1. © 2006 KPMG — Worldbank Wien March 2006— 1 Turning knowledge into value Case Studies Appliaction of IAS 32/39 Reinhard Klemmer, Partner KPMG DTG Berlin

2. © 2006 KPMG — Worldbank Wien March 2006— 2 Case Studies Equity versus Liability Classification Impairment of Loans and Receivables Derecognition Examples Hedge Accounting Examples

3. © 2006 KPMG — Worldbank Wien March 2006— 3 Case Study 1 – Participation Rights Facts (1) Financial Instrument  Bank issues a Participation Right, volume Euro 75 Mio.  Bearer is an Insurance Company Interest  Interest is 7,07% p.a. based on the notional amount of the issuance

4. © 2006 KPMG — Worldbank Wien March 2006— 4 Case Study 1 – Participation Rights Facts (2) Interest Payments  Payments yearly in arreas  No interest is paid if a P&L loss is caused or increased by the payment  Unpaid amounts of prior years will be paid if and when sufficient funds are available and no P&L loss will be caused Subordination and rights of the holder of the instrument in case of liquidation of the issuer  Subordination of the rights with respect to all other rights in the company that are (a) not equity and (b) are not also subordinated  No rights to participate in liqidation proceeds in case of liquidation of the Bank

5. © 2006 KPMG — Worldbank Wien March 2006— 5 Case Study 1 – Participation Rights Facts (3) Redemption  Maturity is limited to 10 years  In case of early redemption by the issuer, redemption amount is book value of the issuer  Redemption amount is limited to the nominal value of the participation right Termination  No termination rights for the holder of the instrument  Termination option of the Bank

6. © 2006 KPMG — Worldbank Wien March 2006— 6 Case Study 1 – Participation Rights Question Equity or Liability according to IAS 32?

7. © 2006 KPMG — Worldbank Wien March 2006— 7 Case Study 1 – Participation Rights Assessment (1) Interest payments  Issuer is obligated to pay interest  No obligation in case of P&L loss -Specific rules for Banks may allow for the set up of reserves under local rules (home country GAAP) (i.e. § 340f-g HGB, IAS 30.50) -Payments are at the discretion of the issuer  Result -Interest payments are equity

8. © 2006 KPMG — Worldbank Wien March 2006— 8 Case Study 1 – Participation Rights Assessment (2) Redemption obligation  Contractual redemption right/obligation -Participationb right with stated maturity -Redemption of the issuance against payment at the maturity date  Payments in case of liquidation of the issuer -No effect on equity classification (IAS 32.25(b))  Result -Due to stated maturity, the instrument is a Puttable Instrument according to IAS 32.18(b) -Nominal amount of the issuance is a liability

9. © 2006 KPMG — Worldbank Wien March 2006— 9 Case Study 1 – Participation Rights Assessment (3) Termination rights  Regular termination rights -Termination right of the holder is contractually excluded -Termination rights of the issuer in this case not relevant for classification  Exceptional termination rights -Both parties do not have any exceptional termination rights  Result -The existing termination rights do not preclude equity classification

10. © 2006 KPMG — Worldbank Wien March 2006— 10 Case Study 1 – Participation Rights Assessment (4) Settlement in own shares of the issuer  No settlement rights/options in own shares of the issuer are part of the contract  Result -Criteria for classification as equity due to settlement in own shares is not relvant/met in this case

11. © 2006 KPMG — Worldbank Wien March 2006— 11 Case Study 1 – Participation Rights Result Participation right is a Compound Instrument according to IAS 32.28, IAS 32.AG37 Interest payments are at the discretion of the Bank (issuer), therefore qualification as equity The nominal amount of the Participation Right qualifies as a Puttable Instrument, therefore classification as a liability Split Accounting according to IAS 32.31

12. © 2006 KPMG — Worldbank Wien March 2006— 12 Case Study 1 – Participation Rights Example Nominal amount 1,000 Present value of nominal amount at current marekt rate 800 Fair Value of the coupon 200 (residual of 1000-800) Equity: 200 Liability: 800 Cash: 1000 Note: in subsequent periods, the issuer has to record interest expense for the 800 and no expense for the 200!

13. © 2006 KPMG — Worldbank Wien March 2006— 13 Case Study 2: Redeemable preference shares with fixed dividends Facts: Company A issues preference shares which are redeemable for cash after 5 years at the notional amount and which bear a 5% fixed dividend each year subject to the following restrictions: Alternative 1: Dividends will be paid only subject to the availability of distributable profits Alternative 2: Dividends will be paid only if a dividend is paid in respect of A’s ordinary shares Is the instrument a debt instrument, an equity instrument or a compound instrument ? If it is a compound instrument how are the components measured ?

14. © 2006 KPMG — Worldbank Wien March 2006— 14 Case Study 2: Redeemable preference shares with fixed dividends Result: Alternative 1: Dividends will be paid only subject to the availability of distributable profits: as both parts of the instrument are an obligation to surrender cash, the whole instrument is classified as a liability Alternative 2: Dividends will be paid only if a dividend is paid in respect of A’s ordinary shares: Split accounting: Dividend right is equity, nominal amount is a liability (note: liability book value is the present value of the redemption amount using market interest rates for similar liabilities of the issuer)

15. © 2006 KPMG — Worldbank Wien March 2006— 15 Case Study 3: Redeemable preference shares with option of issuer to settle in cash Facts: A issues preference shares which are redeemable after 5 years for ordinary shares (one ordinary share for each preference share) and bear no fixed dividend (but preference shareholders will receive same dividend as ordinary shareholders) A has an option to settle the instrument either through issuing one ordinary share of A for each preference share or by making a cash payment equal to the fair value of the shares at redemption Is the instrument a debt instrument, an equity instrument or a compound instrument ? If it is a compound instrument how are the components measured ?

16. © 2006 KPMG — Worldbank Wien March 2006— 16 Case Study 3: Redeemable preference shares with option of issuer to settle in cash Solution: A issues preference shares which are redeemable after 5 years for ordinary shares (one ordinary share for each preference share) and bear no fixed dividend (but preference shareholders will receive same dividend as ordinary shareholders) Dividend is an equity instrument (same distribution as for ordinary shares). A has an option to settle the instrument either through issuing one ordinary share of A for each preference share or by making a cash payment equal to the fair value of the shares at redemption A is not obliged to settle in cash or another financial instrument, therefore the whole instrument is an equity instrument

17. © 2006 KPMG — Worldbank Wien March 2006— 17 Case Study 4: Convertible bond with option of issuer to settle in cash Facts: A issues a convertible bond which bears 5% fixed interest and is repayable after 5 years at the notional amount, unless converted at the holders option into a fixed number of shares (one ordinary share for each CU 100 notional amount) If the holder exercised its option and the bond is converted into shares, the issuer has an option to settle the instrument either through issuing one ordinary share for each CU 100 notional amount or by making a cash payment equal to the fair value of the shares at redemption Is the instrument a debt instrument, an equity instrument or a compound instrument ? If it is a compound instrument how are the components measured ?

18. © 2006 KPMG — Worldbank Wien March 2006— 18 Case Study 4: Convertible bond with option of issuer to settle in cash Solution: A typical convertible bond would be classified as a compound instrument. In this case, both elements meet the definition of a liability (IAS 39.26) because the conversion option gives one party a cash settlement option. In contrast to Case Study 3, the derivative component changes the classification from equity to liability.

19. © 2006 KPMG — Worldbank Wien March 2006— 19 Case Study 5: Mandatorily convertible bond with option of issuer to settle in cash Facts: A issues a mandatorily convertible bond which bears 5% fixed interest and is automatically converted into a fixed number of shares (one ordinary share for each CU 100 notional amount) at maturity in 5 years time The issuer has an option to settle the instrument either through issuing one ordinary share for each CU 100 notional amount or by making a cash payment equal to the fair value of the shares at redemption Is the instrument a debt instrument, an equity instrument or a compound instrument ? If it is a compound instrument how are the components measured ?

20. © 2006 KPMG — Worldbank Wien March 2006— 20 Case Study 5: Mandatorily convertible bond with option of issuer to settle in cash Solution: The instrument consists of 3 components: a non derivative settlement option of the issuer (does not qualify for derivative as Fair Value is always 0) a liability component, the present value of the interest payments and an equity component representing the prepaid forward sale of the entity’s own equity instruments (IAS 39 IG B9) with no obligation to deliver a variable number of its own equity instrument (IAS 32.16(b)(i))

21. © 2006 KPMG — Worldbank Wien March 2006— 21 Case Study 6: Preference Shares without fixed redemption date Facts: A issues preference shares which are redeemable at the option of the issuer at a fixed redemption price of € 100 per share plus any accrued unpaid dividends There is no fixed redemption date, i.e. the holder does not have any right to demand repayment at a certain date Payment of dividends is at the discretion of the issuer. However, payment of dividends is required in case that the parent company of A pays dividends on its ordinary shares Is the instrument a debt instrument, an equity instrument or a compound instrument ? If it is a compound instrument how are the components measured ?

22. © 2006 KPMG — Worldbank Wien March 2006— 22 Case Study 6: Preference Shares without fixed redemption date Solution: In general, IAS 32.AG25 states that an option of the issuer to redeem the instrument for cash does not satisfy the definition of a liability, because there is no present obligation Because dividend payments are contingent, the key question is whether the payment is beyond the control of the issuer In this case, dividend payment is in the control of the parent company, nit the issuer, therefore, the dividend payments are classified as a liability Note: As the dividend payments are all the payments required, the whole instrument is classified as a liability. In addition, the instrument may qualify as equity on the level of the parent/consolidated financial statements

23. © 2006 KPMG — Worldbank Wien March 2006— 23 Case Study 7: Perpetual bond with contingent step-up interest Facts: A issues a perpetual bond, providing the holder with a contractual right to receive interest payments at fixed dates extending into the indefinite future with no right to receive a return of principal The terms of the perpetual bonds are as follows: Payment of interest is contingent on the payment of dividends on preference shares that have also been issued by A. Interest accrues if no payment is made in a particular year After years 10, 20, 30, etc. the issuer has a right to repay bond Interest is fixed at a rate for 10 years based on market interest rate After each 10 years: The interest rate is adjusted to the then current market interest rate for 10 year fixed rate debt + 100 basis points Is the instrument a debt instrument, an equity instrument or a compound instrument ? If it is a compound instrument how are the components measured ?

24. © 2006 KPMG — Worldbank Wien March 2006— 24 Case Study 7: Perpetual bond with contingent step-up interest Solution: Perpetual bonds with a fixed market-based interest rate are classified as liabilities in their entirety (present value of future interest payments) In this case, interest payments are contingent on payments of dividends to preference shares Therefore, the entire classification of the instrument is dependent on the classification of the preference shares

25. © 2006 KPMG — Worldbank Wien March 2006— 25 Overview: Impairment of Financial Assets carried at Amortized Cost financial assets that are individually significant * financial assets that are not individually significant individually collectively Hinweis liegt vor Assessment of objective Evidence of Impairment (Trigger Events) Assessment of Impairment Impairment Hinweis liegt nicht vor Impairment individuallycollectively Impairment liegt vorKein Impairment collectively * Includes Assets that are individually significant and Assets that are already impaired

26. © 2006 KPMG — Worldbank Wien March 2006— 26 Loans and receivables: evaluation of impairment on a portfolio basis Future cash flows Estimated cash flows Historic loss experience Changes in related observable data Discount rate Weighted average of the original effective interest rate, which reflects estimated cash flows with no double counting or elimination of risk Losses incurred but not reported At each year end the present value of the estimated cash flows is re-calculated and impairment loss recognised for the difference between this amount and the carrying value of the portfolio, but the estimated cash flows take into account incurred losses, not expected future losses When loans are identified as individually impaired they are removed from the portfolio

27. © 2006 KPMG — Worldbank Wien March 2006— 27 Incurred loss defines impairment loss Historic loss rate is determined by dividing charge-offs for a period (e.g. a year or a quarter) by the average portfolio (loan) balance in the pool during the same period Loss confirmation period (‘emergence period’) is the average lag between incurrence of loss and confirmation of loss dates Incurrence loss date is the date on which objective evidence of impairment occurs on an individual asset basis Confirmation loss date is the date on which objective evidence of impairment is identified on an individual asset basis Incurred loss = Historic loss X rate Loss confirmation X period Loan’s balance of portfolio Loans and receivables - measurement of incurred losses on a portfolio basis

28. © 2006 KPMG — Worldbank Wien March 2006— 28 Impairment of available-for-sale equity securities Additional indicators of impairment for equity securities Adverse effects of changes in technological, market, economic or legal environment, in which the entity operates Significant or prolonged decline in the fair value of an investment in the equity instrument Impairment loss can not be reversed through profit or loss as long as the asset continues to be recognised Equity instruments

29. © 2006 KPMG — Worldbank Wien March 2006— 29 Example of Impairment under IAS 39 AfS Equity Securities Impairment - Example 31.12.200431.12.200531.12.200631.12.200731.12.2008 Fair Value 100105957075 Fair Value Change -+5-10-25+5 Fair Value Change cumulated -+5-5-30-25 Impairment -no yesno Amount recognized in equity -+5-50+5 P&L (Impairment) -00-300 Cost Basis 100 70

30. © 2006 KPMG — Worldbank Wien March 2006— 30 Impairment of available-for-sale debt securities Indicators of impairment for debt securities (similar to those for loans and receivables) Significant financial difficulty of the issuer Bankruptcy or financial reorganisation of the issuer Disappearance of an active market for the bonds concerned Measurable decrease in the estimated future cash flows Impairment loss can be reversed through profit or loss if the increase can be objectively related to an event occurring after the loss was recognised Debt instruments

31. © 2006 KPMG — Worldbank Wien March 2006— 31 Example of Impairment under IAS 39 AfS Debt Securities Impairment - Example 31.12.200431.12.200531.12.200631.12.200731.12.2008 Fair Value 100105957090 Fair Value Change -+5-10-25+20 Fair Value Change cumulated -+5-5-30-10 Impairment -no yesno Amount recognized in equity -+5-500 P&L (Impairment) -00-30+20 Cost Basis 100

32. © 2006 KPMG — Worldbank Wien March 2006— 32 Amortised cost (1) Definition Amount at which the financial asset or liability was measured at initial recognition minus principal repayments, plus or minus the cumulative amortisation of any difference between that initial amount and the maturity amount minus impairment

33. © 2006 KPMG — Worldbank Wien March 2006— 33 Derecognition Amortisation Financial Liabilities Derecognition Impairment Amortisation P&L impact Financial Assets Amortised Cost (2)

34. © 2006 KPMG — Worldbank Wien March 2006— 34 Facts: Bank is granting a loan to a company as of 1.1.2002 in an amount of € 50 Mio. The loan is paid out at 98 % of the nominal amount. Maturity of the loan is at 31. December 2006. Interest rate is set at 10 % to be paid annually in arreas. The effective interest rate is r = 10,53482 % (internal rate of return) and can be calcualted as follows: 49,000,000 = 5,000,000 (1+r) + 5,000,000 (1+r) 2 + 5,000,000 (1+r) 3 + 5,000,000 (1+r) 4 + 55,000,000 (1+r) 5 Amortised cost (effective interest rate) (1/4)

35. © 2006 KPMG — Worldbank Wien March 2006— 35 DateCarrying amount Interest expenseCouponCarrying amount (1.1.)(10,53482 %)(31.12.) 200249,000,0005,162,063(5,000,000)49,162,063 200349,162,0635,179,136(5,000,000)49,341,199 200449,341,1995,198,008(5,000,000)49,539,207 200549,539,2075,218,868(5,000,000)49,758,075 200649,758,0755,241,925(55,000,000)0 26,000,00075,000,000 Amortised cost (effective interest rate) (2/4)

36. © 2006 KPMG — Worldbank Wien March 2006— 36 Book entries as of 1.1.2002 for the borrowers books 50,000,000Loan, nominal amount 1,000,000Loan, Discount 49,000,000Cash, Bank CreditDebit Amortised cost (effective interest rate) (3/4)

37. © 2006 KPMG — Worldbank Wien March 2006— 37 Book entries as of 31. 12. 2002 for the borrowers books 5,162,063Interest expense 162,063Loan, accretion amount 5,000,000Cash/liabilities to Banks CreditDebit Amortised cost (effective interest rate) (4/4)

38. © 2006 KPMG — Worldbank Wien March 2006— 38 Example of Impairment under IAS 39 (1) 31.12.2004: Granting a loan of 10.000 € at 4%; Maturity 4 years, interest payable annually Impairment - Example 31.12.200431.12.200531.12.200631.12.200731.12.2008 Contractual Cash Flows -10.000+400 +10.400 Expected Cash Flows Amortized Cost./. Impairment Carrying Value Loan Interest Income Carrying Value Loan Interest Income Carrying Value Loan Interest Income Carrying Value Loan

39. © 2006 KPMG — Worldbank Wien March 2006— 39 Example of Impairment under IAS 39 (2) 31.12.2005: Loss Event Expectation: Repayment of Loan 50%; no interest payments 31.12.200431.12.200531.12.200631.12.200731.12.2008 Contractual Cash Flows -10.000+400 +10.400 Expected Cash Flows -10.000+5.000 Amortized Cost 10.400./. Impariment 5.955 Carrying Value Loan 4.445 Interest Income 178 Carrying Value Loan 4.623 Interest Income 185 Carrying Value Loan 4.808 Interest Income 192 Carrying Value Loan 5.000 Impairment – Example (2)

40. © 2006 KPMG — Worldbank Wien March 2006— 40 31.12.200431.12.200531.12.200631.12.200731.12.2008 Contractual Cash Flows -10.000+400 +10.400 Expected Cash Flows -10.000+2.500 Amortized Cost 10.400./. Impairment 5.9558.090 Carrying Value Loan 4.445 Interest Income 178 Carrying Value Loan 2.310 Interest Income 93 Carrying Value Loan 2.403 Interest Income 97 Carrying Value Loan 2.500 Impairment – Example (3) Example of Impairment under IAS 39 (3) 31.12.2006: Change in Expectations New Expectation: Repayment of Loan 25%; no interest payments Additional Impairment Loss of EUR 2.135

41. © 2006 KPMG — Worldbank Wien March 2006— 41 Impairment – Example (4) Example of Impairment under IAS 39 (4) Impairment on Portfolio-Basis effective interest rate = 8%, PD = 2% (probability of default, one year), LGD = 60% (loss given default based on contractual cash flows)

42. © 2006 KPMG — Worldbank Wien March 2006— 42 Case Study A: Measuring risks and rewards Facts: A sells 100 of short-term receivables to Bank B for 95 Historic (adjusted) default rates: expected credit losses are 5% range of losses between 4.5% - 6.5% with a confidence interval of 99.9% A guarantees to reimburse B for losses exceeding 6.5% Assume that credit risk is the only significant risk Has A transferred substantially all risks and rewards?

43. © 2006 KPMG — Worldbank Wien March 2006— 43 Case Study A: Measuring risks and rewards Analysis of credit risk: The risk inherent in the transferred receivables is that actual credit losses will exceed expected credit losses of 5%. The rewards inherent in the receivables is that actual credit losses will be less than expected credit losses of 5%. This does not necessarily mean that A should derecognise the receivables since the other derecognition criteria (e.g. pass-through conditions) must also be met! Consequently, A has transferred the substantially all risks and rewards in relation to credit risk!

44. © 2006 KPMG — Worldbank Wien March 2006— 44 Case Study B: Securitisation Transaction I Subsidiary SPE 1 (Purchase Vehicle) SPE 2 (Financing Vehicle) Cash (par value) Receivables 1 Loan Cash Cash collateral for 40% of first loss of 1.5 % Parent Subordinated loan (second loss) for 9,5 % of notional amount of transferred receivables (required for AAA-rating) External bondholders Insurance Company Financial Guarantee / Credit Insurance Credit Insurance 2 for 60% of notional amount of receivables Premium paid by parent 1 Expected loss:1.0 % Unexpected loss:0.5 % Total risk:1.5% (confidence interval 99.9%) Assume that credit risk is the only significant risk inherent in the receivables 100% Bonds/ CP Cash Pledge of credit insurance contract as collateral for 60% of first loss of 1.5% 2 The insurance contract was established at origination of the receivables and substantially prior to the transfer via a Master Credit Insurance Contract

45. © 2006 KPMG — Worldbank Wien March 2006— 45 Case Study B: Securitisation Transaction I Questions: Who consolidates SPE 1? Can the group achieve derecognition? If not, how can the structure be modified to achieve derecognition?

46. © 2006 KPMG — Worldbank Wien March 2006— 46 NEW Case Study C: Securitisation Transaction II Subsidiary SPE 1 (Purchase Vehicle) SPE 2 (Financing Vehicle) Cash (par value) Receivables 1 Loan Cash Cash collateral for 40% of first loss of 1.5 % Parent Subordinated loan (second loss) for 9,5 % of notional amount of transferred receivables (required for AAA-rating) External bondholders Insurance Company Financial Guarantee / Credit Insurance Credit Insurance 2 for 60% of notional amount of receivables Premium paid by parent 100% Bonds/ CP Cash Sale of credit insurance contract for issuance of financial guarantee 1 / 2 (see previous slide) Financial Guarantee provided by 2 banks (2 x 30 % of 1.5 %) (to avoid consolidation) Pledge of credit insurance contract as collateral for 60% of first loss of 1.5%

47. © 2006 KPMG — Worldbank Wien March 2006— 47 HedgeAccounting Cash Flow Hedges - Example (1/5) A manufacturer of computers purchases various components in Asia. On 28.02.20X1 he signs a contract to purchase 1.000.000 parts from a foreign company, delivery 31.03.20X1 The purchase price is 750.000.000 (foreign currency) due 30.04.20X1 According to the purchasers risk management policy, forign exchange risk is hedged if the limit of 2.500.000 EURO is exceeded The purchaser is entering into a forward sale of 750.000.000 (foreign currency) for EURO at a rate of 102,46 as of 30.04.20X1 Effectiveness of the hedge is given

48. © 2006 KPMG — Worldbank Wien March 2006— 48 HedgeAccounting Cash Flow Hedges - Example (2/5) (120.160)N/a104,1730. April (211.070)105,51105,7831. March ---102,46102,7528. February Fair Value of the forward contract in EURO Forward rate for 30.04. 1 Euro = foreign currency Spot rate 1 Euro = foreign currency Date

49. © 2006 KPMG — Worldbank Wien March 2006— 49 HedgeAccounting Cash Flow Hedges - Example (3/5) 31.03.20X1 28.02.20X1 Recording the purchase at the exchange rate of delivery date (750.000.000/105,78) 7.090.187Trade liabilities 7.090.187Inventory Recording the Fair Value change of the derivative (forward contract) 211.070Derivative (liability) 211.070Equity valuation reserve No book entry; Fair Value of forward contract is Zero CreditDebit

50. © 2006 KPMG — Worldbank Wien March 2006— 50 HedgeAccounting Cash Flow Hedges - Example (4/5) 211.070Inventory 30.04.20X1 211.070Equity valuation reserve Recognition of Fair Value Change of the Forward contract 90.910FX gain (P&L) 90.910Derivative (liability) FX loss recognition on liability 109.583Trade liability 109.583FX loss on trade liability Recognition of the hedge transaction upon delivery of the goods CreditDebit

51. © 2006 KPMG — Worldbank Wien March 2006— 51 HedgeAccounting Cash Flow Hedges - Example (5/5) 7.199.770Trade liability 120.160Derivative (liability) 7.199.770Cash Cash settlement of the Forward contract 120.060Cash Settlemtent of the liability by cash transfer CreditDebit

52. © 2006 KPMG — Worldbank Wien March 2006— 52 Fair Value Hedges – Example (1/13) Global Tech Company (GTC) needs financing for the coming five years of EURO 100 million As of 1.1.20X1 GTC issues a 5-year note for EURO 100 million The note is bearing interest at a fixed rate of 6%, payable each 6 months The note is issued at par

53. © 2006 KPMG — Worldbank Wien March 2006— 53 Fair Value Hedges – Example (2/13) GTC´s risk management strategy requires the financing with variable rates GTC enters into an interest rate Swap (IRSwap) with a 5-year term Nominal amount: EURO 100 million ÍRS: Payment of a variable rate based on LIBOR, receiving 6% fix The variable rate for the first six months is 5,7% Initial Fair Value of the IRSwap is zero Management designates the IRS as a Fair Value hedge for the note issued and prepares the required documentation at inception of the hedge The hedge is effective based on the interest rate based changes in Fiar Value of the IRS and the note issued

54. © 2006 KPMG — Worldbank Wien March 2006— 54 Fair Value Hedges – Example (3/13) Issuance of the note for cash 100.000.000Note (liability) 100.000.000Cash IRSwap is recorded at Fair Value of zero 1. January 20X1 CreditDebit

55. © 2006 KPMG — Worldbank Wien March 2006— 55 Fair Value Hedges – Example (4/13) As of 30.06.20X1 interest rates increased Variable rate for the next 6 months period increased from 5,7% to 6,7% As a result, the Fair Value of the note decreases and the IRSwap has a negative Fair Value Fair Value of the note decreases from 100.000.000 to 96.196.000 The Fair Value of the IRSwap is -3.804.000 Based on the Fair Value changes, Management assesses the hedge relationship to be effective

56. © 2006 KPMG — Worldbank Wien March 2006— 56 Fair Value Hedges – Example (5/13) Recording of the change in Fair Value of the liability due to hedge accounting 3.804.000Change in Fair Value P&L 3.804.000Note (liability) Recording the fixed interest payments at 6% 3.000.000Cash 3.000.000Interest expense 30. Juni 20X1 CreditDebit

57. © 2006 KPMG — Worldbank Wien March 2006— 57 Fair Value Hedges – Example (6/13) Recording of the change in Fair Value of the IRSwap Net interest expense is 2.850.000, the variable interest rate amount for a rate of 5,7 % 3.804.000IRSwap (libability) 3.804.000Fair Value Change of IRSwap P&L IRSwap interest payments for 1.1.20X1 bis 30.6.20X1 150.000Interest income 150.000Cash CreditDebit

58. © 2006 KPMG — Worldbank Wien March 2006— 58 Fair Value Hedges – Example (7/13) As of 31.12.20X1 interest rates remain unchanged at 6,7% Fair Value of the note is 96.563.000 Fair Value of the IRSwap is -3.437.000 Based on the Fair Value changes, Management assesses the hedge relationship to be effective

59. © 2006 KPMG — Worldbank Wien March 2006— 59 Fair Value Hedges – Example (8/13) Change in Fair Value of the note attributable to the risk hedged 367.000Note (liability) 367.000Change in Fair Value P&L Recording of the fixed interest payments at 6% 3.000.000Cash 3.000.000Interest expense 31. Dezember 20X1 CreditDebit

60. © 2006 KPMG — Worldbank Wien March 2006— 60 Fair Value Hedges – Example (9/13) Recording of the change in Fair Value of the derivative 367.000Fair Value Change IRSwap P&L 367.000IRSwap (liability) IRSwap interest payments from 30.6. to 31.12.20X1 350.000Cash 350.000Interest expense CreditDebit

61. © 2006 KPMG — Worldbank Wien March 2006— 61 Fair Value Hedges – Example (10/13) Interest expense is 3.350.000; this is the amount based on a rate of 6,7% for 6 months the balance sheet as of 31.12.20X1: 93.800.000 3.437.000IRSwap 96.563.000note (6.200.000)Equity/reserves93.800.000Cash Equity and liabilitiesAssets

62. © 2006 KPMG — Worldbank Wien March 2006— 62 Fair Value Hedges – Example (11/13) Statement of income and expense: First 6 months at 5,7 %2.850.000 Second 6 months at 6,7%3.350.000  Total for the year 20X1 6.200.000

63. © 2006 KPMG — Worldbank Wien March 2006— 63 Fair Value Hedges – Example (12/13) Termination of the hedge relationship As of 31.12.20X1 GTC terminates the IRSwap based on their changed risk mamagement policy GTC terminates the IRSwap by paying 3.437.000 to the counterparty of the IRS: Termination of the IRSwap as of 31.12.20X1 3.437.000Cash 3.437.000IRSwap (liability) CreditDebit

64. © 2006 KPMG — Worldbank Wien March 2006— 64 Fair Value Hedges – Example (13/13) The carrying value of the note as per the balance sheet as of 31.12.20X1 is 96.563.000 This is based on a reduction of 3.437.000 due to the application of hedge accounting After termination of the hedge relationship, the amount of 3.437.000 will be amortized into income/expense over the remaining maturity of the note, therby adjsuting the interest rate for that remaining period

65. © 2006 KPMG — Worldbank Wien March 2006— 65 Fair Value Hedge – Firm Commitment Example (1/10) A car manufacturer purchases steel coils in Europe He signs at 28.02.20X1 a contract to purchase 10.000t coils with a east european steel producer; delivery 31.08.20X1 The purchase price is 7.500.000 due 30.11.20X1 According to the risk management policy of the car manufacturer, all price risks above the limit of 2.500.000 have to be hedged The car manufaturer purchases a put option for 10.000t od steel a t a strike price of €750/t The premium paid for the option contract is 450.000 Effectiveness is assumed What type of hedge relationship is this?

66. © 2006 KPMG — Worldbank Wien March 2006— 66 Fair Value Hedge – Firm Commitment Example (2/10) The car manufaturer entered into a firm commitment The firm commitment is not recorded on the balance sheet The Fair Value of inventory to be purchased is the hedged item Therefore, Fair Value Hedging would be appropriate Problem: Definition of Hedged Item Solution: IAS 39.93-94

67. © 2006 KPMG — Worldbank Wien March 2006— 67 Fair Value Hedge – Firm Commitment Example (3/10) Option purchased for premium 450.000 Derivative (Premium paid) 450.000Cash No book entry for firm commitment 1. March 20X1 CreditDebit

68. © 2006 KPMG — Worldbank Wien March 2006— 68 Fair Value Hedge – Firm Commitment Example (4/10) at 30.06.20X1 the price for steel decreased to 700/t Fair Value of the Option increased by 500.000 to 950.000 Fair Value of the Firm Commitment is now negative, because the contract onerous for the car manufaturer at current steel prices at -500.000

69. © 2006 KPMG — Worldbank Wien March 2006— 69 Fair Value Hedge – Firm Commitment Example (5/10) Recording of the change in Fair Value of the Firm Commitment; for Hedge Accounting only, the Firm Commitment is recognized on the balance sheet 500.000Result from FV- Hedge 500.000Firm Commitment Recording the change in Fair Value of the Option 500.000Derivative 500.000Valuation result 30. June 20X1 CreditDebit

70. © 2006 KPMG — Worldbank Wien March 2006— 70 Fair Value Hedge – Firm Commitment Example (6/10) at 31.8.20X1 the price of steel decreased to 650/t The Option is exercised bs the car manufaturer and the company receives a payment of (750-650 x 10.000)= 1.000.000 Simultaneously, the steel coils are delivered against trade liability of 7.500.000 Inventory is valued at 6.500.000, the current market price

71. © 2006 KPMG — Worldbank Wien March 2006— 71 Fair Value Hedge – Firm Commitment Example (7/10) Valuation of the derivative at Fair Value (total 1.000.000) 50.000Derivative 50.000Valuation result Recordig of the exercise payment for the Option 1.000.000Cash 1.000.000Gain from Derivative 31. August 20X1 CreditDebit

72. © 2006 KPMG — Worldbank Wien March 2006— 72 Fair Value Hedge – Firm Commitment Example (8/10) Valuation of inventory at current market 1.000.000Result from valuation of inventory 1.000.000Inventory Recording of the delivery of steel coils 7.500.000Inventory 7.500.000Liability CreditDebit

73. © 2006 KPMG — Worldbank Wien March 2006— 73 Fair Value Hedge – Firm Commitment Example (9/10) Derecognition of the firm commitment 500.000Firm Commitment 500.000Hedging result Settlement of the Option 1.000.000Result Hedging 1.000.000Derivative 31. August 20X1 CreditDebit

74. © 2006 KPMG — Worldbank Wien March 2006— 74 Fair Value Hedge – Firm Commitment Example (10/10) Hedging result is a loss of 450.000, the premium paid for the option contract Withour hegding, the loss would have been 1.000.000 due to the revaluation of inventory 7.500.000 Liability 450.000Capital (450.000)Equity/Reserves1.000.000Cash Equity and liabilitiesAssets Inventory6.500.000 Capital is based on the opening balance sheet (cash 450.000; capital 450.000)