CFA Practice Question

There are 89 practice questions for this study session.

CFA Practice Question

A firm uses the protective put strategy to protect its stock portfolio from severe drops in value. Assume the hedge is perfect: the gain or loss on the put options will exactly offset the gain or loss of the stock portfolio. What accounting treatment(s) is (are) true regarding the transaction?

I. The put options bought by the firm should be reported at fair value on the balance sheet.
II. The stock portfolio should be reported at fair value on the balance sheet.
III. The unrealized gains or losses from the put options should be recognized in the income statement.
IV. The unrealized gains or losses from the put options should not be recognized until the options are exercised or sold.
A. I, II and IV.
B. II and III.
C. I, II and III.
Explanation: Both the derivatives and the hedged asset (stock portfolio) should be reported on the balance sheet at fair value. Any unrealized gains or losses from both the derivatives and the hedged asset should be recognized in the income statement.

User Contributed Comments 7

User Comment
HenryQ It this a fair value hedge or cash flow hedge?
noonah This is a fair value hedge because it is hedging an asset (stock portfolio). In a fair value hedge all G/L from the derivative and the underlying go to Income Statement.

HenryQ: a cash flow hedge would be a derivative hedging expected receipt/outlay in cash in the future.
dblueroom what's the treatment of g/l arising from cash flow hedge? I guess bypass the income statement and recorded under shareholder's equity?
yxten1 Unrealized gain/loss for fair value hedge to be reported in Income Statement
Profache Those securities are for trade purposes, so unrealised gains/losses are reported on the Income Statement.

Securities that are available for sale (not the case here) have unrealised gain/losses reported on Other Comprehensive Income. Both are reported as fair value.

Securities which will be held until maturity (again, not the case here) are reported at cost.
somk i thought the question was about hedging. where does it say the securities r 4 trade purposes?
D3456 So I'm assuming almost all derivatives are classified as trading securities? I know they cannot be held to maturity, but they can't be available for sale?
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