Abstract

In this case study, a wide variety of derivatives contracts entered into by Hyundai Group for corporate ownership－related purposes are analyzed in order to derive a deeper understanding regarding their valuation and accounting treatment. Through the use of derivatives contracts, Hyundai Group was able to purchase a stake in its subsidiary through a friendly proxy, rather than purchasing a stake directly. This enabled it to maintain stability in its corporate ownership, while also providing upside potential for gains linked to upward movements in the stock price. Various types of derivatives were included in the contract, including synthetic forwards using options, equity swaps, put options, and equity swaps with multiple options. The fact that a listed stock was the underlying asset and that there was adequate information on the structures of the various contracts made it easier not only to analyze and value the contracts, but also to reconstruct the underlying structure of each contract. The study examined the various aspects of the derivatives contracts, and is expected to provide many good learning opportunities. First, this study broke down the complicated derivatives contract into its basic buildings blocks, such as forward contracts, options or swaps, then selected appropriate valuation methods based on a detailed understanding of each contract’s specific structure. Second, each of the building blocks of the contract was valued. The purpose of this was to enable the readers who may enter similar types of derivatives contracts to understand relevant risk factors and also apply appropriate hedging strategies against them. Third, this study analyzed how changes in the values of such derivatives were reported on financial statements. It should be noted that the accounting treatment of derivatives contracts depends on whether the product is used for speculative versus hedging purposes. In this study, derivatives contracts are categorized as being used for speculative purposes. As a result, changes in the value of the derivatives contract are recorded as a gain or loss in the period at which the changes occur. Fourth, in order to mark－to－model derivatives for which a lack of market prices makes mark－to－market methods impossible, several inputs are needed. Although most inputs are objectively observable, certain inputs, such as stock price volatility, may require some degree of discretion. In cases where the impact on company financial statements is important, there is a need to disclose important inputs in footnotes in order to enhance the verifiability of the reported figures. This case study also shows the necessity of this kind of information.

Keywords

• accounting for derivatives
• equity swap
• synthetic forward
• option
• corporate ownership

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