Function documentationCritical Term Match Method

 

With this effectiveness test method for hedging relationships, some important business data (the critical terms) of the hedged item and of the hedging instrument are checked as to whether they match. If the critical terms match, it can be assumed that the hedging relationship is effective.

As per IAS 39, the prospective effectiveness test can be used for some hedging relationships to test the effectiveness of the hedging relationship using the critical term match method.

Example Example

In the case of an interest rate swap, it can be assumed that there is a complete hedge when the following criteria match for a hedged item (such as a securities position) and for a hedging instrument (such as an interest rate swap):

  • Designated nominal amounts

  • Currency

  • Start date

  • Due date

  • Reference interest rate

  • Spread

  • Interest calculation method

  • Calendar

End of the example.

You can use the critical term match method for the following scenarios:

  • 710 CFH: Security Hedged with Interest Rate Swap

  • 720 CFH: Loan Hedged with Interest Rate Swap

Note Note

The parameters often do not match, in which case other methods need to be applied.

If the effectiveness test has failed for a hedging relationship and you want to establish the effectiveness of that hedging relationship using a different effectiveness test, you have to create a new hedging relationship and assign to it a different hedging profile with different effectiveness tests.

To check the effectiveness (prospectively and retrospectively) of a cashflow hedge hedging relationship using other effectiveness test methods alongside the critical term match method, the hypothetical derivative is used.

End of the note.

Prerequisites

  • In Customizing for Hedge Accounting for Positions under Start of the navigation path Effectiveness Test Next navigation step Define Critical Term Type End of the navigation path, you can create a critical term type and specified which terms need to be applied to check the effectiveness.

  • Under Effectiveness Methods, you have created a method that applies the Critical Term Match Method as the type of effectiveness test method and you have also assigned here the critical term type defined above.

  • Under Define Hedging Profile, you have created a profile and have assigned to it as prospective effectiveness method the effectiveness test method defined above.

Features

  • The following critical terms can be compared:

    • (Designated) nominal amounts

    • Currency

    • Start date

      Here, the start dates of the hedged item and the hedging instrument are compared. However, in the case of a security position, the comparison applies the date of the first purchase of the security.

    • Due date

      The comparison applies the due dates of the security/loan and of the hedging instrument.

    • Reference interest rate

      The reference interest rates are checked to see if they match.

    • Spread

      The fixed interest rate that is added to or subtracted from the reference interest rate used is compared.

    • Interest calculation method

    • Calendar

    • Partner rating

      The rating of the issuer/lender is compared against the rating of the partner of the hedging instrument.

    • Credit spread

      The credit spread of the security/loan and that of the hedging instrument are compared under the assumption that it does not change during the term of the hedging relationship.

      You enter the credit spreads in the market data under Start of the navigation path Treasury and Risk Management Next navigation step Basic Functions Next navigation step Market Data Management Next navigation step Manual Market Data Entry Next navigation step Credit Spread End of the navigation path.