In short
An option gives its holder the right, but not the obligation, to buy (a call) or sell (a put) an asset at a set strike price on or before a set date. The buyer pays a premium for the option.
Key takeaways
- An option's value is its intrinsic value plus its time value.
- A purchased option limits the downside while keeping the upside, unlike a forward.
- Time value can be left out of the hedge effectiveness assessment.
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
A company with variable-rate debt enters into an interest rate swap to pay fixed and receive variable, properly designated and documented as a hedge. Where are changes in the swap's fair value reported?