The financial statements of MNE Corporation revealed the following:

Required

1. Why does MNE Corporation use foreign exchange derivatives? What is the likely form of these derivatives?
2. What is the “notional amount” of a derivative?
3. How are the gains/losses on MNE’s foreign exchange derivatives accounted for?

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The Company operates internationally and is exposed to fluctuations in currency values. The fluctuations can increase the costs of financing and operating the business. The Company manages this risk to acceptable limits through the use of derivatives to create offsetting positions in foreign currency markets. The Company views derivative financial instruments as risk management tools and is not party to any leveraged derivatives. The notional amounts of derivative contracts do not represent the amounts exchanged by the parties, and thus are not a measure of the exposure of the Company through its use of derivatives. The amounts exchanged by the parties are normally based on the notional amounts and other terms of the derivatives, which relate to exchange rates. The value of derivatives is derived from those underlying parameters and changes in the relevant rates. At December 31, 2014, the Company had $154 million notional principal amount of outstand- ing currency swap contracts to hedge its foreign net assets, which were terminated in 2015. Foreign currency commitment and transaction exposures are managed at the operating unit level as an integral part of the business and residual exposures that cannot be offset to an insignificant amount are hedged. Hedged items include foreign currency denominated receiv- ables and payables on the balance sheet, firm purchase orders, and firm sales commitments. At December 31, the Company had the following amounts related to foreign exchange contracts hedging foreign currency transaction and firm commitments: ($ millions) Notional amount Buy contracts.. 2015 2014 $1,685 1,115 $1,749 587 Sell contracts. Gains and losses explicitly deferred as a result of hedging firm commitment Gains deferred.. Losses deferred. $ 24 $ 34 (39) (34) $ (15) $ 0