IFRS 9 Financial Instruments (2024)

(a)

As a fair value hedge, a hedging relationship for fair value interest rate risk and FX risk between the FC denominated fixed rate liability (fixed rate FX liability) as the hedged item and a cross-currency interest rate swap as the hedging instrument (the ‘first level relationship’). This hedging relationship is designated at the beginning of Period 1 (ie t₀) with a term to the end of Period 4.

(b)

As a cash flow hedge, a hedging relationship between the aggregated exposure as the hedged item and an interest rate swap as the hedging instrument (the ‘second level relationship’). This hedging relationship is designated at the end of Period 1, when EntityB decides to lock in its interest payments and hence swaps its aggregated variable rate exposure in LC into a fixed rate exposure in LC, with a term to the end of Period 4. The aggregated exposure that is designated as the hedged item represents, in LC, the variability in cash flows that is the effect of changes in the combined cash flows of the two items designated in the fair value hedge of the fair value interest rate risk and FX risk (see (a) above), compared to the interest rates at the end of Period 1 (ie the time of designation of the hedging relationship between the aggregated exposure and the interest rate swap).

(a)

At the point in time from which the cash flow variability of the aggregated exposure is hedged (ie the start of the second level relationship at the end of Period 1), all cash flows expected on the fixed rate FX liability and the cross-currency interest rate swap over the hedged term (ie until the end of Period 4) are mapped out and equated to a single blended fixed coupon rate so that the total present value (in LC) is nil. This calculation establishes the single blended fixed coupon rate (reference rate) that is used at subsequent dates as the reference point to measure the cash flow variability of the aggregated exposure since the start of the hedging relationship. This calculation is illustrated in the following table:

Example17—Cash flow variability of the aggregated exposure (calibration)
		Variability in cash flows of the aggregated exposure
		FX liability		CCIRS FC leg		CCIRS LC leg		Calibration	PV
		CF(s)	PV	CF(s)	PV	CF(s)	PV	1,200,000 Nominal5.6963% Rate4 Frequency
		[FC]	[FC]	[FC]	[FC]	[LC]	[LC]	[LC]	[LC]
	Time
	t0
Period 1	t1
	t2
	t3
	t4
Period 2	t5	0	0	0	0	(14,771)	(14,591)	17,089	16,881
	t6	(20,426)	(19,977)	20,246	19,801	(15,271)	(14,896)	17,089	16,669
	t7	0	0	0	0	(16,076)	(15,473)	17,089	16,449
	t8	(20,426)	(19,543)	20,582	19,692	(16,241)	(15,424)	17,089	16,229
Period 3	t9	0	0	0	0	(17,060)	(15,974)	17,089	16,002
	t10	(20,426)	(19,148)	20,358	19,084	(17,182)	(15,862)	17,089	15,776
	t11	0	0	0	0	(17,359)	(15,797)	17,089	15,551
	t12	(20,426)	(18,769)	20,582	18,912	(17,778)	(15,942)	17,089	15,324
Period 4	t13	0	0	0	0	(18,188)	(16,066)	17,089	15,095
	t14	(20,426)	(18,391)	20,246	18,229	(18,502)	(16,095)	17,089	14,866
	t15	0	0	0	0	(18,646)	(15,972)	17,089	14,638
	t16	(1,020,426)	(899,695)	1,020,582	899,832	(1,218,767)	(1,027,908)	1,217,089	1,026,493
Totals			(995,522)		995,550		(1,200,000)		1,199,971
Totals in LC			(1,045,298)		1,045,327		(1,200,000)		1,199,971
PV of all CF(s) [LC]

The nominal amount that is used for the calibration of the reference rate is the same as the nominal amount of aggregated exposure that creates the variable cash flows in LC (LC1,200,000), which coincides with the nominal amount of the cross-currency interest rate swap for the variable rate leg in LC. This results in a reference rate of 5.6963 per cent (determined by iteration so that the present value of all cash flows in total is nil).

(b)

At subsequent dates, the cash flow variability of the aggregated exposure is determined by comparison to the reference point established at the end of Period 1. For that purpose, all remaining cash flows expected on the fixed rate FX liability and the cross-currency interest rate swap over the remainder of the hedged term (ie from the effectiveness measurement date until the end of Period 4) are updated (as applicable) and then discounted. Also, the reference rate of 5.6963 per cent is applied to the nominal amount that was used for the calibration of that rate at the end of Period 1 (LC1,200,000) in order to generate a set of cash flows over the remainder of the hedged term that is then also discounted. The total of all those present values represents the cash flow variability of the aggregated exposure. This calculation is illustrated in the following table for the end of Period 2:

Example17—Cash flow variability of the aggregated exposure (at the end of Period2)
		Variability in cash flows of the aggregated exposure
		FX liability		CCIRS FC leg		CCIRS LC leg		Calibration	PV
		CF(s)	PV	CF(s)	PV	CF(s)	PV	1,200,000 Nominal5.6963% Rate4 Frequency
		[FC]	[FC]	[FC]	[FC]	[LC]	[LC]	[LC]	[LC]
	Time
	t0
Period 1	t1
	t2
	t3
	t4
Period 2	t5	0	0	0	0	0	0	0	0
	t6	0	0	0	0	0	0	0	0
	t7	0	0	0	0	0	0	0	0
	t8	0	0	0	0	0	0	0	0
Period 3	t9	0	0	0	0	(18,120)	(17,850)	17,089	16,835
	t10	(20,426)	(20,173)	20,358	20,106	(18,360)	(17,814)	17,089	16,581
	t11	0	0	0	0	(18,683)	(17,850)	17,089	16,327
	t12	(20,426)	(19,965)	20,582	20,117	(19,203)	(18,058)	17,089	16,070
Period 4	t13	0	0	0	0	(19,718)	(18,243)	17,089	15,810
	t14	(20,426)	(19,726)	20,246	19,553	(20,279)	(18,449)	17,089	15,547
	t15	0	0	0	0	(21,014)	(18,789)	17,089	15,280
	t16	(1,020,426)	(971,144)	1,020,582	971,292	(1,221,991)	(1,072,947)	1,217,089	1,068,643
Totals			(1,031,008)		1,031,067		(1,200,000)		1,181,092
Totals in LC			(1,464,031)		1,464,116		(1,200,000)		1,181,092
PV of all CF(s) [LC]

The changes in interest rates and the exchange rate result in a change of the cash flow variability of the aggregated exposure between the end of Period 1 and the end of Period 2 that has a present value of LC‑18,824.24

(a)

In Period 1 the risk management strategy results in interest expense reflecting variable interest rates in LC after taking into account the effect of the cross-currency interest rate swap, including a difference between the cash flows on the fixed rate FX liability and the fixed leg of the cross-currency interest rate swap that were settled during Period 1 (this means the interest expense does not exactly equal the variable interest expense that would arise in LC on a borrowing of LC1,200,000). There is also some hedge ineffectiveness that results from a difference in the changes in value for the fixed rate FX liability (as represented by the fair value hedge adjustment) and the cross-currency interest rate swap.

(b)

For Periods 2 to 4 the risk management strategy results in interest expense that reflects, after taking into account the effect of the interest rate swap entered into at the end of Period 1, fixed interest rates in LC (ielocking in a single blended fixed coupon rate for a three-period term based on the interest rate environment at the end of Period 1). However, Entity B’s interest expense is affected by the hedge ineffectiveness that arises on its hedging relationships. In Period 2 the interest expense is slightly higher than the fixed rate payments locked in with the interest rate swap because the variable payments received under the interest rate swap are less than the total of the cash flows resulting from the aggregated exposure.27 In Periods 3 and 4 the interest expense is equal to the locked in rate because the variable payments received under the swap are more than the total of the cash flows resulting from the aggregated exposure.28