»Ê¹ÚÌåÓýapp

This guidance applies to companies which adopt IAS 39 (or FRS 26 under Old UK GAAP).

Closely related embedded derivatives: examples

Example 1

A building society offers capped mortgage loans to customers. »Ê¹ÚÌåÓýapp loans carry interest at the building society’s standard variable rate (currently 6.25%), but are capped at 7.5%.

»Ê¹ÚÌåÓýapp host contract (a debt contract) contains a derivative (a cap) whose underlying subject matter is interest rates. However, since interest rates are closely linked to debt, and the cap is set at a level above the market rate of interest at the start of the loan, the derivative is closely related to the host contract, and does not have to be separated.

Example 2

A company holds its headquarters building on a 10-year lease. »Ê¹ÚÌåÓýapp lease provides that rental payments are increased annually in line with the Retail Price Index (RPI).

»Ê¹ÚÌåÓýapp host contract is a lease, into which is embedded a forward agreement indexed to inflation. »Ê¹ÚÌåÓýapp IASB regards the economic characteristics of the index-linking term to be closely allied to the economic characteristics of the lease, so the derivative does not have to be separated. If, however, the adjustment was leveraged - for example, if the rent adjustment was 3 times the increase in the RPI - the derivative would not be “closely relatedâ€�.

Example 3

A UK aviation company, whose functional currency is sterling, enters into a contract to buy aviation fuel. »Ê¹ÚÌåÓýapp contract is priced in US dollars, to be paid within 30 days of delivery.

»Ê¹ÚÌåÓýapp purchase contract contains an embedded currency feature, since the sterling amount the company pays will depend on sterling/dollar exchange rate movements. »Ê¹ÚÌåÓýapp currency contract does not need to be separated, because the currency concerned is routinely used for aviation fuel transactions. (»Ê¹ÚÌåÓýapp embedded derivative would also be ‘closely relatedâ€� if the US dollar was the functional currency of the other party to the contract). Furthermore, the contract contains no option or leverage feature (compare example 3 in CFM25070).