Prospective and Retrospective Effectiveness Test/Measurement of Ineffectiveness
The critical terms of the Hedged Item and the Hedge Instrument are identical, and the
Hedge relationship meets all of the requirements of Statement FAS 133, paragraph
68 for fair value interest rate swap hedges:
- The notional amount of the Hedge Instrument equals the principal amount of the
Hedge Item. - The fair value of the Hedge Instrument is zero at the inception of this Hedging
Relationship. - The formula for calculating the net settlements of the Hedge Instrument is the
same for each settlement. - The maturity date of the Hedge Instrument is the date that the Hedge Item matures.
- The fixed interest rate sides of the Hedged Item and Hedge Instrument are iden-
tical. - All flows of the Hedged Item are designated as being hedged.
- There is no floor or cap on either the Hedged Item or the Hedge Instrument
- The repricing dates of the Hedge Instrument match the interest payments dates
of the Hedged Items.
Accordingly, HedgeCo will apply the shortcut method in accounting for the Hedge
Instrument. As a result, HedgeCo will not conduct effectiveness testing of this Hedge
Instrument nor measure any hedge ineffectiveness during the life of this Hedging Re-
lationship.
Quarterly Accounting
However, in accordance with the requirements of Statement No. 133 Implementation
Issue G9, HedgeCo will verify at each quarterly assessment testing date that the crit-
ical terms of the Hedging Relationship have remained the same.
As a fair value hedge, the Hedged Instrument will be marked to market on a quar-
terly basis, using a LIBOR swap curve, with changes in fair value recorded in P&L,
less adjustments for any accrued interest expense. In accordance with Paragraph 68
of FAS 133, the change in fair value of the Hedged Item will exactly equal the change
in the fair value of the Hedge Instrument, with the offset to P&L, less adjustments for
any accrued interest expense.
U.S. Tax Documentation Requirements
[Optional documentation to be filled in by HedgeCo’s Tax Department]
SOURCES AND SUGGESTED REFERENCES
Althoff, John, and John Finnerty. “Testing Hedge Effectiveness.”FAS 133 and the New De-
rivatives Landscape, Henry Davis, (ed.). New York: Institutional Investor, 2001.
Connors, Peter. “FAS 133 Raises Complex Tax Issues for Corporate Treasurers.”FAS 133 and
the New Derivatives Landscape. Henry Davis, (ed.). New York: Institutional Investor, 2001.
Financial Accounting Standards Board. Accounting for Derivative Instruments and Hedging
Activities, Statement of Financial Accounting Standards No. 133, as Amended and Inter-
preted. Norwalk, CT: Financial Accounting Standards Board, 2001.
SOURCES AND SUGGESTED REFERENCES 19 • 23