1.

Sico Inc. owns 30% of equity and 10% of the outstanding $500,000, 10% cumulative
preferred stocks of Mifa Inc. No dividends were declared during the year. If
net income after interest and taxes of Mifa Inc. for the year is $300,000, what
amount should Sico Inc. report in its statement of income as “equity in earnings”?

$80,000 {i.e. [30% of ($300,000 - 10% of $500,000)] + [$50,000 x 10%]}.

2.
Trading securities are the debt securities bought and held principally for the
purpose of selling them in the near term. {Think of it as investment in inventory!}
Held-to-Maturity (HTM) securities are debt securities that the entity has the
positive intent and ability to hold to maturity date. {Think of it as investments
never to be sold in market!}
Available-for-Sale (AFS) securities are debt securities not classified as trading
or held-to-maturity securities. {Think of it as Investment to be sold some day!}

3.
When the securities are reclassified from held for trading to available for sale,
no adjustment is needed for already recognized unrealized gains or losses because
any unrealized gains or losses have already been recognized in earnings.
For the reclassified securities, fair value option is being used, any unrealized
gains or losses on the date of transfer and thereafter are still charged to the
statement of income and not to other comprehensive income. Thus, no gains or losses
would be charged
to other comprehensive income. This change in classification from held for
trading to available for sale would primarily have a balance sheet impact only as
the security would be classified from current to non-current assets. As fair value
was used on both methods, there is no statement of income impact other than the
gain or loss.

4.
For available for sale debt securities for which fair value option is used, all
unrealized and realized gains and losses, along with the interest income are
charged to the statement of income.

5.
HFT → AFS / HTM - Reclassify at fair value; unrealized holding gain or loss at the
date of transfer is already recognized in the statement of income and shall not be
reversed.
AFS / HTM → HFT - Reclassify at fair value; unrealized holding gain or loss at the
date of transfer shall be recognized in the statement of income immediately.

6.Intercompany receivables and payables are set off against each other when the
financial statements of the investee are prepared on a consolidated basis.
Consolidated financial statements are prepared when investor has more than 50%
interest in the investee company. In the given scenario, the investor company has
25% interest
in the investee company, consolidated financial statements are not prepared and
thus receivables from and payables towards the investee should be reported
separately in the financial statements of investor company.

6.
Fair value accounting option to value its debt securities may be adopted for
available for sale and held to maturity securities. But once elected, the election
is irreversible. Also, under US GAAP, impairment loss once recognized cannot be
subsequently reversed. IFRS allows reversal of impairment loss but not US GAAP.
Reclassification of held to maturity to available for sale securities or vice versa
is reversible.

7.
Accrued interest receivable, would be interest earned not yet received during the
year.

Interest revenue for the year = Accrued interest receivable at the end of the year
+ Interest received during the year - Accrued interest receivable at the beginning
of the year

Pentex Inc holds 30% equity in Milo Inc. It would still not be accounted using
equity method because significant influence does not exist if the investment is
only temporary. Pentex Inc.’s investment in Milo Inc. would not be increased by
it’s percentage share of investment in Milo Inc. Thus, Pentex Inc. would report its
investment in Milo Inc at same purchase price of $400,000.

8.
If a held-to-maturity security is impaired, its carrying value is decreased to the
fair value. Should the fair value not be available as an alternative the present
value of its estimated future cash flows will be taken into consideration, using
the effective interest rate as of date of impairment. Note that this value may not
be equal to the fair value of the security.

9.When held for trading securities are reclassified as available for sale
securities, such securities should be transferred at fair market value and any
unrealized holding gains or losses should be ignored because any unrealized gains /
losses have already been recognized in earnings on the statement of income when the
securities were carried as held for trading.

10.
Debt securities, purchased at cost, which are held with an ability and intent to
hold till maturity may be valued at either amortized cost (i.e. the discount needs
to be amortized) or at fair value (if the fair value option is elected).

11.Counterparty risk is the risk that a party may default on its side of the
agreement. Futures contracts are exchange-traded and, thus, are standardized
contracts. Futures contracts have clearing houses that guarantee the transactions,
which drastically lowers the probability of default to almost never.
Thus, in a futures contract, the exchange clearing house acts as the counterparty
to both parties in the contract.

12.
The forward price of an asset with benefits and / or costs is equal to the
settlement price discounted minus the present value of those benefits and costs
associated with the underlying assets. The benefits can include dividends,
interests etc.

13,
A call option is out of the money if the strike or exercise price is greater than
the price of the underlying. A put option is out of the money if the price of the
underlying is greater than the strike or exercise price.

14.
If the interest rates drop by 50%, the company has to still pay the same interest
rate when it issued the bond. To benefit, the company should re-issue the bonds to
have lower cost of debt. A callable bond allows the company to buy back the bonds
and reissue them at the new lower interest rate.

15.An underlying asset is a financial instrument on which a derivative's price is

based.

16.
A swap is most likely a series of:
Forward contracts.

17.
In swaps, there is right and obligation to exchange cash flows of one party's
financial instrument for those of the other party's financial instrument. A swap
can be described as a series of forward contracts. The difference between a forward
contract and a swap is that a swap has a series of payments in the future, whereas
a forward has a single future payment. Forwards and swaps are custom instruments
and are traded / created by dealers in a market with no central location.

18.
Which of the following does not affect option prices?

Interest rates.
Dividends.
Underlying price.
-None of the above.{right}

19.
Interest rates – Interest rates have a small effect on an option’s value. When
interest rates rise a call option's value will also rise and a put option's value
will fall. Considering a call option vs speculating by owning the underlying, there
are costs associated with owning the underlying: The purchase incurs either
interest expense (if the money is borrowed) or lost interest income (if existing
funds are used to purchase the shares). Instead, by buying a call option, the
purchase of the underlying would be delayed and interest could be earned on the
money. Thus, higher the interest rates, higher the demand for call options and
would increase the price of call options. In case of put options, the sale of the
underlying would be delayed and interest would be lost. Thus, higher the interest
rates, lesser will be the demand for put options and would decrease the price of
put options.

Dividends - Options do not receive dividends so their value fluctuates when

dividends are released. When a company releases dividends they have an ex-dividend
date. If you own the stock on that date you will be awarded the dividend. Also on
this date the value of the stock will decrease by the amount of dividend. There is
more demand for owning the stock now, rather than purchasing a call option at the
time of dividend declaration. This would lead to a decrease in demand for call
options, thereby decreasing prices. Similarly, at the time of dividend declaration
there would be lesser people willing to sell an underlying and would be more
interested in buying a put option. With an increase in demand for the put option,
the put option’s value increase.

Underlying price - The most influential factor on an option price is the current
market price of the underlying asset. In general, as the price of the underlying
increases, there would be more demand to buy a call at a strike price lower than
the anticipated increased market price and the increase in demand for call options
would increase call prices and similarly, put prices would decrease (as if the
price of the underlying increases, it would be more profitable to sell directly in
the market and thus the demand for put will decrease, thereby decreasing the
price). Conversely, as the price of the underlying decreases, call prices decrease
and put prices increase.

20.
Fair value hedge is a hedge against the risk of loss from an existing or already
recognized asset or liability or a firm purchase commitment. Cash flow hedge is a
hedge against the risk of loss from a planned or forecasted future transaction but
not yet a legal commitment. The gain/loss in fair value hedge (instrument A) is
reported in income from continuing operations in I/S and cash flow hedge
(instrument B) is reported in OCI (PACE) in the B/S.

21.
A European call option provides the holder the right to buy the underlying at an
exercise or strike price at the end of its life only. A gain accrues to the holder
as the strike price of the underlying falls below the market price. An American
option can be exercised at anytime during the life of the option.

22.
The Black-Scholes option-pricing model is a mathematical model for estimating the
price of stock options, using the following five variables:

• Time to expiration of the option.

• Exercise or strike price.

• Risk-free interest rate.

• Price of the underlying stock.

• Volatility of the price of the underlying stock.

23.
In a foreign currency swap, one party makes payments denominated in one currency
and the counterparty makes payments in other currency. At the initiation and the
termination, both parties exchange the notional amount as they are in two different
countries. Periodic interest payments are exchanged on each settlement date.

Which of the following is true of foreign currency swaps?

Periodic interest payments are exchanged on each settlement date.

24.
When the interest rates decrease after a swap contract is initiated:

The present value of floating-rate payments will be more than the present value of
fixed-rate payments.

The swap will have a positive value for the fixed-rate payer.

The swap will be a liability for the floating-rate receiver.

The swap will be an asset to the floating-rate receiver.

The correct answer is (c).
In a plain vanilla interest rate swap, one party makes fixed-rate interest payments
on a notional principal amount specified in the swap in return for floating-rate
payments from the other party. If interest rates decrease after swap initiation,
the present value of floating-rate payments will be less than the present value of
fixed-rate payments. The swap will have a negative value for the fixed-rate payer
or floating-rate receiver. The swap will be a liability to the fixed-rate payer
(floating rate receiver) and an asset for the floating-rate payer (fixed rate
receiver).