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Definition:
Businesses are exposed to variety of risks such as equity risk, market risk, interest rate risk, liquidity risk, credit risk, default risk, etc. To cover the risks and hedge themselves, business engage in derivatives where they can pass on the risk to other counterparty with help of some derivative contracts.
For example, to hedge there are below products:
Type of Risk Derivative Products
Equity risk Futures, Options
Interest rate risk Interest rate swaps, Options
Credit Risk Credit Default Swaps
Foreign Exchange Risk Fx Forwards, Fx Swaps, Fx Options
Derivatives are accounted at Fair Value through Profit or Loss under which mark-to-market accounting is performed. These contracts are recognised at Fair value as at reporting date. Positive / Favourable position is accounted as a part of Derivative Asset.
Accounting Entries:
The accounting entries below are general accounting for Derivative Assets. Specific product level accounting for Derivative contracts can be refered from Financial Products > Derivatives.
Recognition of derivative asset (favourable position):
Derivative Asset (MTM Gain) A/c DR
Derivative P&L A/c CR
Amount: Derivative asset or positive position on MTM based on computation from clearing house or internal financial models.
Realisation of gain from derivative counterparty:
Cash/Bank A/c DR
Derivative Asset (MTM Gain) A/c CR
Amount: Cash realised on financial settlement date.