1. Explain the purpose of derivatives.

Derivatives are instruments that are used to manage financial risk. The primary
objective of derivatives is to predict and reduce the financial risk. It allows an entity to
speculate on or hedge against future changes in market factors at minimal initial cost.
Examples are call options, put options, forwards, futures, and swaps. It may also be
traded over the counter or on a formal exchange.

2. Explain the measurement of derivatives

All derivatives are measured at Fair value. The accounting for changes in fair value
depends on whether the derivative is:
• The derivative is not designated as a hedging instrument.
• The derivative is designated as a cash flow hedge.
• The derivative is designated as a fair value hedge.

3. Explain the recognition of changes in fair value of derivatives

If the derivative is not designated as a hedging instrument, changes in fair value
of a derivative that is not designated as a hedging instrument shall be recognized in profit
of loss. In this case. The derivative can be thought of as speculation. But if the derivative
is designated as a cash flow hedge, the change in fair value is recognized as component
of other comprehensive income to that extent that the hedge is effective. And if the
derivative is designated as a fair value hedge, the changes in fair value are recognized in
profit or loss.

4. Explain an interest rate swap.

An interest rate swap is a type of forward contract that enables investors to
exchange future interest payments for another. It is typically used to reduce or increase
their exposure to interest rate fluctuations. The contract of loan is the primary financial
instrument and the interest rate swap agreement is the derivative financial instrument.

5. Explain a forward contract

A forward contract is a type of derivative contract that enables two parties to
purchase or sell an asset at a certain price in the future.

6. Explain a future contract

A futures contract is a contract to purchase or sell a commodity at a future date in
a certain price. The main difference between a futures contract and a forward contract is
that futures contracts are traded in a future exchange market, similar to debt and equity
securities being trade in the stock market. In other words, a forward contract is a private
contract between two parties who know each other very well. A futures contract is a
standard contract traded in a future exchange market and one party will never know is on
the other side of the contract. All cash settlements are made through the exchange market.
7. Explain a call option and a put option.
There are two options, namely call option on the part of the buyer, and put option
on the part of the seller. A call option gives the holder the right to purchase an asset, and
a put option gives the holder the right to sell an asset.

8. Explain a foreign currency forward contact.

A forward currency contract is an agreement between two parties to purchase two
currencies at a certain exchange rate in the future. It mitigates the risk of foreign exchange
volatility and enables the parties to transact business in a given country.

9. What is an embedded derivative?

PAS 39, paragraph 10, defines an embedded derivative as “a component of hybrid
combine contract that also includes a non-derivative host contract with the effect that
same of the cash flows of the combined contract vary in a way similar to a stand – alone
derivative”. This simply means that there is a basic contract known as the “host contract”
that has as embedded derivative.

1. 2. 3. 4.

5. 6. 7. 8.

9. 10. 11. 12.

13. 14. 15. 16.

17. 18. 19. 20.

21. 22. 23. 24.

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Step-by-step explanation
Journal entry on 31 Dec 2018 
 
Debit forward contract payable 893000
Credit unrealized gain on forward contract 893000
(Being gain recognized) (100,000*(90-80))*.893
 
The forward contract payable is a derivative asset 
Because of the reduction in the market value of fish Laguna company will pay the forward
contract payment to financial institution on 1 Jan 2020
 
Journal entry on 31 Dec 2019 
 
1) debit interest 107,000
   Credit unrealised gain on the  contract 10700
   (Being interest recognised on income) 
 
2). Debit forward contract payable 107000
     Credit interest 107000
     ( being interest booked on payables)
 
3) Debit unrealised loss 500,000
     Debit unrealised gain on forward contract 1,000,000
     Credit forward contract payable  1,500,000
    ( being forward contract recognised at fair value) 
Note- not discounted because payable on next day 
 
Journal entry on 1 Jan 2020
 
1) debit purchases 7,500,000
    Credit cash/bank 7,500,000
   ( being fishes purchased at market rate 100000*75)
 
2) debit forward contract payable 500,000
     Credit cash/bank 500,000
   ( being payment for forward contract) 
 
3) debit loss on forward contract 500,000
     Credit unrealised loss 500,000
   ( being loss recognised )

1.Which of the following is not a characteristic of derivative?

a.It is settled at a future date.
b.It derives its value from the changes in value of some other notional amount.
c.It requires no initial net investment or only a very minimal initial net investment.
d.All of these are valid characteristics of a derivative.
2.Which of the following can be an underlying for a derivative?
a.temperature or climate
b.specified price
c.interest or exchange rate
d.all of these
3.Entity X enters into a forward contract to sell 1,000,000 foreign currency units at a
forward rate of PHP 0.50. At the reporting date and on settlement date, the current
rates are PHP 0.48 and PHP 0.52, respectively. Identify the notional amount and the
underlying in the contract.
Notional Amount Underlying
a.PHP 0.50 1,000,000
b.1,000,000 foreign currency
c.1,000,000 forward rates
d.PHP 0.50, PHP 0.48, PHP 0.52 1,000,000
4.It is an agreement between two parties to exchange a specified amount of a
commodity, security, or foreign currency at a specified date in the future at a pre-
agreed price. It is most likely an over-the-counter transaction rather than a
standardized and traded instrument.
a.forward contract
b.futures contract
c.backward contract
d.pasts contract
5.Which of the following derivative sis most likely to be settled on a net cash basis.
a.forward contract
b.futures contract
c.call option
d.put option
6.An entity acquires futures contract for 1,000 units of a commodity . The future price
at contract inception is PHP 80 per unit. The current price on settlement date is PHP
90. Which of the following statement is correct?
if the entity is in the... the entity will recognize
a.Short position Gain
b. Long position Gain
c.Long position Loss
d.Wrong position None
7.Classic Co. enters into a "short" futures contract during the period. The futures
contract will be settled net in the following period. At the reporting date, Classic Co.
recognizes a gain on the futures contract. Which of the following statement is
correct?
a. Classic Co.'s current period statement of financial position will include a derivative liability
for the future contract.
b. Prices have increased
c.Prices have decreased
d. a and c
8.If the strike price in a call option contract exceed the current price, the option is
considered
a. in the money
b. out of the money
c. at the money
d. no money, no honey.
9.In which of the following instances would the holder of the instrument recognizes
loss when the market rate or price decreases?
a.Futures contract where the holder is in the long position
b.forward contract to purchase a specified quantity of a commodity.
c. Call option
d. Put option
10.In which of the following instances would the holder of the instrument recognizes
gain when the market rate or price increase?
a.futures contracts where the holder is in the short position
b.forward contract to sell foreign currency units
c."received fixed, pay variable" interest rate swap
d."received variable, pay fixed" interest rate swap

1. D
2. D
3. A
4. A
5. A
6. B
7. D
8. B
9. A
10. B