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Define the type of hedge that Spartan would need to designate

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Spartan Casino;On January 1, 2009, Spartan Casino (Spartan or the ?Company?) executed a $250 million;revolving credit facility with Uber Bank AG (Uber). The rate of interest on the credit;facility is USD LIBOR + 650 basis points (bps) for the first two years. Spartan has a;choice of 1M-, 3M-, and 6M-USD LIBOR each time it draws down on the credit facility.;Interest payments on the borrowing are settled on the basis of the LIBOR tenor selected;(e.g., if Spartan selects three-month USD LIBOR as the referenced rate, interest is due;every three months on that borrowing). Principal borrowed is typically due five years;from the drawdown date, but each drawdown will contain a specified maturity date.;Upon finalizing the terms of the credit facility, Spartan immediately drew down $50;million on January 1, 2009, at 3M-USD-LIBOR + 650 bps, due on December 31, 2013.;Spartan?s interest rate risk management policy requires that at least 75 percent of its;outstanding debt be fixed rate (either directly or indirectly through the use of derivatives).;In order to maintain compliance with its policy, Spartan entered into an interest rate swap;to ?convert? the borrowing from variable to fixed interest.;The Company designated the interest rate swap as a hedge of forecasted interested;payments associated with changes in 3M-USD-LIBOR on the first previously unhedged;$50 million of 3M-USD-LIBOR based debt. The Company has no other debt.;Specifically, Spartan executed the following interest rate swap transaction;Interest Rate Swap 1;? Notional amount: $50 million;? Trade date: January 1, 2009;? Effective date: January 1, 2009;? Maturity date: December 31, 2013;? Pay leg: 8.0 percent;? Receive leg: 3M-USD-LIBOR + 650 bps;? Initial LIBOR: 1.00 percent;? Payment dates: Each March 31, June 30, September 30, and December 31;? Variable reset dates: Quarterly, each March 31, June 30, September 30, and;December 31;Six months later, on July 1, 2009, Spartan needed to again raise capital to continue;construction on its new City Focus hotel and high-end retail development. The Company;borrowed another $75 million at 3M-USD-LIBOR + 650 bps, due on June 30, 2014.;Similar to the first drawdown, Spartan executed a second interest rate swap with the;following terms;Interest Rate Swap 2;? Notional amount: $75 million;? Trade date: July 1, 2009;? Effective date: July 1, 2009;? Maturity date: June 30, 2014;? Pay leg: 8.5 percent;? Receive leg: 3M-USD-LIBOR + 650 bps;? Initial LIBOR: 1.25 percent;? Payment dates: Each September 30, December 31, March 31, and June 30;? Variable reset dates: Quarterly, each September 30, December 31, March 31;and June 30;Spartan designated this interest rate swap as a hedge of forecasted interested payments;associated with changes in 3M-USD-LIBOR on the first previously unhedged $75;million of 3M-USD-LIBOR based debt.;After two years, Spartan continues to pay interest on the $125 million borrowings on;time, in addition to settling the interest rate swap each quarter. However, on December;31, 2010, Spartan decides to pay $25 million of the $125 million it has borrowed from;Uber to date. The debt is prepayable without penalty. The Company makes no other;changes to its capital structure of derivatives.;Required;1. Define the type of hedge that Spartan would need to designate. In other words, are;these cash flow hedges, fair value hedges, or net investment hedges?;2. Identify the criteria that Spartan would need to meet and document to ensure the;interest rate swaps achieve hedge accounting that is based on the provisions of ASC;815, Derivatives and Hedging Activities.;3. Determine the appropriate journal entries to account for the two hedging relationships;for the year ended December 31, 2009. Use the details below to aid in entry;determination, and assume that both hedging relationships are perfectly effective.;Date;3M-USD-LIBOR;Swap 1;Fair Value*;Swap 2;Fair Value*;March 31, 2009 1.00% (reset 12/31) $250,000 n/a;June 30, 2009 1.10% (reset 03/31) $750,000 n/a;September 30, 2009 1.25% (reset 06/30) $1,200,000 $900,000;December 31, 2009 1.18% (reset 09/30) $1,100,000 $775,000;* Note that the fair values are after the quarterly settlements are made.;4. Briefly describe the implications of Spartan paying down $25 million of the $125;million total borrowing on the two hedging relationships.

 

Paper#24614 | Written in 18-Jul-2015

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