A theory of interest rate swap overhedging
Accounting and Finance
Educators are provided with a classroom example or a self-study tutorial to teach SFAS 133, Accounting for Derivative Instruments and Hedging Activities. The teaching material can help students gain technical knowledge of SFAS 133. It can also help develop critical thinking skills in analyzing the impact of an accounting standard on a firm's operations. A scenario based on a futures contract used by a natural gas company to hedge price fluctuations of its gas inventory is applied across 4 cases to show the impact of derivative designation on the accounting treatment and to provide a comparative analysis of the economic results from using different accounting treatments for the derivative. Case 1 and Case 2 demonstrate hedge accounting under SFAS 133 by designating the derivative as a fair value hedge and a cash flow hedge, respectively. Case 3 illustrates accounting for a derivative that is not designated as a hedge. Case 4 demonstrates the impact of not entering or using a derivative to mitigate market risk.
Hwang, A. L. J., & Jensen, R. E. (2005). A theory of interest rate swap overhedging. Managerial Finance, 31(9), 63–82. doi:10.1108/03074350510769875