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Chapter 9

Q. 9.8

On January 1st, 20X4, ABRA S.A. issues bonds in the amount of 12,000 lei with a 10% interest rate, with a maturity of two years, 20X4–20X6. ABRA’s management wishes to hedge the fair value exposure and enters into a fixed to floating interest rate swap which costs 500 lei. Practically, the swap contract involves a payment (or a receipt) to (or from) the swap partner of an amount equal to 12,000 * (10% − r) lei, when short term interest rates rise above or fall below 10% (r is the short term interest rate). On December 31st, 20X4, the market interest rate is 8%. Provide the specific journal entries.

Step-by-Step

Verified Solution

The relevant journal entries are:

  • on the acquisition of the swap contract:

500 lei               Swap contract            =            Cash                 500 lei


 

  • accrue the interest on the loan: 12,000,000 * 10% = 1200 lei

1200 lei             Interest expense            =           Loan interest payable            1200 lei


 

  • account for the swap: 12,000 * (10% − 8%) = 240 lei

240 lei               Swap contract           =         Revenue from derivatives             240 lei


 

ABRA S.A. will receive an amount of 240 lei at the end of 20X4 from the swap partner and the profit and loss account will show a net interest expense of 11,760 lei (12,000 lei − 240 lei).