Derivatives
Derivative instruments are used as financial management tools to enhance investment returns and to manage such risks relative to interest rates, exchange rates, and financial instrument and commodity prices. Several local and international banks, businesses, municipalities, and others have experienced significant losses with the use of derivatives. However, their use has increased as efforts to control risk in complex situations are perceived to be wise strategic decisions.
Sfas 133's Definition of a Derivative Instrument
In 1998, the Financial Accounting Standards Board (FASB) issued Statement on Financial Accounting Standards No. 133 (SFAS 133), Accounting for Derivative Instruments and Hedging Activities, which is effective for companies with fiscal years beginning after June 15, 2000. SFAS 133 establishes new accounting and reporting rules for derivative instruments, including derivatives embedded in other contracts, and for hedging activities. Derivatives must now be reported at their fair values in financial statements. Gains and losses from derivative transactions must be reported currently in income, except from those transactions that qualify as effective hedges.
According to Statement on Financial Accounting Standards (SFAS) 133, a derivative instrument is defined as a financial instrument or other contract that represents rights or obligations of assets or liabilities with all three of the following characteristics:
- It has (1) one or more underlyings and (2) one or more notional amounts or payment provisions or both.
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