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Primary Article

FAS 133 Option Fair Value Hedges

Financial Engineering and Financial Accounting Perspectives

James N.. Bodurtha and Daniel B. Thornton
The Journal of Derivatives Fall 2002, 10 (1) 62-79; DOI: https://doi.org/10.3905/jod.2002.319191
James N.. Bodurtha Jr
An associate professor of finance and international business at the McDonough School of Business at Georgetown University in Washington, DC.
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  • For correspondence: bodurthj@georgetown.edu
Daniel B. Thornton
A professor of financial accounting, and distinguished faculty fellow, at the Goodes School of Business at Queen's University in Kingston, Canada.
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  • For correspondence: dbt@qsilver.queensu.ca
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Abstract

The attempt of the Financial Accounting Standards Board (FASB) to provide consistent and logical accounting treatment for hedging transactions, in the form of FAS 133, continues to generate controversy. Under the new rules, many kinds of hedges do not cause problems, but a variety of difficulties still remain. One of the more significant ones involves how the changes in the current value of an option used in a hedge are to be treated. In some cases, changes in an option's time value are supposed to enter into earnings, which can produce spurious earnings volatility during the period of a hedge. Bodurtha and Thornton describe the situation under FAS 133 and then propose two possible solutions. One is to suggest a change in the rule that would remove the problem. Their “financial engineering solution” would not depend on a rule change, but would introduce new types of derivatives whose contingent cash flows could be organized in such a way as to qualify for hedge treatment under the current rules, but would remove the artificial earnings volatility that would otherwise occur with a standard option hedge.

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The Journal of Derivatives
Vol. 10, Issue 1
Fall 2002
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FAS 133 Option Fair Value Hedges
James N.. Bodurtha, Daniel B. Thornton
The Journal of Derivatives Aug 2002, 10 (1) 62-79; DOI: 10.3905/jod.2002.319191

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FAS 133 Option Fair Value Hedges
James N.. Bodurtha, Daniel B. Thornton
The Journal of Derivatives Aug 2002, 10 (1) 62-79; DOI: 10.3905/jod.2002.319191
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