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Embedded Derivative

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA SBR Exams › Embedded Derivative

  • This topic has 1 reply, 2 voices, and was last updated 4 months ago by Stephen Widberg.
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  • May 30, 2023 at 7:47 am #685436
    boiledalien
    Participant
    • Topics: 12
    • Replies: 7
    • ☆

    Part of BPP ques 66 Seltc Co.,

    “The entity uses forward and futures contracts to protect it against fluctuation in the price of edible oils. Where forwards are used, the company often takes delivery of the edible oil and sells it shortly afterwards. The contracts are constructed with future delivery in mind but the contracts also allow net settlement in cash as an alternative. The net settlement is based on the change in the price of the oil since the start of the contract. Seltec uses the proceeds of a net settlement to purchase a different type of oil or purchase from a different supplier. Where futures are used these sometimes relate to edible oils of a different type and market than those of Seltec’s own inventory of edible oil. The company intends to apply hedge accounting to these contracts in order to protect itself from earnings volatility.
    Seltec has also entered into a long-term arrangement to buy oil from a foreign entity whose currency is the dinar. The commitment stipulates that the fixed purchase price will be denominated in pounds sterling.”

    They explain about embedded derivative and link it to the foreign currency part in the end. I do understand the meaning of embedded derivative and the conditions related to when the host contract is asset or liability but do not understand how the conditions apply to the scenario. What is the host contract here? and is it an asset or liability? Should all conditions be met in case of a host contract being liability or one? I could unfortunately only identify the derivative and the hedge a/c aspect in this. Also, I could not find embedded derivatives in the lecture note, is this a topic that hardly is tested?

    May 31, 2023 at 7:16 am #685553
    Stephen Widberg
    Keymaster
    • Topics: 15
    • Replies: 3073
    • ☆☆☆☆☆

    Simple embedded derivatives are in syllabus for June, but not afterwards.

    Very rarely tested. No calculations tested to date.

    “Seltec has also entered into a long-term arrangement to buy oil from a foreign entity whose currency is the dinar. The commitment stipulates that the fixed purchase price will be denominated in pounds sterling.”

    Host contract is purchase of oil
    Embedded derivative is some sort of currency derivative (pounds/ dinars). Remember that derivative = betting = gambling.

    🙂

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