tracking ifrs hedging made simple: part 4 cash flow ... · pdf file1. ‘hedging made...

1. ‘Hedging made simple’ – the series ‘Hedging made simple’ is a series of editions of

‘Tracking IFRS’ to discuss concepts, principles, guidance, practices, application and illustrations of hedge accounting under AS 30 Financial

Instruments: Measurement and Recognition. It may be noted that the guidance for hedge accounting in AS 30 is similar to guidance in Indian Accounting

Standards (Ind AS) converged with International Financial Reporting Standards (IFRS) i.e. Ind AS 39 Financial Instruments: Measurement and

Recognition. Part 1 and 2 in the series contained basic concepts

and principles of hedge accounting. Part 3 contained a detailed example illustrating cash flow hedge of a highly probable forecast transaction

using forward contracts. This edition contains an example to illustrate a cash

flow hedging of a variable rate debt using a variable-to-fixed cross-currency interest rate swap. It is recommended that this publication should be

read along with the concepts and principles discussed in Part 1 and 2.

2. Illustrative case study XYZ India Limited (the Company), an Indian

Company with its functional currency INR, on 1 April 2010 borrowed $ 1,000,000 (the USD debt) from DEF Bank for 1 year for quarterly interest

payments (on 30 June, 30 September, 31 December and 31 March) at a variable rate of 3-month USD LIBOR plus 250 basis points.

On the same day, the Company also enters into a 1-year variable-to-fixed cross-currency interest-rate swap (the swap) with DEF Bank with the following

terms: Type: Cross-currency interest rate swap Start date: 1 April 2010

Maturity date: 31 March 2011 Swap terms: Receive 3-month USD LIBOR plus 250 basis points on $ 1,000,000 and pay fixed

quarterly interest of ` 450,000 @ 4% p.a. on `45,000,000 Interest payments (net): Quarterly (on 30 June, 30

September, 31 December and 31 March) Principal payments: At maturity (the Company will receive $ 1,000,000 and pay ` 45,000,000)

The management of the Company designates the cross-currency interest-rate swap as the hedging

instrument in a cash flow hedge of the variable rate USD debt for the risk of variability in INR cash flows due to changes in interest rates and foreign

exchange rates.

Tracking IFRS Hedging made simple: Part 4 Cash flow hedging using cross-currency interest-rate swaps

Issue 10 April 2011

For Private circulation only

Tracking IFRS | Cash flow hedging using cross-currency interest-rate swaps 2

3. Illustrative solution Exhibit 1 Illustrative Board’s resolution (click icon to

retrieve attachment) Exhibit 2 Illustrative risk management policy (click

icon to retrieve attachment)

Note: Board resolution and risk management policy are not a specific requirement of AS 30 (or Ind AS

39). However, these documents have been included here in order that entities may consider the same in their documentation to meet the overall

objectives of hedge accounting and for setting up necessary processes and approvals for hedge accounting. Further, criteria in AS 30 (or Ind AS 39)

for hedge accounting refers to risk management strategy, which assumes that the entities adopting hedge accounting have a documented risk

management policy.

Exhibit 3 Illustrative hedge accounting policy (click icon to retrieve attachment)

Exhibit 4 Illustrative hedge documentation (click icon to retrieve attachment)

Exhibit 5 Illustrative effectiveness testing and

journal entries (refer page 5)

Exhibit 6 Illustrative ineffectiveness scenario and journal entries (refer page 19)

Note Due to rounding-off, the results of calculations of interest percentages and amounts presented in

the illustration may not exactly match the recalculations.

Note It is emphasised that exhibits included in this

publication are only illustrative; and applying hedge accounting in practice may require a more careful consideration of the requirements

of AS 30 (or Ind AS 39) and the facts surrounding the case.

Additional facts Zero-coupon rates Determining the term structure of the zero-coupon

rates based on applicable interest-rate index is the starting point in determining estimated future cash flows of an interest-rate swap. The zero-coupon

rates are used to determine the forward rates and to discount the future cash flows to determine their present value.

In the illustrative case study, the applicable index is USD LIBOR. The zero-coupon rates based on USD

LIBOR are the spot rates for expiry on relevant periodic intervals. For example, in the illustrative case study, since the variable leg of the hedging

instrument is linked to 3-month USD LIBOR, the relevant periodic interval for spot rates is 3 months.

Thus, on each testing/reporting date, XYZ India Limited will obtain the spot rates of USD LIBOR for expiry at end of 3 months, 6 months, 9 months, 12

months, as applicable, i.e. at 3-monthly intervals. In practice, especially over long-term periods, say

more than 1 year, spot rates beyond a certain period may not be readily available. In such cases, market yields for longer-term instruments e.g.

futures’ interest-rates, swaps’ interest-rates, are converted to zero-coupon rates by eliminating the time-effect (effect of coupon payments) on such

long-term interest rates. This is also known as ‘bootstrapping’.

Tracking IFRS | Hedging made simple: Part 4 3

Term structure of zero-coupon interest rates (using quarterly compounding) on relevant dates based on

USD LIBOR considered in the illustrative solution are as follows:

30 Jun 2010 30 Sep 2010 31 Dec 2010 31 Mar 2011

1 Apr 2010 0.29% p.a. 0.43% p.a. 0.67% p.a. 0.91% p.a.

30 Jun 2010 - 0.53% p.a. 0.75% p.a. 0.96% p.a.

30 Sep 2010 - - 0.29% p.a. 0.44% p.a.

31 Dec 2010 - - - 0.35% p.a.

For example, relevant zero-coupon rate on 1 April 2010 for cash flows occurring on 30 September

2010 is 0.43% p.a. USD LIBOR on relevant date for interest payments

on the USD debt and settlement of the swap considered in the illustrative solution are as follows:

30 Jun 2010 30 Sep 2010 31 Dec 2010 31 Mar 2011

0.31% p.a. 0.23% p.a. 0.29% p.a. 0.40% p.a.

Forward interest rates

After the determination of zero-coupon rates, the term structure of the forward rates based on the zero-coupon rates is determined. Forward rates are

used to compute variable future estimated cash flows. The forward rate is derived from the zero-coupon rates using the following formula:

B = [ (1 + At)^ t - 1 ] (1 + At-1) ^ (t-1)

where B = forward rate (%) A = zero-coupon/ spot rate (%) t = period in time (e.g. 1, 2, 3, 4)

At denotes zero-coupon rate of the date for which the forward rate is calculated, and At-1 denotes the


zero-coupon rate for the immediately preceding relevant date. For example, as of 1 April 2010, t =

1, 2, 3, 4 respectively for period ending 30 June 2010, 30 September 2010, 31 December 2010 and 31 March 2011. To illustrate, as of 1 April 2010,

forward rate for 30 September 2010 is calculated as [ (1 + 0.43%)^ 2 / (1 + 0.29%)^ 1 - 1 ] and forward rate for 31 December 2010 is calculated as

[ (1 + 0.67%)^ 3 / (1 + 0.43%)^ 2 - 1 ], and similarly for all other periods.

Forward rate for the first period for a given yield curve will equal the zero-coupon rate. For example, forward rate as of 1 April 2010 applicable for first 3-

month i.e. period ending 30 June 2010 will equal the

relevant 3-month zero-coupon rate as of 1 April 2010.

While the zero-coupon rates provide the yield-curve, forward rates are the derived spot rates for

the relevant interim periods ‘fitted’ on that yield curve. For example, in the illustrative solution below, the quarterly-period term structure of interest

rates on 1 April 2010 is as follows:

30 Jun 2010 30 Sep 2010 31 Dec 2010 31 Mar 2011 Zero-coupon 0.29% p.a. 0.43% p.a. 0.67% p.a. 0.91% p.a.

Forward 0.29% p.a. 0.57% p.a. 1.15% p.a. 1.63% p.a.

Foreign exchange rates Additionally, for a cross-currency interest-rate swap, in order to determine the future cash flows,

another key consideration is to obtain forward foreign exchange rates of relevant date for translating foreign-currency denominated future

cash flows on account of interest and principal. USD-INR forward rates on relevant dates

considered in the illustrative solution are as follows:

30 Jun 2010 30 Sep 2010 31 Dec 2010 31 Mar 2011

1 Apr 2010 45.18 45.19 45.23 45.26

30 Jun 2010 - 46.70 46.75 46.80

30 Sep 2010 - - 44.70 44.20

31 Dec 2010 - - - 45.50

For example, relevant USD-INR forward rate on 1

April 2010 for cash flows occurring on 31 December 2010 is 1 $ = ` 45.23.

USD-INR spot rates on relevant dates considered in the illustrative solution are as follows:

1 Apr 2010 30 Jun 2010 30 Sep 2010 31 Dec 2010 31 Mar 2011

45 46.45 44.80 45.35 45.30


XYZ India Limited Hedge accounting

In the books of XYZ India Limited

1 April 2010 (inception of hedging relationship) 1. Computation of fair valuation of cross-currency interest rate swap on the date of testing (click icon to retrieve attachment) 2. Sensitivity analysis: Computation of fair valuation of cross-currency interest rate swap on the date of testing using shifted rates (click icon to retrieve attachment) 3. Computation of fair valuation of hypothetical derivative on the date of testing (click icon to retrieve attachment) 4. Sensitivity analysis: Computation of fair valuation of hypothetical derivative on the date of testing using shifted rates (click icon to retrieve attachment) 5. Prospective effectiveness testing Effectiveness = Change in fair value of the cash flows on hedging instrument due to sensitivity analysis Change in fair value of the cash flows on hedged item due to sensitivity analysis = ∑ J minus ∑JS ∑ hJ minus ∑hJS = Zero minus 2,761,742 Zero minus (2,761,742) = 100% (sign ignored). Since, the results are within the range 80%-125%, the hedge relationship is expected to be highly effective.

6. Accounting entries

Particulars Derivative instrument

Hedging reserve account - equity

Debt - other financial liabilities Bank Interest expense

– finance cost Foreign exchange

loss/ (gain) Bank Dr. Debt Cr. (being recording of debt obligation @ spot rate of 1 USD = INR 45)

` (45,000,000)

` 45,000,000

No accounting entry will be passed for the cross-currency interest-rate swap on this date as the fair value of the swap is zero.

Exhibit 5: Illustrative effectiveness testing and journal entries




30 June 2010 (reporting date during hedge period) 1. Computation of fair valuation of cross-currency interest rate swap on the date of testing (click icon to retrieve attachment) 2. Sensitivity analysis: Computation of fair valuation of cross-currency interest rate swap on the date of testing using shifted rates (click icon to retrieve attachment) 3. Computation of fair valuation of hypothetical derivative on the date of testing (click icon to retrieve attachment) 4. Sensitivity analysis: Computation of fair valuation of hypothetical derivative on the date of testing using shifted rates (click icon to retrieve attachment) 5. Retrospective effectiveness testing Effectiveness = Change in fair value of the cash flows on hedging instrument during the period Change in fair value of the cash flows on hedged item during the period = ∑J 30 Jun minus ∑ J 1 Apr

∑hJ 30 Jun

minus ∑ hJ 1 Apr = 1,650,636 minus Zero (1,650,636) minus Zero = 100% (sign ignored). Since, the results are within the range 80%-125%, the hedge relationship has been highly effective during the period.

6. Prospective effectiveness testing Effectiveness = Change in fair value of the cash flows on hedging instrument due to sensitivity analysis Change in fair value of the cash flows on hedged item due to sensitivity analysis = ∑ J minus ∑JS ∑ hJ minus ∑hJS = 1,650,636 minus 4,368,700 (1,650,636) minus (4,368,700) = 100% (sign ignored). Since, the results are within the range 80%-125%, the hedge relationship is expected to be highly effective.




30 June 2010 (reporting date during hedge period) (contd.) 7. ‘Lower of the two’ rule for determining ineffectiveness in cash flow hedge accounting All the criteria for hedge accounting are met for the period ended 30 June 2010, and accordingly cash flow hedge accounting can be applied. The hedge is 100% effective, and, therefore, the amount recognised in hedging reserve account is equal to the cumulative change in the fair value of the hedging instrument which shall be determined as the lower (a) the cumulative change in the fair value of the cash flows on the hedging instrument from inception of hedge, and (b) the cumulative change in the fair value of the of the cash flows on the hypothetical derivative.

Fair value Hedging instrument - A

Hedged item (hypothetical derivative) - B

Effective portion – C Lower of A and B in

absolute terms

Ineffective portion – Difference between A and

C in absolute terms

Change from inception of hedge ` 1,650,636 ` (1,650,636) ` 1,650,636 Nil

Change in the period ` 1,650,636 ` (1,650,636) ` 1,650,636 Nil

8. Interest expense 1. Amount of interest on debt = $ 1,000,000 x (0.31% (USD LIBOR) + 2.5%) x 90/360 x 46.45 (USD-INR spot rate)

= ` 326,311

2. Amount of net settlement on swap = ` 326,311 – ` 450,000

= ` 123,689 (loss)





– finance cost Exchange loss/

(gain) Interest Dr. Bank Cr. (being recording of interest expense on USD debt)

` (326,311)

` 326,311

Interest Dr. Bank Cr. (being recording of settlement of net swap cash flows i.e. the difference between the fixed and variable interest amounts)

` (123,689)

` 123,689




30 June 2010 (reporting date during hedge period) (contd.)

Particulars Derivative

instrument Hedging reserve account - equity



(gain) Derivative instrument Dr. Hedging reserve A/c Cr. (being the gain on account of fair value changes of cross-currency swap recognised in equity by virtue of cash flow hedge accounting)

` 1,650,636

` (1,650,636)

Exchange loss Dr. Debt Cr. (being translation of monetary liability i.e. debt @ spot rate of 1 USD = INR 46.45)

` (1,450,000)

` 1,450,000

Hedging reserve A/c Dr. Exchange loss Cr. (being reclassif-ication out of hedging reserve account to offset spot remeasure-ment on the debt by virtue of cash flow hedge accounting)

` 1,450,000

` (1,450,000)

Summary ` 1,650,636 ` (200,636) ` (1,450,000) ` (450,000) ` 450,000 ` 0

Observation From the summary of accounting entries above, by virtue of cash flow hedge accounting, following may be observed: 1. During the period, the Company has limited the impact on its profit or loss to fixed rate INR interest on the cross-currency swap of

`450,000, and thereby successfully eliminated the volatility due to variable rate interest on the USD debt. 2. During the period, the Company has successfully eliminated the volatility in its profit or loss due to changes in the fair value of its

derivative instrument of ` 1,650,636 by recognising such changes in ‘hedging reserve account’ which forms part of equity. 3. During the period, the Company has successfully eliminated the volatility in its profit or loss due to foreign exchange translation

differences on its debt of ` 1,450,000 by reclassifying an equivalent amount out of ‘hedging reserve account’ to offset such foreign exchange translation differences.




30 September 2010 (reporting date during hedge period) 1. Computation of fair valuation of cross-currency interest rate swap on the date of testing (click icon to retrieve attachment) 2. Sensitivity analysis: Computation of fair valuation of cross-currency interest rate swap on the date of testing using shifted rates (click icon to retrieve attachment) 3. Computation of fair valuation of hypothetical derivative on the date of testing (click icon to retrieve attachment) 4. Sensitivity analysis: Computation of fair valuation of hypothetical derivative on the date of testing using shifted rates (click icon to retrieve attachment)

5. Retrospective effectiveness testing Effectiveness = Change in fair value of the cash flows on hedging instrument during the period Change in fair value of the cash flows on hedged item during the period = ∑J 30 Sep minus ∑ J 30 Jun ∑hJ 30 Sep

minus ∑ hJ 30 Jun = (1,044,677) minus 1,650,636 1,044,677 minus (1,650,636) = 100% (sign ignored). Since, the results are within the range 80%-125%, the hedge relationship has been highly effective during the period.

6. Prospective effectiveness testing Effectiveness = Change in fair value of the cash flows on hedging instrument due to sensitivity analysis Change in fair value of the cash flows on hedged item due to sensitivity analysis = ∑ J minus ∑JS ∑ hJ minus ∑hJS = (1,044,677) minus 1,419,043 1,044,677 minus (1,419,043) = 100% (sign ignored). Since, the results are within the range 80%-125%, the hedge relationship is expected to be highly effective.




30 September 2010 (reporting date during hedge period) (contd.) 7. ‘Lower of the two’ rule for determining ineffectiveness in cash flow hedge accounting All the criteria for hedge accounting are met for the period ended 30 September 2010, and accordingly cash flow hedge accounting can be applied. The hedge is 100% effective, and, therefore, the amount recognised in hedging reserve account is equal to the cumulative change in the fair value of the hedging instrument which shall be determined as the lower (a) the cumulative change in the fair value of the cash flows on the hedging instrument from inception of hedge, and (b) the cumulative change in the fair value of the of the cash flows on the hypothetical derivative.




absolute terms


C in absolute terms Change from inception of hedge ` (1,044,677) ` 1,044,677 ` 1,044,677 Nil

Change in the period ` (2,695,313) ` 2,695,313 ` 2,695,313 Nil


= ` 305,760


= ` 144,240 (loss)







` (305,760)

` 305,760


` (144,240)

` 144,240




30 September 2010 (reporting date during hedge period) (contd.)





(gain) Hedging reserve A/c Dr. Derivative instrument Cr. (being the loss on account of fair value changes of cross-currency swap recognised in equity by virtue of cash flow hedge accounting)

` (2,695,313)

` 2,695,313

Debt Dr. Exchange gain Dr. (being translation of monetary liability i.e. debt @ spot rate of 1 USD = INR 44.8)

` 1,650,000

` (1,650,000)

Exchange gain Dr. Hedging reserve A/c Cr. (being reclassification out of hedging reserve account to offset spot remeasure-ment on the debt by virtue of cash flow hedge accounting)

` (1,650,000)

` 1,650,000

Summary ` (2,695,313) ` 1,045,313 ` 1,650,000 ` (450,000) ` 450,000 ` 0




differences on its debt of ` 1,650,000 by reclassifying an equivalent amount out of ‘hedging reserve account’ to offset such foreign exchange translation differences.




31 December 2010 (reporting date during hedge period)

1. Computation of fair valuation of cross-currency interest rate swap on the date of testing (click icon to retrieve attachment) 2. Sensitivity analysis: Computation of fair valuation of cross-currency interest rate swap on the date of testing using shifted rates (click icon to retrieve attachment) 3. Computation of fair valuation of hypothetical derivative on the date of testing (click icon to retrieve attachment) 4. Sensitivity analysis: Computation of fair valuation of hypothetical derivative on the date of testing using shifted rates (click icon to retrieve attachment) 5. Retrospective effectiveness testing Effectiveness = Change in fair value of the cash flows on hedging instrument during the period Change in fair value of the cash flows on hedged item during the period = ∑J 31 Dec minus ∑ J 30 Sep ∑hJ 31 Dec

minus ∑ hJ 30 Sep = 373,861 minus (1,044,677) (373,861) minus 1,044,677 = 100% (sign ignored). Since, the results are within the range 80%-125%, the hedge relationship has been highly effective during the period.

6. Prospective effectiveness testing Effectiveness = Change in fair value of the cash flows on hedging instrument due to sensitivity analysis Change in fair value of the cash flows on hedged item due to sensitivity analysis = ∑ J minus ∑JS ∑ hJ minus ∑hJS = 373,861 minus 2,780,499 (373,861) minus (2,780,499) = 100% (sign ignored). Since, the results are within the range 80%-125%, the hedge relationship is expected to be highly effective.




31 December 2010 (reporting date during hedge period) (contd.) 7. ‘Lower of the two’ rule for determining ineffectiveness in cash flow hedge accounting All the criteria for hedge accounting are met for the period ended 31 December 2010, and accordingly cash flow hedge accounting can be applied. The hedge is 100% effective, and, therefore, the amount recognised in hedging reserve account is equal to the cumulative change in the fair value of the hedging instrument which shall be determined as the lower (a) the cumulative change in the fair value of the cash flows on the hedging instrument from inception of hedge, and (b) the cumulative change in the fair value of the of the cash flows on the hypothetical derivative.




absolute terms


C in absolute terms Change from inception of hedge ` 373,861 ` (373,861) ` 373,861 Nil

Change in the period ` 1,418,538 ` (1,418,538) ` 1,418,538 Nil


= ` 316,316


= ` 133,684 (loss)




Debt - other financial liabilities

Bank Interest expense – finance cost

Exchange loss/ (gain)

Interest Dr. Bank Cr. (being recording of interest expense on USD debt)

` (316,316)

` 316,316


` (133,684)

` 133,684




31 December 2010 (reporting date during hedge period) (contd.)





(gain) Derivative instrument Dr. Hedging reserve A/c Cr. (being the gain on account of fair value changes of cross-currency swap recognised in equity by virtue of cash flow hedge accounting)

` 1,418,538

` (1,418,538)


` (550,000)

` 550,000

Hedging reserve A/c Dr. Exchange loss Cr. (being reclassification out of hedging reserve account to offset spot remeasure-ment on the debt by virtue of cash flow hedge accounting)

` 550,000

` (550,000)

Summary ` 1,418,538 ` (868,538) ` (550,000) ` (450,000) ` 450,000 ` 0




differences on its debt of ` 550,000 by reclassifying an equivalent amount out of ‘hedging reserve account’ to offset such foreign exchange translation differences.




31 March 2011 (end of the hedge period)

1. Computation of fair valuation of cross-currency interest rate swap on the date of testing Fair value [∑ J] of the swap on 31 March 2011 will be INR 300,000 being the intrinsic value representing the difference in the swap USD-INR rate and the spot USD-INR rate. 2. Computation of fair valuation of hypothetical derivative on the date of testing Fair value [∑ hJ] of the hypothetical swap on 31 March 2011 will be INR (300,000) representing the difference in the hypothetical swap USD-INR rate and the spot USD-INR rate. 3. Retrospective effectiveness testing Effectiveness = Change in fair value of the cash flows on hedging instrument during the period Change in fair value of the cash flows on hedged item during the period = ∑J 31 Mar minus ∑ J 31 Dec ∑hJ 31 Mar

minus ∑ hJ 31 Dec = 300,000 minus 373,861 (300,000) minus (373,861) = 100% (sign ignored). Since, the results are within the range 80%-125%, the hedge relationship has been highly effective during the period. 4. Interest expense 1. Amount of interest on debt = $ 1,000,000 x (0.40% (USD LIBOR) + 2.5%) x 90/360 x 45.3 (USD-INR spot rate)

= ` 328,425


= ` 121,575 (loss)




31 March 2011 (end of the hedge period) (contd.) 5. ‘Lower of the two’ rule for determining ineffectiveness in cash flow hedge accounting All the criteria for hedge accounting are met for the period ended 31 December 2010, and accordingly cash flow hedge accounting can be applied. The hedge is 100% effective, and, therefore, the amount recognised in hedging reserve account is equal to the cumulative change in the fair value of the hedging instrument which shall be determined as the lower (a) the cumulative change in the fair value of the cash flows on the hedging instrument from inception of hedge, and (b) the cumulative change in the fair value of the of the cash flows on the hypothetical derivative.




absolute terms


C in absolute terms Change from inception of hedge ` 300,000 ` (300,000) ` 300,000 Nil

Change in the period ` (73,861) ` 73,861 ` 73,861 Nil







` (328,425)

` 328,425


` (121,575)

` 121,575

Hedging reserve A/c Dr. Derivative instrument Cr. (being the loss on account of fair value changes of cross-currency swap recognised in equity by virtue of cash flow hedge accounting)

` (73,861)

` 73,861




31 March 2011 (end of the hedge period) (contd.)





(gain) Debt Dr. Exchange gain Cr. (being translation of monetary liability i.e. debt @ spot rate of 1 USD = INR 45.3)

` 50,000 ` (50,000)


` (50,000)

` 50,000

Debt Dr. Bank Cr. (Being repayment of debt @ spot rate of 1 USD = INR 45.3)

` 45,300,000 ` (45,300,000)

Bank Dr. Derivative instrument Cr. (being net exchange of notional principal amounts @ 1 USD = INR 45 versus the spot price of 1 USD = INR 45.3)

` (300,000)

` 300,000

Summary ` (373,861) ` 23,861 ` 45,350,000 ` (45,450,000) ` 450,000 ` 0




31 March 2011 (end of the hedge period) (contd.) 7. Summary of hedge accounting A cumulative summary of all accounts at the end of the hedging period is as follows:





(gain) 1 April 2010 ` (45,000,000) ` 45,000,000 30 June 2010 ` 1,650,636 ` (200,636) ` (1,450,000) ` (450,000) ` 450,000 ` 0

30 Sep 2010 ` (2,695,313) ` 1,045,313 ` 1,650,000 ` (450,000) ` 450,000 ` 0 31 Dec 2010 ` 1,418,538 ` (868,538) ` (550,000) ` (450,000) ` 450,000 ` 0

31 March 2011 ` (373,861) ` 23,861 ` 45,350,000 ` (45,450,000) ` 450,000 ` 0

Grand total ` 0 ` 0 ` 0 ` (1,800,000) ` 1,800,000 ` 0

Observation It can be observed that by using the cross-currency interest rate swap, XYZ India Limited has perfectly hedged its cash flows arising out of the variable USD debt transaction for, both, principal as well as the interest amounts against the variability in interest rates and variability in foreign exchange rates (by fixing the interest amount to ` 450,000 per quarter and the USD-INR rate at 45 on the USD debt). It can also be observed that by adopting cash flow hedge accounting for the aforesaid transaction, XYZ India Limited has perfectly hedged the volatility in its profit or loss (by fixing the interest expense to ` 450,000 per quarter; by recognising the changes in fair value of the derivative in hedging reserve account; and by offsetting the foreign exchange losses on remeasurement of the USD debt through a reclassification from the hedging reserve account), and volatility in its cash flows (by fixing the net payment to ` 450,000 per quarter through an offset of variable interest on USD debt with gains and losses on the swap) in the interim periods during the hedge tenure.

Exhibit 6: Illustrative ineffectiveness scenario and journal entries High hedge effectiveness can be achieved if the fair value of the interest-rate swap at the inception of the hedge is zero (or near-zero). In such cases,

under the ‘hypothetical derivative’ method, the hypothetical swap is structured with the critical terms exactly opposite as those of the hedging

instrument. Hypothetical swap is always structured in a way that its fair value is equal to zero at the inception of the hedge. Thus, in situations when

a variable-to-fixed interest-rate swap is designated

as a hedging instrument at a date later than itsinception, the fixed interest-rate on the hypotheticalswap, that makes the fair value of the hypothetical

swap zero on inception of the hedge, may not exactly match the fixed interest-rate on the hedginginstrument and will result in hedge ineffectiveness.

To illustrate an ineffectiveness scenario in a cash flow hedging using cross-currency interest-rate

swap, let us assume that XYZ India Limited designates the hedging relationship on 1 July 2010, instead of 1 April 2010. All other facts remain the

same as mentioned on page 1.

In this case, XYZ India Limited will structure the hypothetical derivative as follows:

Type: Cross-currency interest rate swap Inception date: 1 July 2010 Maturity date: 31 March 2011

Swap terms: Pay 3-month USD LIBOR plus 250 basis points on $ 1,000,000 and receive fixed quarterly interest of ` 520,630 @ 4.6278% p.a. on

`46,450,000 Settlement dates: End of each calendar quarter Reset dates: End of each calendar quarter

Principal payments: At maturity The source of ineffectiveness in the illustrated

scenario is the fact that on the date of designation, the derivative hedging instrument has a fair value other than zero, however the fair value on that date

of hypothetical derivative is zero (refer attachment for Computation of fair valuation of hypothetical derivative on the date of testing as of 1 July 2010).

This results in different patterns of fair value winding and unwinding on the hedging instrument and the hedged item.

Note Illustrative hedge documentation for situation

illustrated in Exhibit 6 has not been provided in this illustration. Effectiveness calculations and journal entries have been illustrated only up to 30

September 2010.


In the books of XYZ India Limited 30 June 2010


= ` 326,311


= ` 123,689 (loss)





– finance cost

Profit or loss A/c - Foreign exchange

loss (gain)/ Fair value loss (gain)

Interest Dr. Bank Cr. (being recording of interest expense on USD debt)

` (326,311)

` 326,311


` (123,689)

` 123,689

Derivative instrument Dr. Profit or loss A/c Cr. (being the gain on account of fair value changes of cross-currency swap recognised profit or loss)

` 1,650,636

` (1,650,636)


` (1,450,000)

` 1,450,000

Summary ` 1,650,636 ` 0 ` (1,450,000) ` (450,000) ` 450,000 ` (200,636)

Observation Comparing the summary of accounting of the same date in Exhibit 5 i.e. when XYZ India Limited followed hedge accounting, it may be observed that XYZ India Limited, in the absence of cash flow hedge accounting, has recorded a loss of ` 1,450,000 due to foreign exchange translation differences and a gain of `1,650,636 due to changes in fair value of the derivative instrument; and XYZ India Limited is not protected against the volatility in its profit or loss due to such amounts.



In the books of XYZ India Limited 1 July 2010 (inception of hedge relationship)

1. Computation of fair valuation of cross-currency interest rate swap on the date of testing (click icon to retrieve attachment) 2. Sensitivity analysis: Computation of fair valuation of cross-currency interest rate swap on the date of testing using shifted rates (click icon to retrieve attachment) 3. Computation of fair valuation of hypothetical derivative on the date of testing (click icon to retrieve attachment) 4. Sensitivity analysis: Computation of fair valuation of hypothetical derivative on the date of testing using shifted rates (click icon to retrieve attachment) 5. Prospective effectiveness testing Effectiveness = Change in fair value of the cash flows on hedging instrument due to sensitivity analysis Change in fair value of the cash flows on hedged item due to sensitivity analysis = ∑ J minus ∑JS ∑ hJ minus ∑hJS = 1,650,636 minus 4,368,700 Zero minus (2,729,828) = 99.56%% (sign ignored). Since, the results are within the range 80%-125%, the hedge relationship is expected to be highly effective.



In the books of XYZ India Limited 30 September 2010 (reporting date during hedging period)

1. Computation of fair valuation of cross-currency interest rate swap on the date of testing (click icon to retrieve attachment) 2. Sensitivity analysis: Computation of fair valuation of cross-currency interest rate swap on the date of testing using shifted rates (click icon to retrieve attachment) 3. Computation of fair valuation of hypothetical derivative on the date of testing (click icon to retrieve attachment) 4. Sensitivity analysis: Computation of fair valuation of hypothetical derivative on the date of testing using shifted rates (click icon to retrieve attachment) 5. Retrospective effectiveness testing Effectiveness = Change in fair value of the cash flows on hedging instrument during the period Change in fair value of the cash flows on hedged item during the period = ∑J 30 Sep minus ∑ J 30 Jun ∑hJ 30 Sep

minus ∑ hJ 30 Jun = (1,044,677) minus 1,650,636 2,632,545 minus Zero = 102.35% (sign ignored). Since, the results are within the range 80%-125%, the hedge relationship has been highly effective during the period.

6. Prospective effectiveness testing Effectiveness = Change in fair value of the cash flows on hedging instrument due to sensitivity analysis Change in fair value of the cash flows on hedged item due to sensitivity analysis = ∑ J minus ∑JS ∑ hJ minus ∑hJS = (1,044,677) minus 1,419,043 2,632,545 minus 161,101 = 99.69% (sign ignored). Since, the results are within the range 80%-125%, the hedge relationship is expected to be highly effective.



In the books of XYZ India Limited 30 September 2010 (reporting date during hedging period) (contd.) 7. ‘Lower of the two’ rule for determining ineffectiveness in cash flow hedge accounting All the criteria for hedge accounting are met for the period ended 30 September 2010, and accordingly cash flow hedge accounting can be applied. The hedge is 102.35% effective, and, therefore, the amount recognised in hedging reserve account is equal to the cumulative change in the fair value of the hedging instrument which shall be determined as the lower (a) the cumulative change in the fair value of the cash flows on the hedging instrument, and (b) the cumulative change in the fair value of the of the cash flows on the hypothetical derivative.




absolute terms


C in absolute terms Change from inception of hedge ` (2,695,313) ` 2,632,545 ` 2,632,545 ` 62,768

Change in the period ` (2,695,313) ` 2,632,545 ` 2,632,545 ` 62,768


= ` 305,760


= ` 144,240 (loss)







` (305,760)

` 305,760


` (144,240)

` 144,240



In the books of XYZ India Limited 30 September 2010 (reporting date during hedging period) (contd.)




– finance cost

Profit or loss A/c - Foreign exchange

loss (gain)/ Fair value loss (gain)

Hedging reserve A/c Dr. Profit or loss A/c Dr. Derivative instrument Cr. (being the effective portion of loss on account of fair value changes of cross-currency swap recognised in equity by virtue of cash flow hedge accounting and ineffective portion recognised in profit or loss)

` (2,695,313)

` 2,632,545

` 62,768

Debt Dr. Exchange gain Dr. (being translation of monetary liability i.e. debt @ spot rate of 1 USD = INR 44.8)

` 1,650,000

` (1,650,000)


` (1,650,000)

` 1,650,000

Summary ` (2,695,313) ` 982,545 ` 1,650,000 ` (450,000) ` 450,000 ` 62,678

Observation Comparing the summary of accounting of the same date in Exhibit 5, it may be observed that due to ineffectiveness in the hedging relationship, XYZ India Limited has recorded a loss of ` 62,678 due to changes in fair value of the derivative instrument being the ineffective portion of hedge; and XYZ India Limited has not been able to fully protected itself against the volatility in its profit or loss due to such amounts.


Contacts

For more information, please contact: Ritesh Sanyal Senior Director

Deloitte Touche Tohmatsu India Private Limited +91 80 6627 6111 [email protected]

Yogesh Sharma Director

Deloitte Touche Tohmatsu India Private Limited +91 80 6627 6120 [email protected]

Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see www.deloitte.com/about for a detailed description of the legal structure of Deloitte Touche Tohmatsu Limited and its member firms. This material and the information contained herein prepared by Deloitte Touche Tohmatsu India Private Limited (DTTIPL) is intended to provide general information on a particular subject or subjects and is not an exhaustive treatment of such subject(s). None of DTTIPL, Deloitte Touche Tohmatsu Limited, its member firms, or their related entities (collectively, the “Deloitte Network”) is, by means of this material, rendering professional advice or services. The information is not intended to be relied upon as the sole basis for any decision which may affect you or your business. Before making any decision or taking any action that might affect your personal finances or business, you should consult a qualified professional adviser. No entity in the Deloitte Network shall be responsible for any loss whatsoever sustained by any person who relies on this material. ©2011 Deloitte Touche Tohmatsu India Private Limited. Member of Deloitte Touche Tohmatsu Limited

Tracking IFRS | Hedging made simple: Part 4 x



30 September 2010 (reporting date during hedge period) (contd.) 4. Sensitivity analysis: Computation of fair valuation of hypothetical derivative on the date of testing using shifted rates

Particulars 30 June 2010 30 Sept 2010 31 Dec 2010 31 March 2011 31 March 20115

Zero-coupon rates (A)1 - - 0.29% p.a. 0.44% p.a. 0.44% p.a.

Shifted zero coupon rates (A1)

[ A + 100 bps ] - - 1.29% p.a. 1.44% p.a. 1.44% p.a.

Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

- - 1.29% p.a. 1.59% p.a. -

Applicable variable rate (C)

[ B + 250 bps ] - - 3.79% p.a. 4.09% p.a. -

USD-INR forward exchange

rates (D) - - 44.70 44.20 44.20

Shifted USD-INR forward

exchange rates (D1)

[ D x 105 % ]

- - 46.94 46.41 46.41

Pay-variable USD (E)

[ C x USD notional (USD 1 mn)

x 90/3603 ]

- - $ (9,475) $ (10,225) $ (1,000,000)

Pay-variable INR4 (F)

[ E x D1 ] - - ` (444,757) ` (474,542) ` (46,410,000)

Receive-fixed INR (G) - - ` 450,000 ` 450,000 ` 45,000,000

Difference (H) [ F minus G ] - - ` 5,243 ` (24,542) ` (1,410,000)

Time factor3 for discounting (T) - - 1 2 2

Present value of future cash

flows (hJS) [ H x 1 ] (1+A1/4)^ T

- - ` 5,226 ` (24,366) ` (1,399,903)

Fair value [ ∑ hJS ] ` (1,419,043)

1 Zero-coupon rates have been built using USD LIBOR curve as of 30 September 2010. 2 Forward rates have been derived from the shifted zero-coupon rates listed in A1. 3 In this illustration, for convenience of calculation, a calendar year has been assumed to be of 360 days, and each calendar quarter has

been assumed to be of 90 days. 4 USD-INR forward exchange rates as of 30 September 2010 for relevant dates are used for converting USD denominated future cash flows

to INR. 5 Exchange of notional amounts at maturity.




1 July 2010 (inception of hedging relationship) 1. Computation of fair valuation of cross-currency interest rate swap on the date of testing

Particulars 1 July 2010 30 Sept 2010 31 Dec 2010 31 March 2011 31 March 20115

Zero-coupon rates (A)1 - 0.53% p.a. 0.75% p.a. 0.96% p.a. 0.96% p.a.

Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

- 0.53% p.a. 0.97% p.a. 1.38% p.a. -


[ B + 250 bps ] - 3.03% p.a. 3.47% p.a. 3.88% p.a. -


rates (D) - 46.70 46.75 46.80 46.80

Receive-variable USD (E)


x 90/3603 ]

- $ 7,575 $ 8,675 $ 9,700 $ 1,000,000

Receive-variable INR4 (F)

[ E x D ] - ` 353,753 ` 405,556 ` 453,960 ` 46,800,000

Pay-fixed INR (G) - ` (450,000) ` (450,000) ` (450,000) ` (45,000,000)

Difference (H) [ F minus G ] - ` (96,247) ` (44,444) ` 3,960 ` 1,800,000

Time factor3 for discounting (T) - 1 2 3 3


flows (J) [ H x 1 ] (1+A/4)^ T

- ` (96,120) ` (44,278) ` 3,932 ` 1,787,102

Fair value [ ∑ J ] ` 1,650,636

1 Zero-coupon rates have been built using USD LIBOR curve as of 1 July 2010. 2 Forward rates have been derived from the zero-coupon rates listed in A. 3 In this illustration, for convenience of calculation, a calendar year has been assumed to be of 360 days, and each calendar quarter has

been assumed to be of 90 days. 4 USD-INR forward exchange rates as of 1 July 2010 for relevant dates are used for converting USD denominated future cash flows to INR. 5 Exchange of notional amounts at maturity.




30 September 2010 (reporting date during hedge period) 1. Computation of fair valuation of cross-currency interest rate swap on the date of testing



Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

- - 0.29% p.a. 0.59% p.a. -


[ B + 250 bps ] - - 2.79% p.a. 3.09% p.a. -


rates (D) - - 44.70 44.20 44.20



x 90/3603 ]

- - $ 6,975 $ 7,725 $ 1,000,000


[ E x D ] - - ` 311,783 ` 341,445 ` 44,200,000

Pay-fixed INR (G) - - ` (450,000) ` (450,000) ` (45,000,000)

Difference (H) [ F minus G ] - - ` (138,217) ` (108,855) ` (800,000)



flows (J) [ H x 1 ] (1+A/4)^ T

- - ` (138,117) ` (108,317) ` (798,243)

Fair value [ ∑ J ] ` (1,044,677)

1 Zero-coupon rates have been built using USD LIBOR curve as of 30 September 2010. 2 Forward rates have been derived from the zero-coupon rates listed in A. 3 In this illustration, for convenience of calculation, a calendar year has been assumed to be of 360 days, and each calendar quarter has


to INR. 5 Exchange of notional amounts at maturity




1 April 2010 (inception of hedging relationship) (contd.) 2. Sensitivity analysis: Computation of fair valuation of cross-currency interest rate swap on the date of testing using shifted rates


Zero-coupon rates (A)1 0.29% p.a. 0.43% p.a. 0.67% p.a. 0.91% p.a. 0.91% p.a.


[ A + 100 bps ] 1.29% p.a. 1.43% p.a. 1.67% p.a. 1.91% p.a. 1.91% p.a.

Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

1.29% p.a. 1.57% p.a. 2.15% p.a. 2.63% p.a. -


[ B + 250 bps ] 3.79% p.a. 4.07% p.a. 4.65% p.a. 5.13% p.a. -


rates (D) 45.18 45.19 45.23 45.26 45.26


exchange rates (D1)

[ D x 105 % ]

47.44 47.45 47.49 47.52 47.52



x 90/3603 ]

$ 9,475 $ 10,175 $ 11,625 $ 12,825 $ 1,000,000


[ E x D1 ] ` 449,494 ` 482,804 ` 552,071 ` 609,444 ` 47,520,000

Pay-fixed INR (G) ` (450,000) ` (450,000) ` (450,000) ` (450,000) ` (45,000,000)

Difference (H) [ F minus G ] ` (506) ` 32,804 ` 102,071 ` 159,444 ` 2,520,000

Time factor3 for discounting (T) 1 2 3 4 4


flows (JS) [ H x 1 ] (1+A1/4)^ T

` (504) ` 32,571 ` 100,803 ` 156,435 ` 2,472,437

Fair value [ ∑ JS ] ` 2,761,742

1 Zero-coupon rates have been built using USD LIBOR curve as of 1 April 2010. 2 Forward rates have been derived from the shifted zero-coupon rates listed in A1. 3 In this illustration, for convenience of calculation, a calendar year has been assumed to be of 360 days, and each calendar quarter has

been assumed to be of 90 days. 4 USD-INR forward exchange rates as of 1 April 2010 for relevant dates are used for converting USD denominated future cash flows to INR. 5 Exchange of notional amounts at maturity.




30 June 2010 (reporting date during hedge period) (contd.) 4. Sensitivity analysis: Computation of fair valuation of hypothetical derivative on the date of testing using shifted rates




[ A + 100 bps ] - 1.53% p.a. 1.75% p.a. 1.96% p.a. 1.96% p.a.

Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

- 1.53% p.a. 1.97% p.a. 2.38% p.a. -


[ B + 250 bps ] - 4.03% p.a. 4.47% p.a. 4.88% p.a. -


rates (D) - 46.70 46.75 46.80 46.80


exchange rates (D1)

[ D x 105 % ]

- 49.04 49.09 49.14 49.14



x 90/3603 ]

- $ (10,075) $ (11,175) $ (12,200) $ (1,000,000)


[ E x D1 ] - ` (494,078) ` (548,581) ` (599,508) ` (49,140,000)

Receive-fixed INR (G) - ` 450,000 ` 450,000 ` 450,000 ` 45,000,000

Difference (H) [ F minus G ] - ` (44,078) ` (98,581) ` (149,508) ` (4,140,000)



flows (hJS) [ H x 1 ] (1+A1/4)^ T

- ` (43,910) ` (97,724) ` (147,332) ` (4,079,734)

Fair value [ ∑ hJS ] ` (4,368,700)

1 Zero-coupon rates have been built using USD LIBOR curve as of 30 June 2010. 2 Forward rates have been derived from the shifted zero-coupon rates listed in A1. 3 In this illustration, for convenience of calculation, a calendar year has been assumed to be of 360 days, and each calendar quarter has

been assumed to be of 90 days. 4 USD-INR forward exchange rates as of 30 June 2010 for relevant dates are used for converting USD denominated future cash flows to

INR. 5 Exchange of notional amounts at maturity.





2. Sensitivity analysis: Computation of fair valuation of cross-currency interest rate swap on the date of testing using shifted rates


Zero-coupon rates (A)1 - - - 0.35% p.a. 0.35% p.a.


[ A + 100 bps ] - - - 1.35% p.a. 1.35% p.a.

Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

- - - 1.35% p.a. -


[ B + 250 bps ] - - - 3.85% p.a. -


rates (D) - - - 45.50 45.50


exchange rates (D1)

[ D x 105 % ]

- - - 47.78 47.78



x 90/3603 ]

- - - $ 9,625 $ 1,000,000


[ E x D1 ] - - - ` 459,883 ` 47,780,000

Pay-fixed INR (G) - - - ` (450,000) ` (45,000,000)

Difference (H) [ F minus G ] - - - ` 9,883 ` 2,780,000

Time factor3 for discounting (T) - - - 1 1


flows (JS) [ H x 1 ] (1+A1/4)^ T

- - - ` 9,850 ` 2,770,649

Fair value [ ∑ JS ] ` 2,780,499

1 Zero-coupon rates have been built using USD LIBOR curve as of 31 December 2010. 2 Forward rates have been derived from the shifted zero-coupon rates listed in A1. 3 In this illustration, for convenience of calculation, a calendar year has been assumed to be of 360 days, and each calendar quarter has

been assumed to be of 90 days. 4 USD-INR forward exchange rates as of 31 December 2010 for relevant dates are used for converting USD denominated future cash flows





30 September 2010 (reporting date during hedge period) (contd.) 2. Sensitivity analysis: Computation of fair valuation of cross-currency interest rate swap on the date of testing using shifted rates




[ A + 100 bps ] - - 1.29% p.a. 1.44% p.a. 1.44% p.a.

Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

- - 1.29% p.a. 1.59% p.a. -


[ B + 250 bps ] - - 3.79% p.a. 4.09% p.a. -


rates (D) - - 44.70 44.20 44.20


exchange rates (D1)

[ D x 105 % ]

- - 46.94 46.41 46.41



x 90/3603 ]

- - $ 9,475 $ 10,225 $ 1,000,000


[ E x D1 ] - - ` 444,757 ` 474,542 ` 46,410,000

Pay-fixed INR (G) - - ` (450,000) ` (450,000) ` (45,000,000)

Difference (H) [ F minus G ] - - ` (5,243) ` 24,542 ` 1,410,000



flows (JS) [ H x 1 ] (1+A1/4)^ T

- - ` (5,226) ` 24,366 ` 1,399,903

Fair value [ ∑ JS ] ` 1,419,043







30 June 2010 (reporting date during hedge period) (contd.) 3. Computation of fair valuation of hypothetical derivative on the date of testing



Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

- 0.53% p.a. 0.97% p.a. 1.38% p.a. -


[ B + 250 bps ] - 3.03% p.a. 3.47% p.a. 3.88% p.a. -


rates (D) - 46.70 46.75 46.80 46.80



x 90/3603 ]

- $ (7,575) $ (8,675) $ (9,700) $ (1,000,000)


[ E x D ] - ` (353,753) ` (405,556) ` (453,960) ` (46,800,000)


Difference (H) [ F minus G ] - ` 96,247 ` 44,444 ` (3,960) ` (1,800,000)



flows (hJ) [ H x 1 ] (1+A/4)^ T

- ` 96,120 ` 44,278 ` (3,932) ` (1,787,102)

Fair value [ ∑ hJ ] ` (1,650,636)

1 Zero-coupon rates have been built using USD LIBOR curve as of 30 June 2010. 2 Forward rates have been derived from the zero-coupon rates listed in A. 3 In this illustration, for convenience of calculation, a calendar year has been assumed to be of 360 days, and each calendar quarter has






30 September 2010 (reporting date during hedge period) (contd.) 3. Computation of fair valuation of hypothetical derivative on the date of testing



Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

- - 0.29% p.a. 0.59% p.a. -


[ B + 250 bps ] - - 2.79% p.a. 3.09% p.a. -


rates (D) - - 44.70 44.20 44.20



x 90/3603 ]

- - $ (6,975) $ (7,725) $ (1,000,000)


[ E x D ] - - ` (311,783) ` (341,445) ` (44,200,000)


Difference (H) [ F minus G ] - - ` 138,217 ` 108,855 ` 800,000



flows (hJ) [ H x 1 ] (1+A/4)^ T

- - ` 138,117 ` 108,317 ` 798,243

Fair value [ ∑ hJ ] ` 1,044,677







31 December 2010 (reporting date during hedge period)

1. Computation of fair valuation of cross-currency interest rate swap on the date of testing



Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

- - - 0.35% p.a. -


[ B + 250 bps ] - - - 2.85% p.a. -


rates (D) - - - 45.50 45.50



x 90/3603 ]

- - - $ 7,125 $ 1,000,000


[ E x D ] - - - ` 324,188 ` 45,500,000

Pay-fixed INR (G) - - - ` (450,000) ` (45,000,000)

Difference (H) [ F minus G ] - - - ` (125,812) ` 500,000



flows (J) [ H x 1 ] (1+A/4)^ T

- - - ` (125,702) ` 499,563

Fair value [ ∑ J ] ` 373,861

1 Zero-coupon rates have been built using USD LIBOR curve as of 31 December 2010. 2 Forward rates have been derived from the zero-coupon rates listed in A. 3 In this illustration, for convenience of calculation, a calendar year has been assumed to be of 360 days, and each calendar quarter has






1 July 2010 (inception of hedging relationship) (contd.) 2. Sensitivity analysis: Computation of fair valuation of cross-currency interest rate swap on the date of testing using shifted rates




[ A + 100 bps ] - 1.53% p.a. 1.75% p.a. 1.96% p.a. 1.96% p.a.

Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

- 1.53% p.a. 1.97% p.a. 2.38% p.a. -


[ B + 250 bps ] - 4.03% p.a. 4.47% p.a. 4.88% p.a. -


rates (D) - 46.70 46.75 46.80 46.80


exchange rates (D1)

[ D x 105 % ]

- 49.04 49.09 49.14 49.14



x 90/3603 ]

- $ 10,075 $ 11,175 $ 12,200 $ 1,000,000


[ E x D1 ] - ` 494,078 ` 548,581 ` 599,508 ` 49,140,000

Pay-fixed INR (G) - ` (450,000) ` (450,000) ` (450,000) ` (45,000,000)

Difference (H) [ F minus G ] - ` 44,078 ` 98,581 ` 149,508 ` 4,140,000



flows (JS) [ H x 1 ] (1+A1/4)^ T

- ` 43,910 ` 97,724 ` 147,332 ` 4,079,734

Fair value [ ∑ JS ] ` 4,368,700

1 Zero-coupon rates have been built using USD LIBOR curve as of 1 July 2010. 2 Forward rates have been derived from the shifted zero-coupon rates listed in A1. 3 In this illustration, for convenience of calculation, a calendar year has been assumed to be of 360 days, and each calendar quarter has


Tracking IFRS | Hedging made simple: Part 4 Exhibit 4

Exhibit 4: Illustrative hedge documentation Illustrative hedge documentation of XYZ India Limited for cash flow hedging of variable USD debt using

floating to fixed cross-currency interest rate swap

XYZ India Limited Proforma documentation template

for hedge designation

1. Risk management objective and strategy (this section may make reference to the risk management strategy) Refer clause 2(d)(iii) and 3(d)(iii) of Company’s Risk Management Strategy

2. Type of hedging relationship (tick one as applicable) a. Fair value hedge b. Cash flow hedge c. Hedge of net investment

3. Nature of risk being hedged (tick one as applicable) a. Foreign exchange currency risk b. Interest rate risk c. Credit risk d. Other risk (please specify) Risk of variability in total INR cash flows on the USD debt identified in point 4 below due to changes in foreign exchange rates and interest rates

4. Identification of hedged item [Transaction No.] $ 1,000,000 (USD debt) borrowed from DEF bank on 1 April 2010 for 1 year for quarterly interest payments (on 30 June, 30 September, 31 December, 31 March) at a variable rate of 3-month USD LIBOR plus 250 basis points with interest reset at the end of each calendar quarter

5. Identification of hedging instrument [Transaction No.] DR.10.04.001 (entry in the Derivatives Register maintained by the Treasury

Department of the Company.). The details of the instrument are as below: Type: Cross-currency interest rate swap Trade date: 1 April 2010 Maturity date: 31 March 2011 Swap terms: Receive 3-month USD LIBOR plus 250 basis point on $ 1,000,000 and pay fixed quarterly interest of ` 450,000 @ 4% p.a. on ` 45,000,000

Settlement dates: End of each calendar quarter Reset dates: End of each calendar quarter Principal payments: At maturity (the Company will receive $ 1,000,000 and pay ` 45,000,000)


6. Hedge designation [define specific risk being hedged] The risk being hedged is the variability in Company’s cash flows in INR due to a fluctuation in 3-month USD LIBOR and USD-INR exchange rate arising from hedged item identified in point 4 above modeled as a

hypothetical derivative with the following terms: Type: Cross-currency interest rate swap Trade date: 1 April 2010 Maturity date: 31 March 2011 Swap terms: Pay 3-month USD LIBOR plus 250 basis point on $ 1,000,000 and receive fixed quarterly interest of ` 450,000 @ 4% p.a. on ` 45,000,000

Settlement dates: End of each calendar quarter Reset dates: End of each calendar quarter Principal payments: At maturity

7. Hedge effectiveness testing at inception and prospectively at each reporting date a. Description of testing Sensitivity analysis shall be performed to measure the prospective hedge effectiveness. As the critical terms of the

hedging instrument perfectly match the critical terms of the hedge item, including reset dates of the hedged item, the effectiveness shall be measured as the ratio of change in the fair value of the hedging instrument and the hypothetical derivative resulting from a shift of 100 basis points in the zero-coupon rates and 5% in foreign exchange rates on the testing date.

b. Frequency of testing At the inception of the hedge and at each reporting date to assess whether the hedge is expected to be highly effective (prospective testing)

8. Hedge effectiveness testing on-going a. Description of testing Retrospective effectiveness testing will be performed at each reporting date using change in fair value of cash flows method (hypothetical derivative method) on a periodic basis. Hedge effectiveness will be demonstrated by comparing the periodic change in the fair value of cash flows of the hedging instrument with the periodic change in the fair value of cash flows of the hedged item attributable to the hedged risk and showing that it falls within the required range of 80%-125%

b. Frequency of testing At each reporting date after the inception of the hedge to determine that the hedge was actually effective (retrospective testing)

9. Other information [please specify] None

10. Approvals (refer clause 4 of Company’s Risk Management Strategy) By Head of the Department, Accounts dated 1 April 2010




1 April 2010 (inception of hedging relationship) 1. Computation of fair valuation of cross-currency interest rate swap on the date of testing



Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

0.29% p.a. 0.57% p.a. 1.15% p.a. 1.63% p.a. -


[ B + 250 bps ] 2.79% p.a. 3.07% p.a. 3.65% p.a. 4.13% p.a. -


rates (D) 45.18 45.19 45.23 45.26 45.26



x 90/3603 ]

$ 6,975 $ 7,675 $ 9,125 $ 10,325 $ 1,000,000


[ E x D ] ` 315,131 ` 346,833 ` 412,724 ` 467,316 ` 45,260,000

Pay-fixed INR (G) ` (450,000) ` (450,000) ` (450,000) ` (450,000) ` (45,000,000)

Difference (H) [ F minus G ] ` (134,869) ` (103,167) ` (37,276) ` 17,316 ` 260,000



flows (J) [ H x 1 ] (1+A/4)^ T

INR (134,771) INR (102,946) INR (37,089) INR 17,159 INR 257,647

Fair value [ ∑ J ] ` 0

1 Zero-coupon rates have been built using USD LIBOR curve as of 1 April 2010. 2 Forward rates have been derived from the zero-coupon rates listed in A. 3 In this illustration, for convenience of calculation, a calendar year has been assumed to be of 360 days, and each calendar quarter has





30 June 2010 (reporting date during hedge period) (contd.) 2. Sensitivity analysis: Computation of fair valuation of cross-currency interest rate swap on the date of testing using shifted rates




[ A + 100 bps ] - 1.53% p.a. 1.75% p.a. 1.96% p.a. 1.96% p.a.

Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

- 1.53% p.a. 1.97% p.a. 2.38% p.a. -


[ B + 250 bps ] - 4.03% p.a. 4.47% p.a. 4.88% p.a. -


rates (D) - 46.70 46.75 46.80 46.80


exchange rates (D1)

[ D x 105 % ]

- 49.04 49.09 49.14 49.14



x 90/3603 ]

- $ 10,075 $ 11,175 $ 12,200 $ 1,000,000


[ E x D1 ] - ` 494,078 ` 548,581 ` 599,508 ` 49,140,000

Pay-fixed INR (G) - ` (450,000) ` (450,000) ` (450,000) ` (45,000,000)

Difference (H) [ F minus G ] - ` 44,078 ` 98,581 ` 149,508 ` 4,140,000



flows (JS) [ H x 1 ] (1+A1/4)^ T

- ` 43,910 ` 97,724 ` 147,332 ` 4,079,734

Fair value [ ∑ JS ] ` 4,368,700

1 Zero-coupon rates have been built using USD LIBOR curve as of 30 June 2010. 2 Forward rates have been derived from the shifted zero-coupon rates listed in A1. 3 In this illustration, for convenience of calculation, a calendar year has been assumed to be of 360 days, and each calendar quarter has






1 April 2010 (inception of hedging relationship) (contd.) 4. Sensitivity analysis: Computation of fair valuation of hypothetical derivative on the date of testing using shifted rates




[ A + 100 bps ] 1.29% p.a. 1.43% p.a. 1.67% p.a. 1.91% p.a. 1.91% p.a.

Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

1.29% p.a. 1.57% p.a. 2.15% p.a. 2.63% p.a. -


[ B + 250 bps ] 3.79% p.a. 4.07% p.a. 4.65% p.a. 5.13% p.a. -


rates (D) 45.18 45.19 45.23 45.26 45.26


exchange rates (D1)

[ D x 105 % ]

47.44 47.45 47.49 47.52 47.52



x 90/3603 ]

$ (9,475) $ (10,175) $ (11,625) $ (12,825) $ (1,000,000)


[ E x D1 ] ` (449,494) ` (482,804) ` (552,071) ` (609,444) ` (47,520,000)

Receive-fixed INR (G) ` 450,000 ` 450,000 ` 450,000 ` 450,000 ` 45,000,000

Difference (H) [ F minus G ] ` 506 ` (32,804) ` (102,071) ` (159,444) ` (2,520,000)



flows (hJS) [ H x 1 ] (1+A1/4)^ T

` 504 ` (32,571) ` (100,803) ` (156,435 ) ` (2,472,437)

Fair value [ ∑ hJS ] ` (2,761,742)

1 Zero-coupon rates have been built using USD LIBOR curve as of 1 April 2010. 2 Forward rates have been derived from the shifted zero-coupon rates listed in A1. 3 In this illustration, for convenience of calculation, a calendar year has been assumed to be of 360 days, and each calendar quarter has





30 September 2010 (reporting date during hedge period) (contd.) 2. Sensitivity analysis: Computation of fair valuation of cross-currency interest rate swap on the date of testing using shifted rates




[ A + 100 bps ] - - 1.29% p.a. 1.44% p.a. 1.44% p.a.

Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

- - 1.29% p.a. 1.59% p.a. -


[ B + 250 bps ] - - 3.79% p.a. 4.09% p.a. -


rates (D) - - 44.70 44.20 44.20


exchange rates (D1)

[ D x 105 % ]

- - 46.94 46.41 46.41



x 90/3603 ]

- - $ 9,475 $ 10,225 $ 1,000,000


[ E x D1 ] - - ` 444,757 ` 474,542 ` 46,410,000

Pay-fixed INR (G) - - ` (450,000) ` (450,000) ` (45,000,000)

Difference (H) [ F minus G ] - - ` (5,243) ` 24,542 ` 1,410,000



flows (JS) [ H x 1 ] (1+A1/4)^ T

- - ` (5,226) ` 24,366 ` 1,399,903

Fair value [ ∑ JS ] ` 1,419,043







1 July 2010 (inception of hedging relationship) (contd.) 3. Computation of fair valuation of hypothetical derivative on the date of testing



Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

- 0.53% p.a. 0.97% p.a. 1.38% p.a. -


[ B + 250 bps ] - 3.03% p.a. 3.47% p.a. 3.88% p.a. -


rates (D) - 46.70 46.75 46.80 46.80



x 90/3603 ]

- $ (7,575) $ (8,675) $ (9,700) $ (1,000,000)


[ E x D ] - ` (353,753) ` (405,556) ` (453,960) ` (46,800,000)


Difference (H) [ F minus G ] - ` 166,877 ` 115,074 ` 66,670 ` (350,000)



flows (hJ) [ H x 1 ] (1+A/4)^ T

- ` 166,656 ` 114,644 ` 66,192 ` (347,492)

Fair value [ ∑ hJ ] ` 0

1 Zero-coupon rates have been built using USD LIBOR curve as of 1 July 2010. 2 Forward rates have been derived from the zero-coupon rates listed in A. 3 In this illustration, for convenience of calculation, a calendar year has been assumed to be of 360 days, and each calendar quarter has





30 September 2010 (reporting date during hedge period) 1. Computation of fair valuation of cross-currency interest rate swap on the date of testing



Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

- - 0.29% p.a. 0.59% p.a. -


[ B + 250 bps ] - - 2.79% p.a. 3.09% p.a. -


rates (D) - - 44.70 44.20 44.20



x 90/3603 ]

- - $ 6,975 $ 7,725 $ 1,000,000


[ E x D ] - - ` 311,783 ` 341,445 ` 44,200,000

Pay-fixed INR (G) - - ` (450,000) ` (450,000) ` (45,000,000)

Difference (H) [ F minus G ] - - ` (138,217) ` (108,855) ` (800,000)



flows (J) [ H x 1 ] (1+A/4)^ T

- - ` (138,117) ` (108,317) ` (798,243)

Fair value [ ∑ J ] ` (1,044,677)



to INR. 5 Exchange of notional amounts at maturity


Exhibit 1: Illustrative Board’s resolution Illustrative resolution of Board of Directors of XYZ India Limited for adoption of hedge accounting

XYZ India Limited

Resolution of the Board of Directors

RESOLVED THAT the Company be and is hereby authorised to carry out treasury activities to hedge its exposure to financial risks as identified in the Company’s Risk Management Strategy placed before the Board herewith. And for that purpose, the Company may enter into transaction/s with M/s ABC Bank and/or M/s DEF Bank for sale and/or purchase of derivatives, and/or other financial products, excluding written financial options, including but not limited to, foreign currency forward contracts, foreign currency option contracts, floating to fixed cross-currency interest-rate swaps; and that for the aforesaid purpose, the Company may execute such agreements and/or documents, but excluding writing financial options, and fulfill all requirements therein in connection with the aforementioned transaction/s.

RESOLVED FURTHER THAT any two of the officers of the Company, hereinafter referred as ‘authorised officers’, be and are hereby, jointly, authorised, directed and empowered to execute agreements and/or documents, but excluding writing financial options, in connection with the aforementioned transaction/s, and bind the Company. AND THAT the authorised officers may delegate powers to such officials of the Company with appropriate seniority and experience for operational purposes. AND THAT the authorised officers, authorised, directed and empowered herein are:

Mr. CEO

Mr. CFO

Mr. Finance Controller

Signed: Chairman


Exhibit 3: Illustrative hedge accounting policy Illustrative accounting policy of XYZ India Limited for cash flow hedging of variable rate USD debt using

variable-to-fixed cross-currency interest-rate swap

XYZ India Limited Illustrative hedge accounting policy

(relevant extracts only)

Derivative financial instruments The Company enters into a variety of derivative financial instruments to manage its exposure of foreign exchange and interest rate risk,

including variable-to-fixed cross-currency interest-rate swaps.

Derivatives are initially recognised at fair value at the date the derivative contract is entered into, and are subsequently remeasured to their fair value at the end of each reporting period. The resulting gain or loss is recognised in profit or loss immediately unless the derivative is designated and is effective as a hedging instrument, in which event the timing of the recognition in profit or loss depends on the nature of the hedge relationship.

Embedded derivatives (not included in the illustration)

Hedge accounting The Company designates variable-to-fixed cross-currency interest-rate swaps as hedging instruments in cash flow hedges in respect of risk of variability, due to changes in interest rates and foreign exchange rates, in INR cash flows on variable-rate financial assets and financial

liabilities denominated in foreign currency.

At the inception of the hedge relationship, the entity documents the relationship between the hedging instrument and the hedged item, along with its risk management objectives and its strategy for undertaking various hedge transactions. Furthermore, at the inception of the hedge and on an ongoing basis, the Company documents whether the hedging instrument is highly effective in offsetting changes in fair values or cash flows of the hedged item.

Fair value hedges (not included in the illustration)

Cash flow hedges The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges is recognised in equity in ‘Hedging Reserve Account’. The gain or loss relating to the ineffective portion is recognised immediately in profit or loss, and is included in

the ‘Other gains and losses’. Amounts previously recognised in ‘Hedging Reserve Account’ and accumulated in equity are reclassified to profit or loss in the periods when the hedged item affects profit or loss, in the same period as the recognised hedged item.

Discontinuation of hedge accounting Hedge accounting is discontinued when the Company revokes the hedging relationship, when the hedging instrument expires or is sold, terminated, or exercised, or it no longer qualifies for hedge accounting. Any gain or loss accumulated in equity is reclassified from equity to profit or loss in the same period or periods during which the hedged forecast cash flows affect profit or loss.




30 September 2010 (reporting date during hedge period) (contd.) 4. Sensitivity analysis: Computation of fair valuation of hypothetical derivative on the date of testing using shifted rates




[ A + 100 bps ] - - 1.29% p.a. 1.44% p.a. 1.44% p.a.

Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

- - 1.29% p.a. 1.59% p.a. -


[ B + 250 bps ] - - 3.79% p.a. 4.09% p.a. -


rates (D) - - 44.70 44.20 44.20


exchange rates (D1)

[ D x 105 % ]

- - 46.94 46.41 46.41



x 90/3603 ]

- - $ (9,475) $ (10,225) $ (1,000,000)


[ E x D1 ] - - ` (444,757) ` (474,542) ` (46,410,000)


Difference (H) [ F minus G ] - - ` 75,873 ` 46,088 ` 40,000



flows (hJS) [ H x 1 ] (1+A1/4)^ T

- - ` 75,629 ` 45,758 ` 39,714

Fair value [ ∑ hJS ] ` 161,101







1 April 2010 (inception of hedging relationship) (contd.) 3. Computation of fair valuation of hypothetical derivative on the date of testing



Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

0.29% p.a. 0.57% p.a. 1.15% p.a. 1.63% p.a. -


[ B + 250 bps ] 2.79% p.a. 3.07% p.a. 3.65% p.a. 4.13% p.a. -


rates (D) 45.18 45.19 45.23 45.26 45.26



x 90/3603 ]

$ (6,975) $ (7,675) $ (9,125) $ (10,325) $ (1,000,000)


[ E x D ] ` (315,131) ` (346,833) ` (412,724) ` (467,316) ` (45,260,000)

Receive-fixed INR (G) ` 450,000 ` 450,000 ` 450,000 ` 450,000 ` 45,000,000

Difference (H) [ F minus G ] ` 134,869 ` 103,167 ` 37,276 ` (17,316) ` (260,000)



flows (hJ) [ H x 1 ] (1+A/4)^ T

` 134,771 ` 102,946 ` 37,089 ` (17,159) ` (257,647)

Fair value [ ∑ hJ ] ` 0

1 Zero-coupon rates have been built using USD LIBOR curve as of 1 April 2010. 2 Forward rates have been derived from the zero-coupon rates listed in A. 3 In this illustration, for convenience of calculation, a calendar year has been assumed to be of 360 days, and each calendar quarter has





30 June 2010 (reporting date during hedge period) 1. Computation of fair valuation of cross-currency interest rate swap on the date of testing



Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

- 0.53% p.a. 0.97% p.a. 1.38% p.a. -


[ B + 250 bps ] - 3.03% p.a. 3.47% p.a. 3.88% p.a. -


rates (D) - 46.70 46.75 46.80 46.80



x 90/3603 ]

- $ 7,575 $ 8,675 $ 9,700 $ 1,000,000


[ E x D ] - ` 353,753 ` 405,556 ` 453,960 ` 46,800,000

Pay-fixed INR (G) - ` (450,000) ` (450,000) ` (450,000) ` (45,000,000)

Difference (H) [ F minus G ] - ` (96,247) ` (44,444) ` 3,960 ` 1,800,000



flows (J) [ H x 1 ] (1+A/4)^ T

- ` (96,120) ` (44,278) ` 3,932 ` 1,787,102

Fair value [ ∑ J ] ` 1,650,636

1 Zero-coupon rates have been built using USD LIBOR curve as of 30 June 2010. 2 Forward rates have been derived from the zero-coupon rates listed in A. 3 In this illustration, for convenience of calculation, a calendar year has been assumed to be of 360 days, and each calendar quarter has







3. Computation of fair valuation of hypothetical derivative on the date of testing



Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

- - - 0.35% p.a. -


[ B + 250 bps ] - - - 2.85% p.a. -


rates (D) - - - 45.50 45.50



x 90/3603 ]

- - - $ (7,125) $ (1,000,000)


[ E x D ] - - - ` (324,188) ` (45,500,000)

Receive-fixed INR (G) - - - ` 450,000 ` 45,000,000

Difference (H) [ F minus G ] - - - ` 125,812 ` (500,000)



flows (hJ) [ H x 1 ] (1+A/4)^ T

- - - ` 125,702 ` (499,563)

Fair value [ ∑ hJ ] ` (373,861)

1 Zero-coupon rates have been built using USD LIBOR curve as of 31 December 2010. 2 Forward rates have been derived from the zero-coupon rates listed in A. 3 In this illustration, for convenience of calculation, a calendar year has been assumed to be of 360 days, and each calendar quarter has






1 July 2010 (inception of hedging relationship) (contd.) 4. Sensitivity analysis: Computation of fair valuation of hypothetical derivative on the date of testing using shifted rates




[ A + 100 bps ] - 1.53% p.a. 1.75% p.a. 1.96% p.a. 1.96% p.a.

Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

- 1.53% p.a. 1.97% p.a. 2.38% p.a. -


[ B + 250 bps ] - 4.03% p.a. 4.47% p.a. 4.88% p.a. -


rates (D) - 46.70 46.75 46.80 46.80


exchange rates (D1)

[ D x 105 % ]

- 49.04 49.09 49.14 49.14



x 90/3603 ]

- $ (10,075) $ (11,175) $ (12,200) $ (1,000,000)


[ E x D1 ] - ` (494,078) ` (548,581) ` (599,508) ` (49,140,000)


Difference (H) [ F minus G ] - ` 26,552 ` (27,951) ` (78,878) ` (2,690,000)



flows (hJS) [ H x 1 ] (1+A1/4)^ T

- ` 26,451 ` (27,708) ` (77,730) ` (2,650,841)

Fair value [ ∑ hJS ] ` (2,729,828)

1 Zero-coupon rates have been built using USD LIBOR curve as of 1 July 2010. 2 Forward rates have been derived from the shifted zero-coupon rates listed in A1. 3 In this illustration, for convenience of calculation, a calendar year has been assumed to be of 360 days, and each calendar quarter has






4. Sensitivity analysis: Computation of fair valuation of hypothetical derivative on the date of testing using shifted rates




[ A + 100 bps ] - - - 1.35% p.a. 1.35% p.a.

Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

- - - 1.35% p.a. -


[ B + 250 bps ] - - - 3.85% p.a. -


rates (D) - - - 45.50 45.50


exchange rates (D1)

[ D x 105 % ]

- - - 47.78 47.78



x 90/3603 ]

- - - $ (9,625) $ (1,000,000)


[ E x D1 ] - - - ` (459,883) ` (47,780,000)

Receive-fixed INR (G) - - - ` 450,000 ` 45,000,000

Difference (H) [ F minus G ] - - - ` (9,883) ` (2,780,000)



flows (hJS) [ H x 1 ] (1+A1/4)^ T

- - - ` (9,850) ` (2,770,649)

Fair value [ ∑ hJS ] ` (2,780,499)

1 Zero-coupon rates have been built using USD LIBOR curve as of 31 December 2010. 2 Forward rates have been derived from the shifted zero-coupon rates listed in A1. 3 In this illustration, for convenience of calculation, a calendar year has been assumed to be of 360 days, and each calendar quarter has






30 September 2010 (reporting date during hedge period) (contd.) 3. Computation of fair valuation of hypothetical derivative on the date of testing



Forward rates (B)2

[ (1 + At)^ t - 1 ]

(1 + At-1) ^ (t-1)

- - 0.29% p.a. 0.59% p.a. -


[ B + 250 bps ] - - 2.79% p.a. 3.09% p.a. -


rates (D) - - 44.70 44.20 44.20



x 90/3603 ]

- - $ (6,975) $ (7,725) $ (1,000,000)


[ E x D ] - - ` (311,783) ` (341,445) ` (44,200,000)


Difference (H) [ F minus G ] - - ` 208,847 ` 179,185 ` 2,250,000



flows (hJ) [ H x 1 ] (1+A/4)^ T

- - ` 208,696 ` 178,791 ` 2,245,058

Fair value [ ∑ hJ ] ` 2,632,545





Exhibit 2: Illustrative risk management strategy Illustrative extracts of risk management strategy of XYZ India Limited for cash flow hedging of variable rate

USD debt using variable-to-fixed cross-currency interest rate swap

XYZ India Limited Risk management strategy

(relevant extracts only) 1. SCOPE

a. Strategic risks (not included in the illustration) b. Business risks (not included in the illustration)

c. Operational risks (not included in the illustration) d. Financial risks

The Company’s financial risks comprise of liquidity risks, credit risks and market risks. i. Particularly, liquidity risks shall mean risk of inability to meet short-term and long-term capital requirements of the

Company to carry out operational and growth activities. ii. Particularly, credit risks shall mean risk of counterparty’s inability to discharge its obligations to the Company.

iii. Particularly, market risks shall mean risk of unfavorable movement in foreign currency exchange prices (currency risk) and interest rates (rate risk) that adversely affect Company’s [real and accounting] earnings and cash flows.

2. OBJECTIVES d. Financial risks

i. Liquidity risks (not included in the illustration) ii. Credit risks (not included in the illustration)

iii. Market risks – o To minimize the sensitivity of Company’s [real and accounting] earnings and cash flows [in INR terms] to currency

risk and price risk and protect margins by entering hedging contracts o Documentation of the Company’s risk management policy o Documentation of responsibility and authority matrices o Compliance with AS 30 (or Ind AS 39)

3. STRATEGY d. Financial risks

i. Liquidity risks (not included in the illustration) ii. Credit risks (not included in the illustration) iii. Market risks

The Company borrows short, medium and long term USD debts from international markets at variable rates, generally

linked to LIBOR. The Company is exposed to currency risk and interest-rate risk arising from variability in foreign exchange rates and interest rates.

Fair value hedges (not included in the illustration)

Cash flow hedges

Hedging approach

The Company shall hedge upto 100% of its variable rate USD debts to protect its cash flows in INR. Company’s hedging strategy shall comprise entering into variable-to-fixed cross-currency interest-rate swap, in which it would receive


variable USD London Interbank Offered Rate (LIBOR) plus the spread on the notional USD amount equivalent to variable interest rate on USD debt amount and pay fixed INR rate of interest; and receive notional USD amount and pay

fixed notional INR amount equivalent to principal amount of USD debt. Company’s strategy shall aim to eliminate the variability in foreign exchange rates and interest rates completely by entering into swap contracts with matching critical terms as of the USD debts.

The Company shall not enter into complex interest rate swaps or other derivatives that are difficult to understand and evaluate.

Effectiveness and review

o Company will prefer the use of Method B – Change in fair value of cash flows method (hypothetical derivative

method) as prescribed in AS 30 while assessing hedge effectiveness. The company may also use Method A – Change in fair value of debt method (change in fair value method) as prescribed in AS 30. The method of

assessing effectiveness shall be appropriately documented in the hedge documentation. Company shall not use a

method not permitted under AS 30, e.g. short-cut (non-quantitative) method, or by comparing only the variable cash flows on the interest rate swap with the interest cash flows in the debt that would be generated by the forward interest rates

o Fair value of the cross-currency interest rate swap shall be computed as the present values of the future swap cash flows.

Future swap cash flows shall be determined using the forward rates derived from the zero-coupon rates. The forward rates shall be derived from the zero-coupon rates by using the formula prescribed in AS 30.

The present value shall be determined by discounting future swap cash flows using the zero-coupon rates. The zero-coupon curve shall be built using the LIBOR curve (cash rates over short-term, and swap rates over medium and long term; the swap rates will be statistically adjusted to be converted to zero-coupon rates).

o Sensitivity analysis shall be performed to measure the prospective hedge effectiveness. With respect to hedges where the critical terms of the hedging instrument perfectly match the critical terms, including reset dates of the hedged item, the effectiveness shall be measured as the ratio of change in the fair value of the hedging instrument and the hypothetical derivative resulting from a shift in the hedged interest rate of 100 basis points in the zero-coupon rates and 5% in foreign exchange rates on the testing date.

o Retrospective effectiveness testing will be performed at each reporting date using change in fair value of cash flows

method (hypothetical derivative method) at each reporting date during the period of hedging. The effectiveness shall be measured as the ratio of change in the fair value of the hedging instrument and the hypothetical derivative during the period.

o Retrospective effectiveness testing should be performed at each reporting date on a cumulative or a period-by-period basis. Hedge effectiveness is demonstrated by comparing the cumulative or periodic change in the fair value

of cash flows of the hedging instrument with the cumulative or periodic change in the fair value of cash flows of the hedged item (to be modeled as hypothetical derivative) attributable to the hedged risk and showing that it falls within the required range of 80%-125%. Effectiveness assessment on a cumulative basis should be preferred. The basis of assessment i.e. whether cumulative or period-by-period should be specifically documented at the inception of the hedge and should be followed consistently throughout the hedge period.


Changes in value of the cross-currency interest rate swap would be accounted as:

o The effective portion of change in the fair value of the swap is initially recognised in equity as hedging reserve o The ineffective portion (if any) of the change in the swap is recognised directly in profit or loss o Amounts recorded as hedging reserve are reclassified to income statement in the same period or periods during

which the hedged cash flows affect profit or loss

Review of hedging transaction:

o An appropriate approval matrix would be implemented for the preparation, maintenance and approval of deal sheet and hedge documentation

o The review of the hedging process would be included as part of the scope of the internal audit review program

Hedge accounting conditions

The Company shall adopt hedge accounting in accordance with AS 30 (or Ind AS 39). All of the following 5 conditions

should be met to qualify for hedge accounting:

a) At the inception of the hedge, there is formal designation and documentation of the hedging relationship and the entity’s risk management objective and strategy for undertaking the hedge. That documentation shall include identification of the hedging instrument, the hedged item or transaction, the nature of the risk being hedged and how the entity will assess the hedging instrument’s effectiveness in offsetting the exposure to changes in the hedged item’s fair value or cash flows attributable to the hedged risk.

(b) The hedge is expected to be highly effective in achieving offsetting changes in fair value or cash flows attributable to the hedged risk, consistently with the originally documented risk management strategy for that particular hedging relationship.

(c) For cash flow hedges, a forecast transaction that is the subject of the hedge must be highly probable and must present an exposure to variations in cash flows that could ultimately affect profit or loss.

(d) The effectiveness of the hedge can be reliably measured, i.e., the fair value or cash flows of the hedged item that are attributable to the hedged risk and the fair value of the hedging instrument can be reliably measured.

(e) The hedge is assessed on an ongoing basis and determined actually to have been highly effective throughout the financial reporting periods for which the hedge was designated.

The Company shall perform appropriate and timely designation, designation and re-designation to ensure high effectiveness (80%-125%) throughout the life of the hedge.

The Company shall ensure contemporaneous documentation to comply with the requirements of AS 30 (or Ind AS 39).

4. RESPONSIBILITY AND AUTHORITY MATRICES (not included in the illustration)

5. APPROVAL AND AMENDMENTS This document is effective from the date of approval by the Board. Any amendments to this document shall require the approval of the Board.

Note The illustrative risk management policy includes policy primarily only for cash flow hedging of variable rate USD debt using variable-to-fixed cross-currency interest rate swap and does not include any other type of hedges.

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