C11-6: Accounting for Hedges of Available-for-Sale
Securities
Rainy Day Insurance Company maintains an extensive
portfolio of bond investments classified as available-for-sale
securities under FASB 115 (ASC 320).  The bond
investments have a variety of fixed interest rates and have
maturity dates ranging from 1 to 15 years.  Rainy Day acquired
the bonds with the expectation that it could hold them until
maturity or sell them any time that funds are required for
unusually high insurance claims.

           
Because of the large dollar amount invested, Rainy Day is concerned
about fluctuations in interest rates that affect the fair value of
its bond portfolio.  One of Rainy Day’s investment
professionals has proposed that the company invest in an interest
rate futures contract to hedge its exposure to interest rate
changes.  Changes in the fair value of the futures contract
would offset changes in the bond portfolio’s fair value.  If
Rainy Day applies hedge accounting under FASB 133 (ASC
815), the income statement effect of changes in the fair value
of the derivative would be offset by recording in earnings the
changes in the fair value of the bond portfolio attributable to the
hedged (interest rate) risk.
 
Required
Obtain the most current accounting standards on
accounting for hedges of available-for-sale securities.  You
can obtain access to accounting standards through the FARS,
library, or other source.  Rainy Day’s CFO, Mark Becker, has
asked you, as an accountant in Rainy Day’s Investment division, to
determine whether hedge accounting can be used in the scenario
proposed.  Write a memo to Mark, reporting on the results of
your research.  Support your recommendations with citations
and quotations from the authoritative financial reporting
standards.