Document ID: chunk:federal_register_of_legislation:F2021C00192:body:0:p42
Version: federal_register_of_legislation:F2021C00192
Segment Type: other
Provision Reference: 
Character Range: 104808–107511

are scheduled into time periods on this basis. On the basis of this analysis, Entity A decides what amount it wishes to hedge in each time period.
IE3 This example deals only with the repricing time period expiring in three months' time, ie the time period maturing on 31 March 20X1 (a similar procedure would be applied for each of the other 59 time periods). Entity A has scheduled assets of CU100 million[9] and liabilities of CU80 million into this time period. All of the liabilities are repayable on demand.
IE4 Entity A decides, for risk management purposes, to hedge the net position of CU20 million and accordingly enters into an interest rate swap[10] on 1 January 20X1 to pay a fixed rate and receive LIBOR, with a notional principal amount of CU20 million and a fixed life of three months.
IE5 This example makes the following simplifying assumptions:
(a) the coupon on the fixed leg of the swap is equal to the fixed coupon on the asset;
(b) the coupon on the fixed leg of the swap becomes payable on the same dates as the interest payments on the asset; and
(c) the interest on the variable leg of the swap is the overnight LIBOR rate. As a result, the entire fair value change of the swap arises from the fixed leg only, because the variable leg is not exposed to changes in fair value due to changes in interest rates.
In cases when these simplifying assumptions do not hold, greater ineffectiveness will arise. (The ineffectiveness arising from (a) could be eliminated by designating as the hedged item a portion of the cash flows on the asset that are equivalent to the fixed leg of the swap.)
IE6 It is also assumed that Entity A tests effectiveness on a monthly basis.
IE7 The fair value of an equivalent non-prepayable asset of CU20 million, ignoring changes in value that are not attributable to interest rate movements, at various times during the period of the hedge is as follows:

                         1 Jan       31 Jan      1 Feb       28 Feb      31 Mar
                         20X1        20X1        20X1        20X1        20X1
Fair value (asset) (CU)  20,000,000  20,047,408  20,047,408  20,023,795  Nil

IE8 The fair value of the swap at various times during the period of the hedge is as follows:

                             1 Jan  31 Jan    1 Feb     28 Feb    31 Mar
                             20X1   20X1      20X1      20X1      20X1
Fair value (liability) (CU)  Nil    (47,408)  (47,408)  (23,795)  Nil

Accounting treatment
IE9 On 1 January 20X1, Entity A designates as the hedged item an amount of CU20 million of assets in the three-month time period. It designates as the hedged risk the change in the value of the hedged item (ie the CU20 million