although recent financial reporting regulations have made it necessary for some companies to include them on the balance sheet.

Question 17

A put option on a company's shares entitles the holder to buy that company's shares at a future time for a prespecified price:

Accepted Answer

A put option on a company's shares entitles the holder to sell the company's shares at a future time for a prespecified price, not to buy them.

Question 18

Under AASB 139, an entity is required to recognise a financial asset or liability on its statement of financial position when and only when, it becomes a party to the contractual provisions of the instrument.

Accepted Answer

AASB 139 requires recognition of a financial asset or liability on the statement of financial position when an entity becomes a party to the contractual provisions of the instrument.

Question 19

For a designated cash flow hedge, AASB 139 "Financial Instruments: Recognition and Measurement" requires the gain or loss on the hedging instrument to be transferred initially to equity and subsequently to profit or loss to offset the gains or losses on the hedged item.

Accepted Answer

This is consistent with the requirements of IAS 39 Financial Instruments: Recognition and Measurement, the predecessor to the current IFRS 9 Financial Instruments standard, which has superseded AASB 139 in Australia.

Question 20

The central issue in classifying a financial liability is the existence of a present obligation:

Accepted Answer

The answer of The central issue in classifying a financial...

Quiz 15: Accounting for Financial Instruments