Chapter A, Problem 2Q

To determine

Derivatives: Derivatives are some financial instruments which are meant for managing risk and safeguard the risk created by other financial instruments. These financial instruments derive the values from the future value of underlying security or index. Some examples of derivatives are forward contracts, interest rate swaps, futures, and options.

Hedging: This is the business deal entered into, by a company to produce exposure or coverage over the exposure caused by the existing deal. In simple terms, this is the transaction which produces gains to cover the losses produced by existing transaction.

Fair value hedge: If the company uses any derivative to cover the risk due to fair value changes of asset, liability, or a commitment, the derivative is classified as fair value hedge.

To explain: Whether the gains and losses on fair value hedge should be recorded immediately, or should be included in the gains and losses on the item being hedged