CFH: Cross Currency Interest Rate Swap Used as a Hedging Transaction

Valuation and Effectiveness Test

As part of the effectiveness test, the system determines the forward interest rates of the variable interest payments of the cross-currency interest rate swap, and the variable interest payments of the assigned exposure. These values are discounted on the valuation key date and then totaled for the underlying transaction and hedging transaction. Both totals are then compared.

To value the cross-currency interest rate swap, the system runs a foreign currency valuation and security valuation.

Unlike other interest rate instruments, cross-currency interest rate swaps are characterized by a one-off repayment at the end of the term. This future cash flow is usually linked to a currency risk. To ensure that only the interest rate effect is posted as part of the effectiveness test for the hedging relationship, the system first subtracts the change in value caused by the repayment from the total value of the cross-currency interest rate swap.

When you use a cross-currency interest rate swap to hedge interest rate risk, it is important that the critical terms of the hedging transaction match those of the underlying transaction (particularly the nominal values). If this is not the case, the system subtracts the wrong amount from the value of the cross-currency interest rate swap.

As part of this operation, only the foreign currency effect associated with the repayment of the underlying transaction is subtracted from the value of the cross-currency interest rate swap. The total effect of all the interest payments from the cross-currency interest rate swap is posted to equity without affecting profit and loss.

Since it is not technically possibly to separate the value of the repayment from the value of the cross-currency interest rate swap, the system first calculates the change in value of the underlying transaction and deducts this from the total change in value of the cross-currency interest rate swap. The difference represents the interest rate effect that the system posts to equity. The change in value of the underlying transaction is recorded on the profit and loss statement.

Alternatively, you can use a hypothetical derivative in the effectiveness test.

Creating a Hedging Relationship

To create a hedging relationship, proceed as follows:

On the SAP Easy Access screen, choose Treasury and Risk Management Hedge Management and Accounting Hedge Accounting for Exposures Hedging Relationships Hedge Plan (THMEX).
Specify Interest Rate Risk as the risk category.

Note
If the Single Hedged Item indicator is set, the system assigns all the loaded exposures (an interest rate instrument or the interest payment in a transaction) to only one hedged item. We recommend setting this indicator if you want to use only one cross-currency interest rate swap to hedge an interest rate instrument with multiple interest payments.

End of the note.
Once the underlying transaction has been uploaded, Liabilities or Financial Assets are displayed under the Transaction Category, and Position or Cash Flow are displayed under Transaction Activity. You can also select the underlying transaction manually.
Choose the Hedged Item tab page and select the hedge category Cash Flow Hedge.
On the Hedging Relationship tab page, specify the cross-currency interest rate swap that you entered as the hedging instrument.
Select the hedge strategy 103 CF Forward Discounted, Period/Period.

Selecting the Hedge Strategy

We recommend that you use the hedge strategy 103 (CF Forward Discounted, Period/Period) with calculation type 103 that are defined as standard in Customizing.

If you decide to use a different hedge strategy, this strategy must use a calculation type based on calculation category 003 Cash Flow Differences, Forward Rate Discounted and on Cash Flow Determination Method 2 (FAS133: DIG G7 method 1(.

Customizing Settings

In Customizing for the Transaction Manager, you need to define product type 62D (Cross-Currency Interest Rate Swap, Hedge Acc.). To do this, choose Start of the navigation path Listed Derivatives Next navigation step Transaction Management Product Types Define Product Types End of the navigation path .

Product type 62D must be assigned to position management procedure 3000 (Derivatives: Hedging Instr., Hedge Acc.). This setting is made in Customizing for the Transaction Manager under Start of the navigation path Accounting Next navigation step Settings for Position Management Assign Position Management Procedure End of the navigation path .