The Matching Convention Provides Both the Basis for Hedge Accounting

question 84

Multiple Choice

The matching convention provides both the basis for hedge accounting, as well as the logic for the treating gains and losses from changes in fair value of fair value hedges differently from cash flow hedges.Which of the following is/are not true?

• A)In a fair value hedge of a recognized asset or liability, both the hedged asset (or liability) and its related derivative (hedging instrument) appear on the balance sheet.
• B)Remeasuring both the hedged asset (or liability) and its related derivative to fair value each period and including the gain or loss on the hedged asset (or liability) and the loss or gain on the derivative in net income results in a net gain or loss that indicates the effectiveness of the hedge in neutralizing the risk.
• C)If the hedge is completely effective, there is a zero net effect on income (the gain or loss on the hedged item exactly offsets the loss or gain on the hedging instrument).
• D)In a cash flow hedge of a forecasted transaction, the hedged cash flow commitment does not appear on the balance sheet but the derivative instrument does appear.
• E)Application of the matching convention results in classifying the gain or loss on the derivative instrument in net income each period.

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Definitions:

Risk-free Asset

An investment with a guaranteed return and no risk of financial loss.

Risky Asset

An investment that carries a significant possibility of losing some or all of its original value.

Delta

In finance, delta refers to the ratio that compares the change in the price of an asset, usually a derivative, to the corresponding change in the price of its underlying asset.