In short
An embedded derivative is a feature within a contract (the host) that changes some of the contract's cash flows like a derivative would, such as an equity-indexed return in a debt instrument.
Key takeaways
- It is separated and accounted for as a derivative if it isn't clearly and closely related to the host, the whole contract isn't measured at fair value through net income, and it would be a derivative on its own.
- Separated derivatives are measured at fair value, with changes in earnings.
- Companies may instead elect fair value for the whole hybrid contract.
Where it's tested
BAR: Derivatives & Hedge Accounting — study notes, a five-minute revision sheet and practice questions.
Practise: 3 questions
Question 1 of 3 · 0 answered
An embedded derivative must be separated from its host contract and accounted for as a derivative when, among other conditions: