21 January 2009
What is mean by embedded Derivatives? Please clarify in simple terms.
Guest
Guest
(Expert)
21 January 2009
An embedded derivative is a derivative instrument that is combined with a non-derivative host contract to form a single hybrid instrument.
The host contract might be a debt or equity instrument, a lease, an insurance contract or a sale or purchase contract.
30 August 2010
There may be contract that you enter in real life which has hidden derivative in it. These are called embedded derivatives.
Let us say you are buyer of oil and you entered into contract with ABC Petroleum. Let us say as per the contract ABL Petroleum is bound to supply you 1000 barrels at the end of every month at Rs. 3,000 per barrel. If you look at simply it is a normal business contract. But if you look closely you will see that you have entered into forward contract (derivative).
Another example is if you are holding a convertible debenture (a debenture that you can convert into equity share). You are actually holding an option to buy a share which is "hidden" in the convertible debenture.
Basically, these are contracts / instruments in which a derivate is hidden (embedded).
Accounting standard says the derivative should be separated and treated if it meets the following conditions: • the economic risks and characteristics of the embedded derivative are not closely related to those of the host contract • a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative, and • the entire instrument is not measured at fair value with changes in fair value recognised in the income statement Hope your query is solved, if not, then pls revert.
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