Contract Valuation and Basis Risk in Hedging

Financial Derivatives
Contract Valuation & Basis Risk in Hedging
Dr Eirini Konstantinidi & Dr Ser-Huang Poon
October 22, 2020
(Konstantinidi & Poon, AMBS) Financial Derivatives October 22, 2020 1 / 55

Outline adn Intended Learning Outcomes
What is the value of a forward contract?
k Understand how ”No arbitrage” principle is used in contract valuation
k Demonstrate that forward and futures prices are the same when
interest rate is constant
k Analyse how futures price will change when the spot price is correlated
with the interest rate
Fair value accounting, net asset value & credit valuation adjustment.
k Understand credit and debt valuation adjustments and how they
change the contract valuation
k Introduce Fair Value Accounting (SFAS 157 and IAS 39)
Hedging strategies using forwards and futures.
k Explain forward/futures hedging strategies
k Demonstrate how basis risk complicates hedging outcome
k Show how short maturity futures contract is rolled over a longer term
hedge position
Reading list:
k Hull (6th , 7th , 8th & 9th Edition): Sections 5.7-5.8, 5.14, 3.1-3.3, 3.6.
k Reading material on Blackboard
Forward Contract Valuation

Some notation
k K is the delivery price of a forward contract that was negotiated at

time 0 for delivery at T .
k This particular T -maturity forward contract with delivery price K has
a value f0,T at time 0, and ft,T at time t.
k F0,T is the time 0 forward price for delivery at T . Ft,T is the time t
forward price for delivery at T . Note that there is no reference here
to a specific contract.
0 t T
Delivery Price: K = F0,T K K
Forward Price: F0,T Ft,T FT ,T
Value: f0,T = 0 ft,T fT ,T

Valuing a forward contract
L , is
The value of a long T -maturity forward contract at time t, ft,T
L
ft,T = (Ft,T − K )e −r (T −t )
S , is
The value of a short T -maturity forward contract at time t, ft,T
S
ft,T = (K − Ft,T )e −r (T −t )

Valuing a forward contract: Long position
(i) a long forward (entered at time 0) with a delivery price K

L at time t)
(the value of this first contract is ft,T
t T
Cash Flows: 0 ST − K
(ii) a short forward (entered at time t) with a delivery price Ft,T

(the value of this second contract is zero at time t)
t T
Cash Flows: 0 Ft,T − ST
−r (T −t )
Total Cash Flow: (Ft,T − K )e Ft,T − K

Valuing a forward contract: Long position (cont’d)
Here, we have a portfolio of two forward contracts; one entered at

time 0 and the other entered at time t.
L +0 = fL .
At time t, the portfolio value is ft,T t,T
At time T , the portfolio value is ST − K − (ST − Ft,T ) = Ft,T − K .
At time t,
L
ft,T = (Ft,T − K )e −r (T −t )
S !
Similar arguments can be used to value a short forward, ft,T

Value of a forward at time 0, t & T : Long position
Time 0: f0,T = 0 ⇔ (F0,T − K )e −r (T −0) = 0

⇔ K = F0,T
Time t: ft,T = (Ft,T − K )e −r (T −t )
= (St e r (T −t ) − K )e −r (T −t )
= St e r (T −t ) e −r (T −t ) − Ke −r (T −t )
= St − Ke −r (T −t )
Time T : FT ,T = ST e r (T −T ) = ST
fT ,T = ST − K

Value of a forward at time 0, t & T : Short position
Time 0: f0,T = 0 ⇔ K = F0,T
Time t: ft,T = (K − Ft,T )e −r (T −t ) = Ke −r (T −t ) − St
Time T : fT ,T = K − ST

Valuing a forward contract: An example
Consider a six-month long forward contract on a non-dividend-paying

stock. The continuously compounded risk free rate of interest is 10% per
annum, the stock price St is $25, and the delivery price K is $24. What is
the value of the long forward contract?
1st way
6
Ft,T = St e r (T −t ) = 25e 0.1× 12 = 26.28
6
ft,T = (Ft,T − K )e −r (T −t ) = (26.28 − 24)e (−0.1 12 ) = $2.17
2nd way
6
ft,T = St − Ke −r (T −t ) = 25 − 24e (−0.1 12 ) = $2.17

Are Forward and Futures Prices Equal?

Forward vs futures price: An example
A one-year-long forward (futures) contract on a non-dividend-paying stock

is entered into when the stock is $40 and the risk-free rate of interest is
10% per annum with continuous compounding.
Six months later, the price of the stock is $45 and the risk-free interest
rate is still 10%.
In one year the price of the stock is $42.
What are the forward (futures) price and the value of the forward
(futures) contract at t = 0 and t = 6 months?

Example: Forward contract cash flows
0 6 months 1 year
S0 = $40 St = $45 ST = $42

F0,T = $44.21
(40e 0.1x1 )
K = $44.21
f0,T = 0
Forward CF 0 0 fT ,T = −$2.21
(ST − K = 42 − 44.21)

Example: Futures contracts cash flows
0 6 months 1 year
S0 = $40 St = $45 ST = $42

F0,T = $44.21 Ft,T = $47.31
(40e 0.1x1 ) (45e 0.1x0.5 )
K = $44.21 K 0 = $47.31
f0,T = 0 ft,T = $2.95
(47.31 − 44.21)e −0.1x0.5
Futures CF 0 ft,T = $2.95 fT ,T = −$5.31

(ST − K 0 = 42 − 47.31)

Example: Futures contracts cash flows (cont’d)
0 6 months 1 year
Forward CF 0 0 −$2.21
Futures CF 0 $2.95 −$5.31
It looks as if the futures contract holder is worse off losing more at T

k But, futures contract holder received $2.95 six months before.
The net position of a futures contract holder at time T is:

Net = 2.95e 0.1×0.5 − 5.31
= −$2.21
which is exactly the same as that for the forward contract.
Notice that we assumed that the interest rate is constant.

Forward vs futures price
The price of a T -maturity forward is equal to the price of a

T -maturity future when:
k The short-term interest rate is constant.
www-2.rotman.utoronto.ca/ hull/TechnicalNotes/TechnicalNote24.pdf
OR
k The interest rate is a known function of time.
The price of a T -maturity forward is NOT equal to the price of a

T -maturity future when interest rates vary unpredictably.
k corr (S, r ) > (<)0.

Forward vs futures price:corr (S, r ) > 0
S ↑ → long futures makes immediate gain (daily settlement)

→ gain tends to be invested at a higher than average rare (r ↑)
S ↓ → long futures makes immediate loss (daily settlement)

→ loss tends to be financed at a lower than average rare (r ↓)
Long futures contract is more attractive than long forward contract

i.e. futures prices tend to be higher than forward prices.

Forward vs futures price:corr (S, r ) < 0
S ↑ → long futures makes immediate gain (daily settlement)

→ gain tends to be invested at a lower than average rare (r ↓)
S ↓ → long futures makes immediate loss (daily settlement)

→ loss tends to be financed at a higher than average rare (r ↑)
Long futures contract is less attractive than long forward contract

i.e. futures prices tend to be lower than forward prices.

Fair Value Accounting

Accounting and tax
FAS157, IAS39 - Fair Value Accounting
Hedging profits (losses) should be recognized at the same time as the

losses (profits) on the item being hedged.
Profits and losses from speculation should be recognized on a

mark-to-market basis.
Unless margin/collateral protected, profit/losses include provision for

counterparty/own default.

Credit Valuation Adjustment (CVA)
In the absence of collateralisation, all OTC forward (or derivative)
contract valuations will need to take counter party (own) default and
offset arrangement into consideration; a process known as credit
valuation adjustment (CVA).
Sometimes, CVA is one-way taking into account couterparty’s default

risk. In this case, DVA (debt valuation adjustment) is the mirror
process that adjusts for own default risk.
If CVA is an adjustment for loss (due to counterparty default), the

DVA is an adjustment for gain (due to own default).
Fair value accounting requires all companies to take both CVA and
DVA into consideration. In contrast, Basel regulations for financial
institutions requires CVA, but specifically exclude DVA.
CVA and DVA can become quite complex in real world.

Fair value accounting
Statements of Financial Accounting Standards (”SFAS” or simply ”FAS”)

are issued by the US Financial Accounting Standards Board (FASB). The
International Accounting Standards (”IAS”) are issued by the International
Accounting Standards Board (IASB).
Fair value is better than e.g. historical cost.
For financial derivatives, fair value often means marked to market

value, and for the uncollateralised OTC trades, it has to be adjusted
for counterparty (and own) credit risk.
When financial instruments are not traded in active market, fair value
accounting involves subjective estimations based on valuation models.

SFAS 157: Fair value measurements
Fair value as “the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction between market
participants at the measurement date”
Exit price instead of entry price
Orderly, not forced liquidation or distressed sale
Valuation by market approach (e.g. market quotes), income

approach, or cost approach (e.g. amount required to replace).
Examples of the income approach include present value of future cash

flows, option pricing model such as Black-Scholes and Binomial
model.

SFAS 157: Input to valuation
Valuation should use observable input (e.g. market data independent from
firm), and minimum use of assumptions and subjectivity.
Level 1: unadjusted market quotes except when they do not represent

fair value
Level 2: quoted price of similar asset/liabilities or observed value of

market variables (e.g. yield curve, default risk etc other than direct
quotes)
Level 3: firms’ internal model and assumptions

IAS 39: Financial Instruments - Recognition and
Measurement
Fair value is defined as “the amount for which an asset can be exchanged,
or a liability settled between knowledgeable willing parties in an arm’s
length transaction”.
Bid price for long position and ask price for short position.
Most recent traded price may be use if there is no substantial change
in market condition.
Similar to SFAS 157 exclude forced transaction, involuntary
liquidation or distress sale.
If price is not available, the preferred valuation techniques must be
one that commonly used by market participants.
Valuation should make maximum use of market input and least firm
specific input. Model must be “calibrated” and “backtested”.
Using Forward & Futures in Hedging

Hedging example
A company knows it will need copper in 3 months.
It is exposed to the risk of fluctuations in the price of copper.
Decides to hedge using a long position in a forward contract.

k Gains when the price of copper goes up.
k Loses when the price of copper goes down.
It hedges so as to neutralize the risk as far as possible.

Long & short Hedges
A long forward/futures hedge is appropriate when you know you

will purchase an asset in the future and want to lock in the price.
A short forward/futures hedge is appropriate when you know you

will sell an asset in the future and want to lock in the price.

Hedging: Advantages and disadvantages
Disadvantages.
k Shareholders can make their own hedging decisions and are usually well
diversified.
k It may increase risk to hedge when competitors do not.
k Explaining a situation where there is a loss on the hedge can be
difficult.
Advantages.
k Companies should focus on the main business they are in and take
steps to minimize risks arising from interest rates, exchange rates, and
other market variables
k Bankruptcy is costly!

Basis Risk

Basis
Basis is the difference between the spot & the futures price:
Basist = St − Ft,T
CONTANGO BACKWARDATION
Price% Price%
Futures%price% Spot%price%
Spot%price% Futures%price%
Time% Time%
t% T% t% T%
In practice, it is possible that ST 6= FT ,T at maturity.

k It may be difficult to arbitrage between ST and FT ,T .
k Spot & futures are often traded in different markets and locations.
Basis (cont’d)
Given that:
Ft,T = St e r (T −t )
where r is usually positive, we usually observe that Ft,T > St .
In some cases where there is a convenience yield, y , (i.e. the benefit

of holding the assets), then prices might appear to be inverted if the
convenience yield is greater then the risk free rate, r ,
Ft,T = St e (r −y )(T −t ) .

Basis risk
Basis risk arises because of the uncertainty about the basis.

k Mismatch of asset to be hedged & asset underlying the futures
contract.
k Mismatch of date when the asset to be hedged is bought/sold and
delivery month of the futures.
k Uncertainty on the date when the asset to be hedged is bought/sold
Only cash settled futures or forwards are exposed to basis risk!

Hedging mechanism
t1 t2 T
Hedge is initiated Hedge expiration The contract expires

(enter a reversing contract)
Suppose that time t1 < t2 < T ,

k Ft1 ,T , futures market price at t1 when the hedge is initiated.
k Ft2 ,T , futures market price at t2 when the hedge position is unwound
by entering into a reversing contract.
k St2 , spot market asset price at t2 .

Hedging mechanism: Long hedge
You need some gold at time t2 (< T ).
You buy a gold futures contract at time t1 that matures at time T .
You unwound your position at time t2 .
t1 t2 T
Buy gold futures Ft1 ,T Sell gold futures Ft2 ,T

Buy gold at the spot market St2
Cash Inflow at time t2 = −St2 + Ft2 ,T − Ft1 ,T

= −Basist2 − Ft1 ,T
Basis risk arises because we do not know Basist2 at time t1 .

k It can improve or worsen the position of the hedger.
Hedging mechanism: Short hedge
You want to sell gold at time t2 (< T ).
You sell a gold futures contract at time t1 that matures at time T .
You unwound your position at time t2 .
t1 t2 T
Sell gold futures Ft1 ,T Buy gold futures Ft2 ,T

Sell gold at the spot market St2
Cash Inflow at time t2 = St2 − Ft2 ,T + Ft1 ,T

= Basist2 + Ft1 ,T
Basis risk arises because we do not know Basist2 at time t1 .

k It can improve or worsen the position of the hedger.
Basis risk & choice of contract
Maturity mismatch.
k Basis risk increases as the difference between hedge expiration and
delivery month increases.
k Choose a delivery month that is as close as possible to, but later than,
the end of the life of the hedge.
k Liquidity is larger for short-maturity contracts - Rolling forward.
Asset mismatch.
k Choose the contract whose futures price is most highly correlated with
the asset price.
k Cross hedge.
k Basis risk exists even when t2 = T .
Both cases above will result in basis risk.
Basis risk is normally much smaller than unhedged risk.

Basis risk: An example
It is March 1. A US firm expects to receive U50 million at the end of

July.
Yen futures contracts on the Chicago Merchantile Exchange have

delivery months of March, June, September and December.
One contract is for the delivery of U12.5 million.
When the yen are received at the end of July, the company closes out
its position.
The September contract futures price on March 1 in cents per yen is

0.7800 (Ft1 ,T ) and that the spot and futures prices when contract is
closed out are 0.7200 (St2 ) and 0.7250 (Ft2 ,T ), respectively.

Basis risk: An example (cont’d)
The company is long in U (i.e. cash position).

k To hedge the company enters a short (or sell) U futures position.
50
No of contracts = =4
12.5
k The company enters September contract NOW and closes out the
futures position at the end of July.
If it used the June contract then it would be exposed to unnecessary

risk between end of June and end of July.

Basis risk: An example (cont’d)
Since the September contract is to close out early in July, there will
be basis risk.
k Basis risk arises due to the gap between futures price and spot price at
the end of July.
cent per U
Futures price March 1 0.7800 (Ft1 ,T )
July 31 0.7250 (Ft2 ,T )
Spot price July 31 0.7200 (St2 )

An example: No basis risk
If there is NO basis then:

k Ft2 ,T = St2 = 0.7200 cents/U
k The company would have locked the exchange rate of 0.7800 cents/U.
Gain on futures contract = Ft1 ,T − Ft2 ,T = 0.78 − 0.72 = 0.06

Loss on the basis = St2 − Ft2 ,T = 0.72 − 0.72 = 0
Closes out the futures position with a gain: 0.06 × 50million
Sells U in the spot market for 0.72 & receives: 0.72 × 50 million
In total, it receives the original locked in price: 0.78 × 50 million

An example: With basis risk
Now, there is a basis.
k Ft2 ,T 6= St2
Cash Inflow = Ft1 ,T + (St2 − Ft2 ,T ) = 0.7800 + (0.7200 − 0.7250)

= 0.7800 − 0.005
| {z } = 0.7750
Basis
Closes out the futures position with a gain: (0.78 − 0.725) × 50

= 0.0550 × 50million
Sell U in the spot market for 0.72: 0.72 × 50 million
In total, it receives: 0.7750 × 50 million or $387, 500

Another example: Jaffa Orange
Mr Jaffa is an orange juice distributor who, in January, signed a contract

to deliver 60,000 pounds of frozen orange juice to Ashwood Race Course
on the Grand National Day (first Saturday in May). Mr Jaffa plans to buy
the orange juice from a local distributor in May. With a small profit
margin, Mr Jaffa is worried that he might incur a loss if the orange juice
price increases.

Another example: Jaffa Orange (cont’d)
(a) Explain how Mr Jaffa could lock in his orange juice costs with a May
frozen orange juice futures contract trading in January at $0.95/lb
(contract size of 15,000 lbs). The futures contract is settled by cash and
without physical delivery.
Mr Jaffa needs orange juice in May. He should therefore long in

orange juice futures.
He should buy 60,000 lb orange juice futures which is 4 contracts

(60,000/15,000) at $0.95 per lb.

(b) Show Mr Jaffa’s net cost, at the futures expiration date (assume 1st
May), from closing the futures position, in e.g. Chicago Mercantile
Exchange, and buying 60,000 pounds of frozen orange juice on the spot
(commodity) market at the possible prices of $0.90/lb, $0.95/lb and
$1.00/lb.

Futures Settlement Spot purchase

Spot price Net
No basis, Ft2 ,T = FT ,T = ST at ST
4 × 15, 000 × (0.90 − 0.95) 0.90 × 60, 000
$0.90/lb = −$3, 000 $57, 000
= $54, 000
0.95 × 60, 000
$0.95/lb 0 = $57, 000 $57, 000
4 × 15, 000 × (1.00 − 0.95) 1.00 × 60, 000

$1.00/lb $57, 000
= +$3, 000 = $60, 000
The three outcomes are the same (i.e. $57,000)!

k The hedge is perfect.

(c) If the futures contract expires on 30th June instead of 1st May and the
futures price on 1st May, when Mr Jaffa was closing out the contract, was
$0.90/lb (Ft2 ,T ), calculate the basis if the spot price on 1st May was
$0.92/lb (St2 ) and the amount of cash Mr Jaffa has to pay to fulfill his
contractual agreement to supply orange juice on the Grand National Day.
Time T settlement : Net
Spot purchase 0.92 × 60, 000

= $55, 200 $58, 200
at $0.92/lb
Unwind futures contract 4 × 15, 000 × (0.90 − 0.95)
at $0.90/lb (Ft2 ,T ) = −$3, 000
The hedge is to protect at Ft1 ,T = 0.95. At t2 , buy spot at St2 = 0.92.
But unfortunately futures drops further than spot, Ft2 ,T = 0.90 < St2
which results in a loss in basis.
Two different ways of working out the cost:
Cost = Ft1 ,T + (St2 − Ft2 ,T ) = 0.95 + (0.92 − 0.9) = 0.95 + 0.02

| {z }
basis
= (Ft1 ,T − Ft2 ,T ) + St2 = (0.95 − 0.9) + 0.92 = 0.05 + 0.92
| {z }
futures settlement
= 0.97
and the answers should be the same;
Total cash = $0.97 × 60, 000

= $58, 200

(d) Describe quality, quantity and timing risk.
Quality risk: Difference in futures contract specification and the

required quality for the underlying position.
k This creates a price difference similar to the basis risk described above.
Quantity risk: The contract size does not match quantity required
resulting in an underhedged or overhedged position.
Timing risk: It is the same as that shown in part (c) of the “Jaffa
Orange” example.
k If the futures contract has to be closed out early, the hedger will always
face a basis risk.

Rolling forward - Stack & roll
Sometimes the expiration date of the hedge is later than the delivery
dates of all the futures contracts in the market that can be used.
The hedger must then roll the hedge forward.

k Close out one futures contract and take the same position in a futures
contract with a later delivery.
k Hedges can be rolled forward many times.
We can use a series of futures to increase the life of a hedge.
Each time we switch from one futures contract to another we incur a

type of basis risk.

Rolling the hedge forward: An example
In April 2011, a company realizes that it will have 100,000 barrels of crude
oil to sell in June 2012 and decides to hedge its risk with a hedge ratio of
1.0. The current spot price is $19 (S0 ). Although crude oil futures are
traded on the New York Merchantile Exchange with maturities up to six
years, only the first six delivery months have sufficient liquidity to meet the
company’s needs. The company, therefore, short 100 October 2011
contracts. In September 2011, it rolls the hedge forward into the March
2012 contract. In February 2012, it rolls the hedge forward again into the
July 2012 contract.

Rolling the hedge forward: An example (cont’d)
Spot Futures
April 2011 $19 $18.20 sell Oct 2011 contract
September 2011 $17.40 buy Oct 2011 contract Gain $0.8
$17.00 sell Mar 2012 contract
February 2012 $16.50 buy Mar 2012 contract Gain $0.5
$16.30 sell Jul 2012 contract
June 2012 $16 $15.90 buy Jul 2012 contract Gain $0.4
Spot loss = $3 Futures gain = $1.7
The futures contracts provide a total of $1.70 barrel compensation for

the $3 per barrel oil price decline (omitting the interest rate effect).
4 5 6 7 8 9* 10 11 12 1 2* 3 4 5 6∗ 7
April June

Rolling the hedge forward: Selecting a contract
Nearest to maturity contract was chosen for liquidity.

k Futures price can be unfavourably costly if the market is thin.
Rolling of the contract is typically done at least a few days before the
contract expiry instead of at maturity.
k Derivative contract prices at maturity are often erratic and subject to
market manipulation.

˜ End ˜

Contract Valuation and Basis Risk in Hedging

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Financial Derivatives

Contract Valuation & Basis Risk in Hedging

Dr Eirini Konstantinidi & Dr Ser-Huang Poon

October 22, 2020

(Konstantinidi & Poon, AMBS) Financial Derivatives October 22, 2020 1 / 55

(Konstantinidi & Poon, AMBS) Financial Derivatives October 22, 2020 3 / 55

k K is the delivery price of a forward contract that was negotiated at

Delivery Price: K = F0,T K K

Forward Price: F0,T Ft,T FT ,T

Value: f0,T = 0 ft,T fT ,T

(Konstantinidi & Poon, AMBS) Financial Derivatives October 22, 2020 5 / 55

(i) a long forward (entered at time 0) with a delivery price K

(ii) a short forward (entered at time t) with a delivery price Ft,T

Cash Flows: 0 Ft,T − ST

(Konstantinidi & Poon, AMBS) Financial Derivatives October 22, 2020 6 / 55

Here, we have a portfolio of two forward contracts; one entered at

At time T , the portfolio value is ST − K − (ST − Ft,T ) = Ft,T − K .

(Konstantinidi & Poon, AMBS) Financial Derivatives October 22, 2020 7 / 55

Time 0: f0,T = 0 ⇔ (F0,T − K )e −r (T −0) = 0

Time t: ft,T = (Ft,T − K )e −r (T −t )

(Konstantinidi & Poon, AMBS) Financial Derivatives October 22, 2020 8 / 55

Time 0: f0,T = 0 ⇔ K = F0,T

Time t: ft,T = (K − Ft,T )e −r (T −t ) = Ke −r (T −t ) − St

(Konstantinidi & Poon, AMBS) Financial Derivatives October 22, 2020 9 / 55

Consider a six-month long forward contract on a non-dividend-paying

(Konstantinidi & Poon, AMBS) Financial Derivatives October 22, 2020 10 / 55

(Konstantinidi & Poon, AMBS) Financial Derivatives October 22, 2020 11 / 55

A one-year-long forward (futures) contract on a non-dividend-paying stock

In one year the price of the stock is $42.

(Konstantinidi & Poon, AMBS) Financial Derivatives October 22, 2020 12 / 55

S0 = $40 St = $45 ST = $42

(Konstantinidi & Poon, AMBS) Financial Derivatives October 22, 2020 13 / 55

S0 = $40 St = $45 ST = $42

Futures CF 0 ft,T = $2.95 fT ,T = −$5.31

(Konstantinidi & Poon, AMBS) Financial Derivatives October 22, 2020 14 / 55

Futures CF 0 $2.95 −$5.31

It looks as if the futures contract holder is worse off losing more at T

The net position of a futures contract holder at time T is:

Notice that we assumed that the interest rate is constant.

The price of a T -maturity forward is equal to the price of a

The price of a T -maturity forward is NOT equal to the price of a

(Konstantinidi & Poon, AMBS) Financial Derivatives October 22, 2020 16 / 55

S ↑ → long futures makes immediate gain (daily settlement)

S ↓ → long futures makes immediate loss (daily settlement)

Long futures contract is more attractive than long forward contract

(Konstantinidi & Poon, AMBS) Financial Derivatives October 22, 2020 17 / 55

S ↑ → long futures makes immediate gain (daily settlement)

S ↓ → long futures makes immediate loss (daily settlement)

Long futures contract is less attractive than long forward contract

(Konstantinidi & Poon, AMBS) Financial Derivatives October 22, 2020 18 / 55

(Konstantinidi & Poon, AMBS) Financial Derivatives October 22, 2020 19 / 55

FAS157, IAS39 - Fair Value Accounting

Hedging profits (losses) should be recognized at the same time as the

Profits and losses from speculation should be recognized on a

Unless margin/collateral protected, profit/losses include provision for

(Konstantinidi & Poon, AMBS) Financial Derivatives October 22, 2020 20 / 55

Sometimes, CVA is one-way taking into account couterparty’s default

If CVA is an adjustment for loss (due to counterparty default), the

CVA and DVA can become quite complex in real world.

Statements of Financial Accounting Standards (”SFAS” or simply ”FAS”)

Fair value is better than e.g. historical cost.

For financial derivatives, fair value often means marked to market

(Konstantinidi & Poon, AMBS) Financial Derivatives October 22, 2020 22 / 55

Valuation by market approach (e.g. market quotes), income