CFH: Option on Forward Exchange Transaction Used as a Hedging Transaction

Valuation and Effectiveness Test

As part of the effectiveness test and the valuation for options on forward exchange transactions, you can decide whether to view only the foreign currency effect of the underlying (spot method) or the total effect of the option (full fair value method: interest rate effect and foreign currency effect of the forward exchange transaction as well as the time value of the option).

Note Note

Alternatively, you can use a suitable hypothetical derivative for both methods in the effectiveness test.

End of the note.

Spot Method:

As part of the effectiveness test and on the valuation key date, the system translates the nominal values of the forward exchange transaction (underlying) and the corresponding exposures at the spot rate and then compares them.

During the option valuation for the forward exchange transaction, the system takes into account the foreign currency effect and interest rate effect as well as the time value of the option.

If the hedging relationship is 100% effective, the foreign currency effect of the forward exchange transaction is posted in equity without affecting profit and loss. The time value of the option and the interest rate effect of the forward exchange transaction are recognized however on the profit and loss statement.

If an effective hedging relationship is not 100% effective, the system differentiates between the following two scenarios:

If the change in value of the hedging transaction is greater than the change in value of the hedged item, the foreign currency effect is posted proportionately to the profit and loss account.

If the change in value of the hedging transaction is less than the change in value of the hedged item, the hedging transaction value is posted to equity and not recognized in profit and loss.

Full Fair Value Method:

As part of the effectiveness test, the system calculates the intrinsic value of the option as well as the net present value of the exposure on the valuation key date. It then compares these values. When the system calculates the intrinsic value of the option, it converts the values of the underlying flows using the forward rate and then discounts them. If the amount is negative, it is set automatically to zero.

During the option valuation, the system takes the total value of the option into account (interest rate effect and foreign exchange effect of the forward exchange transaction as well as the time value of the option).

If the hedging relationship is 100% effective, the total value of the option is posted in equity without affecting profit and loss.

If an effective hedging relationship is not 100% effective, the system differentiates between two scenarios as mentioned above.

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 the risk category Exchange Rate Risk and the required data for the new hedge plan. Choose the transaction category Planned Transaction or Firm Commitment. Specify the transaction activity Purchase or Sell.
Choose the Hedged Item tab page and select the relevant exposure. Choose the hedge category Cash Flow Hedge.
On the Hedging Relationship tab page, specify one of the options that you entered as the hedging instrument. Choose the hedge strategy 405 Options: Intrinsic Value Spot Rate or 400 - Option Intrinsic Value, Forward Rate Disc. Period/Period.

Selecting the Hedge Strategy

Spot Method:

We recommend that you use the hedge strategy 405 (CF Spot Rate Period/Period) with calculation type 405 that are defined as standard in Customizing.

If you decide to use a different hedge strategy, it must use a calculation type based on calculation category 11 Options: Intrinsic Value, Spot Rate and on Cash Flow Determination Method 1 (FAS133: Usage of 30(b)...).

Note Note

If hedge strategy 405 is not available in your system, in Customizing for the Transaction Manager, choose Start of the navigation path General Settings Next navigation step Hedge Accounting for Exposures Effectiveness Test Define Calculation Types End of the navigation path .

Copy calculation type 400 and change the ID to 405. Enter the description Option: Intrinsic Value, Spot Rate Period/Period and select calculation category 11 Option: Intrinsic Value, Spot Rate.

In Customizing for the Transaction Manager, choose Start of the navigation path General Settings Next navigation step Hedge Accounting for Exposures Effectiveness Test Define Hedge Strategies End of the navigation path .

Create a copy of hedge strategy 400 with ID 405. Change the description to Option: Intrinsic Value, Spot Rate Period/Period and enter 405 under Assmt Calc Type and Measmt CalcType.

End of the note.

Full Fair Value Method:

We recommend that you use hedge strategy 400 (Option, Intrinsic Value, Forward Rate, Disc. Period/Period) defined as standard in Customizing together with calculation type 400.

If you decide to use a different hedge strategy, it must use a calculation type based on calculation category 13 Options: Intrinsic Value, Forward Rate, Disc. and on Cash Flow Determination Method 1 (FAS133: Usage of 30(b)...).

Customizing Settings

Spot Method and Full Fair Value Method:

In Customizing for the Transaction Manager, you can use the standard product type 76X OTC Forex Option, Hedge Acc. To use this, choose Start of the navigation path OTC Derivatives Next navigation step Transaction Management Product Types Define Product Types End of the navigation path .

Product type 76X is assigned to the position management procedure 3000 (Derivatives: Mark-to-Market as Hedging Instr., Hedge Acc.). You find this setting in Customizing for the Transaction Manager under Start of the navigation path General Settings Next navigation step Accounting Settings for Position Management Assign Position Management Procedure End of the navigation path .

Full Fair Value Method Only:

To ensure that the time value is also posted to equity (and not recorded in profit and loss) when determining the effectiveness of the hedging relationship, you need to make the following settings in Customizing for the Transaction Manager:

Choose Start of the navigation path General Settings Next navigation step Accounting Hedge Accounting for Exposures Update Types Assign Update Types for Hedge Accounting End of the navigation path .

Double-click on the line for position management procedure 3000.

Under Treatment of Time Value, choose B No Classification of Time Value.