Lesson 61 - Advanced Accounting Course

Lesson 61: Understanding Futures, Options, and Swaps

🧠 What Are Derivatives?

Derivatives are financial contracts whose value is based on (or “derived from”) the value of an underlying asset like:

• 📦 Commodities (e.g., oil, gold)
  
  

• 💰 Currencies
  
  

• 📈 Stocks or indexes
  
  

• 🧾 Interest rates
  
  

✅ Businesses use them to hedge risks (protect against losses) or speculate (try to profit from price changes).

⚙️ Key Types of Derivatives

1. 📅 Futures Contracts

A futures contract is an agreement to buy or sell an asset at a specific future date and price.

Example:
A coffee company agrees in January to buy coffee beans in June at today’s price.
✅ If prices go up in June, they save money!

2. 📊 Options Contracts

An option gives the buyer the right (not obligation) to buy or sell an asset at a set price before a certain date.

Example:
You buy a call option for Apple stock at $150.
If Apple rises to $170, you can buy it at $150 and profit!
If it drops to $140, you don’t use the option—you just lose the premium.

3. 🔄 Swaps

A swap is a private agreement between two parties to exchange future cash flows based on different variables (like interest rates or currencies).

Example:
Company A pays fixed interest; Company B pays floating.
They swap payments to reduce risk or save costs.

🧾 Summary Table

💼 Real-World Use Cases 

⚠️ Risks to Keep in Mind

• ❗ Leverage: Small price movements can cause big losses
  
  

• 💸 Premium Loss: With options, the premium can be lost entirely
  
  

• 🔍 Counterparty Risk: Especially with swaps (if one party defaults)
  
  

• 📉 Market Volatility: Makes valuation and accounting complex
  
  

📚 Accounting Treatment

📌 IFRS 9 and ASC 815 provide accounting guidance for derivatives and hedging.

✅ Final Takeaways

• ✅ Derivatives help companies manage financial risk
  
  

• 🧠 Understanding their purpose = better decision-making and safer strategies
  
  

• 🧾 Accountants must know how to value, report, and explain these instruments