ipsas 29—financial instruments: recognition and measurement - IFAC

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FINANCIAL INSTRUMENTS: RECOGNITION AND MEASUREMENT Illustrative Examples These examples accompany, but are not part of, IPSAS 29. Hedging Interest Rate Risk for a Portfolio of Assets and Liabilities IE1. On January 1, 20X1 Entity A identifies a portfolio comprising assets and liabilities whose interest rate risk it wishes to hedge. The liabilities include demandable deposit liabilities that the depositor may withdraw at any time without notice. For risk management purposes, the entity views all of the items in the portfolio as fixed rate items. IE2. For risk management purposes, Entity A analyzes the assets and liabilities in the portfolio into repricing time periods based on expected repricing dates. The entity uses monthly time periods and schedules items for the next five years (i.e., it has 60 separate monthly time periods). 3 The assets in the portfolio are prepayable assets that Entity A allocates into time periods based on the expected prepayment dates, by allocating a percentage of all of the assets, rather than individual items, into each time period. The portfolio also includes demandable liabilities that the entity expects, on a portfolio basis, to repay between one month and five years and, for risk management purposes, are scheduled into time periods on this basis. On the basis of this analysis, Entity A decides what amount it wishes to hedge in each time period. IE3. This example deals only with the repricing time period expiring in three months’ time, i.e., the time period maturing on March 31, 20X1 (a similar procedure would be applied for each of the other 59 time periods). Entity A has scheduled assets of CU100 million and liabilities of CU80 million into this time period. All of the liabilities are repayable on demand. IE4. Entity A decides, for risk management purposes, to hedge the net position of CU20 million and accordingly enters into an interest rate swap 4 on January 1, 20X1, 1 to pay a fixed rate and receive London Interbank Offered Rate (LIBOR), with a notional principal amount of CU20 million and a fixed life of three months. IE5. This example makes the following simplifying assumptions: (a) The coupon on the fixed leg of the swap is equal to the fixed coupon on the asset; 3 In this example principal cash flows have been scheduled into time periods but the related interest cash flows have been included when calculating the change in fair value of the hedged item. Other methods of scheduling assets and liabilities are also possible. Also, in this example, monthly repricing time periods have been used. An entity may choose narrower or wider time periods. 4 This example uses a swap as the hedging instrument. An entity may use forward rate agreements or other derivatives as hedging instruments. 1269 IPSAS 29 ILLUSTRATIVE EXAMPLES PUBLIC SECTOR
FINANCIAL INSTRUMENTS: RECOGNITION AND MEASUREMENT (b) The coupon on the fixed leg of the swap becomes payable on the same dates as the interest payments on the asset; and (c) The interest on the variable leg of the swap is the overnight LIBOR rate. As a result, the entire fair value change of the swap arises from the fixed leg only, because the variable leg is not exposed to changes in fair value due to changes in interest rates. In cases when these simplifying assumptions do not hold, greater ineffectiveness will arise. (The ineffectiveness arising from (a) could be eliminated by designating as the hedged item a portion of the cash flows on the asset that are equivalent to the fixed leg of the swap). IE6. It is also assumed that Entity A tests effectiveness on a monthly basis. IE7. The fair value of an equivalent non-prepayable asset of CU20 million, ignoring changes in value that are not attributable to interest rate movements, at various times during the period of the hedge is as follows: Fair value (asset) (CU) IPSAS 29 ILLUSTRATIVE EXAMPLES 1270 Jan 1, 20X1 Jan 31, 20X1 Feb 1, 20X1 Feb 28, 20X1 Mar 31, 20X1 20,000,000 20,047,408 20,047,408 20,023,795 Nil IE8. The fair value of the swap at various times during the period of the hedge is as follows: Fair value (liability) (CU) Jan 1, 20X1 Jan 31, 20X1 Feb 1, 20X1 Feb 28, 20X1 Mar 31, 20X1 Nil (47,408) (47,408) (23,795) Nil Accounting Treatment IE9. On January 1, 20X1, Entity A designates as the hedged item an amount of CU20 million of assets in the three-month time period. It designates as the hedged risk the change in the value of the hedged item (i.e., the CU20 million of assets) that is attributable to changes in LIBOR. It also complies with the other designation requirements set out in paragraphs 98(d) and AG162 of the Standard. IE10. Entity A designates as the hedging instrument the interest rate swap described in paragraph IE4. End of Month 1 (January 31, 20X1) IE11. On January 31, 20X1 (at the end of month 1) when Entity A tests effectiveness, LIBOR has decreased. Based on historical prepayment experience, Entity A estimates that, as a consequence, prepayments will occur faster than previously estimated. As a result it re-estimates the amount of assets scheduled into this time period (excluding new assets originated during the month) as CU96 million.
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ipsas 29—financial instruments: recognition and measurement - IFAC

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