FVH: Interest Rate Swap Used as a Hedging Transaction

 

Use in Hedge Accounting for Exposures

As part of the effectiveness test, the system calculates the net present value (fair value) of the interest rate swap and the exposure on the valuation key date. The calculation of the interest rate swap does not include accrued interest but is rather the clean price. These values are then compared.

Note Note

If you were to include accrued interest in the net present value, this would usually result in an ineffective hedging relationship.

End of the note.

To calculate the net present value of the exposure, the system takes markup (spread) into account. The basic concept of the markup is that the yield curve used to discount the underlying transaction is shifted by a constant spread. The markup represents the default risk at the time the hedging relationship is created. The parallel shift of the yield curve enables you to differentiate between the credit risk and interest rate risk. The markup is constant so that changes to the credit risk do not affect the effectiveness test.

To value the underlying transaction and the interest rate swap, the system runs a foreign currency valuation and security valuation. If the hedging relationship is partially or completely effective, the total change in fair value (clean price) of the underlying transaction is recorded on the profit and loss statement.

Note Note

If the interest rate swap and underlying transaction are in local currency, the total effect is derived from the interest rate effect. However, when using a foreign currency, the total effect depends on the interest rate and foreign exchange.

End of the note.

When you value a financial asset or liability, you always need to enter the foreign exchange effect or underlying transaction in foreign currency on the profit and loss statement. If the hedging relationship is effective, the interest rate effect is also taken into account in profit and loss. You can also use a hypothetical derivative.

Creating a Hedging Relationship

To create a hedging relationship, proceed as follows:

  1. On the SAP Easy Access screen, choose Start of the navigation path Treasury and Risk Management Next navigation step Hedge Management and Accounting Next navigation step Hedge Accounting for Exposures Next navigation step Hedging Relationships Next navigation step Hedge Plan End of the navigation path (THMEX).

  2. Create a new hedge plan and choose the risk category Interest Rate Risk. You can also set the Single Hedged Item indicator.

    Recommendation Recommendation

    In the case of interest rate risk, the system automatically loads the transaction or interest payments belonging to a transaction as an exposure. If you set the Single Hedged Item indicator, the exposures are only assigned to one hedged item. We recommend setting this indicator if you only want to use an interest rate swap to hedge an interest rate instrument with multiple interest payments.

    End of the recommendation.

    Note Note

    Depending on the underlying transaction, the system automatically assigns Financial Asset or Financial Liability to the Transaction Category field, or Position or Cash Flow to the Transaction Activity field.

    End of the note.

  3. On the Hedged Item tab page, choose the hedge category Fair Value Hedge.

  4. For the hedging relationship, specify the interest rate swap that you entered as the hedging instrument. Choose hedge strategy 500 Benchmark Clean Price and specify a spread.

    Recommendation Recommendation

    We recommend that you choose one value so that the net present value of the underlying transaction corresponds to the market value at the start of the hedging relationship.

    End of the recommendation.

Selecting the Hedge Strategy

The standard Customizing setting available is hedge strategy 500 with calculation type 201 Interest Rate Instrument: Benchmark without Accrued Interest. If you decide to use another hedge strategy, it must use a calculation type based on calculation category 201.

Settings in the Money Market and Position Management Areas

  • The standard setting defined in Customizing for the underlying transaction is product type 55B Interest Rate Instrument, Hedge Acc. which is assigned to valuation procedure 3002 Money Market Transactions: Underlying Transaction, Hedge Acc.

  • The standard Customizing setting for the hedging instrument is product type 62C Int. Rate Swap: Hedge Accounting which is assigned to valuation procedure 3000 Derivatives: Hedging Inst., Hedge Acc.

See also:

Fair Value Hedge (FVH) to Hedge Interest Rate Risk