Definition Components of a nominal amount
A component of a nominal amount is a specified part of the amount of an item. This could be a proportion of an entire item (such as, EUR 60 million of a fixed rate loan of EUR 100 million) or a layer component (for example, the bottom EUR 60 million of a EUR 100 million fixed rate loan). Components of a nominal amount
Nominal components are frequently used in risk management activities in practice. Examples include: Components of a nominal amount
- Part of a monetary transaction volume, e.g., the first USD1 million cash flows from sales to customers in a given period
- Part of a physical volume, e.g., the 50 tonnes bottom layer of coal inventory in a particular location
- A part of a physical or other transaction volume, e.g., the sale of the first 15,000 units of widgets during January 2015
- A layer from the nominal amount of the hedged item, e.g., the top layer of a CHF100 million fixed rate debt that can be prepaid at fair value
Hedging layers of a group Components of a nominal amount
IFRS 9 allows a layer of a group to be designated as the hedged item. A layer component can be specified from a defined, but open, population or from a defined nominal amount. Examples include:
- A part of a monetary transaction volume (such as the next CU10 cash flows from sales denominated in a foreign currency after the first CU 20 in March 201X);
- A part of a physical or other transaction volume (such as the first 100 barrels of the oil purchases in June 201X, or the first 100 MWh of electricity sales in June 201X); or
- A layer of the nominal amount of the hedged item (such as the last CU 80 million of a CU 100 million firm commitment, or the bottom layer of CU 20 million of a CU 100 million fixed rate bond, where the defined nominal amount is CU100 million).
If a layer component is designated in a fair value hedge, an entity must specify it from a defined nominal amount. To comply with the requirements for qualifying fair value hedges, an entity must remeasure the hedged item for fair value changes attributable to the hedged risk. The fair value adjustment must be recognised in P&L no later than when the item is derecognised. Therefore, it is necessary to track the item to which the fair value hedge adjustment relates. Entities are required to track the nominal amount from which the layer is defined in order to track the designated layer (for example, the total defined amount of CU 100 million sales must be tracked in order to track the bottom layer of CU 20 million sales or the top layer of CU 30 million sales).
A layer of a contract that includes a prepayment option (if the fair value of the prepayment option is affected by changes in the hedged risk) is only eligible as a hedged item in a fair value hedge if the layer includes the effect of the prepayment option when determining the change in fair value of the hedged item. In this situation, if an entity hedges with a hedging instrument that does not have option features that mirror the layer’s prepayment option, hedge ineffectiveness would arise.