DM–1
DERIVATIVES MODULE
UNDERSTANDING THE ISSUES
1. The intrinsic value of a forward contract to
sell a commodity or currency is determined
by comparing the spot rate/price at the date
of inception of the forward to the spot
rate/price at a later valuation date. At date
of inception of the forward, the difference
between the forward rate and spot
the current spot price. The difference be-
tween these two values times the notional
amount represents the total intrinsic value.
The time value of an option is measured by
subtracting the intrinsic value from the total
value of the option.
2. A firm commitment to sell inventory is fixed
in terms of the quantity, price, and delivery
ment.
3. A cash flow hedge of a forecasted transac-
tion affects both current and future operat-
ue increases $700, then the time value has
decreased by $200. This $200 change
would be recognized in current income.
Changes in the intrinsic value over time are
initially recorded as a component of other
comprehensive income and therefore do
not currently impact operating income.
4. Unlike a futures contract, an option contract
represents a right, rather than an obliga-
tion. While the option contract requires the
holder to make an initial nonrefundable
cash outlay, the holder can allow the option
to expire in unfavorable conditions. In the
case of a futures contract, the contract
6.5% fixed in exchange for receipt of a
variable rate of LIBOR plus 2%. If LIBOR is
greater than 4.5%, the borrower will gain