- Question 4, 5 and 7 please.
Not sure how to answer the questions, please provide details answers / solutions.
3101AFE S2 2016
Topic 9: Financial instruments
Categorise each of the following common financial instruments as financial assets,
financial liabilities or equity instruments - of the issuer or the holder, as specified.
(a) Loans receivable (holder) financial asset
(b) Loans payable (issuer) financial liability
(c) Ordinary shares of the issuer equity
(d) The holder?s investment in the ordinary shares in part (c) financial asset
(e) Redeemable preference shares of the issuer, redeemable at any time at the option of
the holder equity
(f) The holder?s investment in the preference shares in part (e) financial asset
What factors influence the value of a derivative financial instrument, and how should
changes in the value of derivatives be treated from an accounting perspective?
The value of a derivative is directly related to another underlying item. For example, a share
option - which is a derivative - derives its value from the market value of the underlying
shares. Derivative financial instruments create rights and obligations that have the effect of
transferring one or more of the fi nancial risks inherent in the underlying primary
fi nancial instrument. According to paragraph 9(a) of AASB 139, the value of a derivative:
changes in response to the change in a specified interest rate, financial instrument price,
commodity price, foreign exchange rate, index of prices or rates, credit rati ng or
credit index, or other variable, provided in the case of a non-financial variable that the
variable is not specific to a party to the contract (sometimes called the ?underlying?);
In relation to the measurement of derivative financial instruments there is a general
requirement, as provided in AASB 139, that financial instruments are to be measured at
fair value. As with fi nancial instruments generally, all derivatives are required to be
recognised and measured at fair value. Gains and losses on the financial instruments would
generally go directly to profit or loss. However, this will be influenced by whether there is an
associated hedge that has been designated as a hedge and that has been deemed to be
Question 3: What does mark to market mean?
Mark to market means that particular assets will be valued on the basis of their net market
value, that is, their current selling prices less the costs that will arise in making such a sale.
When assets are ?marked to market? it is normal for any gain or loss in the value of the
assets to be treated as part of the period?s profit or loss (that is, as an income or
Question 4: Arthur Ltd has the following statement of financial position:
Statement of financial position before set-of
Loans receivable 1,200,000
Shareholder?s equity 1,000, 000
Non-current assets 800,000
1 Assume that Arthur Ltd has an amount owing to Blayney Ltd of $300,000 and an amount
receivable from Blayney Ltd of $400,000. Assuming a right of set-of exists, why would
Arthur want to perform a set-of? What would be the impact on the debt to assets ratio?
Question 5: Subsequent to initial measurement, financial assets are to be classified as
being measured at either fair value or amortised cost. What is the basis for determining
whether fair value or amortised cost shall be used?
Question 6: Futures contracts are considered to be highly leveraged instruments, with the
result that considerable gains or losses can be incurred. What does this mean?
A futures contract is a contract to buy or sell an agreed quantity of a particular item, at an
agreed price, on a specific date. Substantial gains or losses can be made given that typically
only a small deposit is made on the contract. For example, a deposit of 5 per cent may
be made on a futures contract that requires the delivery of a commodity for a fixed
price of $1 million. If the price of the commodity rises to $1.05 million (a modest increase of 5 per cent) the futures trader has lost $50 000 on the contract (the trader
is locked in to receiving only $1 million for an asset that can be acquired on the
market for $1.05 million)?that is, the trader has lost the entire amount of the
deposit as a result of a 5 per cent rise in the price of the commodity.
Question 7: Holder Ltd purchases a option contract from Issuer Ltd that gives Holder Ltd
the right to acquire 100 000 options in Torquay Ltd for a price (exercise price) of $10.00 per
share. When the contract was exchanged the price of Torquay Ltd shares were $9.00 each.
The option entitles Holder Ltd to exercise the options and buy the shares any time within
the next six months. If the options are not exercised within the six month period, then the
options will expire.
Determine whether a financial liability or financial asset exists from the perspective of
Holder Ltd and Issuer Ltd. Further, if the price of shares in Torquay Ltd falls to $5.00, with
the result that it is improbable that Holder Ltd will ever exercise the options, will this
change the classification of the options as either financial assets or financial liabilities?
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