is the underlying asset Derivative financial instruments can either be on the balance sheet or off the balance sheet and include options contract, interest rate swaps, interest rate flows, interest rate collars, forward contracts, futures etc. A derivative instrument is therefore a financial instrument or other contract with the following three characteristics: (i) It has one or more underlying and one or more notional amounts or payments provisions or both. These terms determine the amount of settlement or settlements and in some cases, whether or not settlement is required; (ii) It requires no initial net investment or an initial net investment that is smaller than what is required for similar responses to changes in market factors. (iii) Its terms require or permit net settlement; it can readily be settled net by means outside the contract or it provides for delivery of an asset that puts the recipient in a position not substantially different from net settlement. Accounting for foreign exchange derivatives is guided by AS 11 (Revised 2003). The ICAI has also issued a Guidance Note dealing with the accounting procedures to be adopted while accounting for Equity Index Options and Equity Stock Options. (b) Currency Options give the client the right, but not the obligation, to buy/sell a specific amount of currency at a specific price on a specific date. Currency options provide a tool for hedging foreign exchange risk arising out of the firm's operations. Currency options enable the business house to remove downside risk without limiting the upride potential. Options can be put option or call option. A put option is a contract that specifies the currency that the holder has the right to sell. A call option is a contract that specifies the currency that the holder has the right to buy. (c) Interest rate swap can be defined as a financial contract between two parties (called counter parties) to exchange on a particular date in the future, one series of cash flows (fixed interest) for another series of cash flows (variable or floating interest) in the same currency on the same principal (an agreed amount called notional principal) for an agreed period of time. The contract will specify the interest rates, the benchmark rate to be followed, the notional principal amount for he transaction, etc. Interest rates are of two types, fixed interest rates and floating rates which vary according to changes in a standard benchmark interest rate. An investor holding a security which pays a floating interest rate is exposed to interest rate risk. The investor can manage this risk by entering into an interest rate swap. 2. On 24th January, 2009 Chinnaswamy of Chennai sold goods to Watson of Washington, U.S.A. for an invoice price of $40,000 when the spot market rate was Rs.44.20 per US $. Payment was to be received after three months on 24th April, 2009. To mitigate the risk of loss from decline in the exchange rate on the date of receipt of payment, Chinnnaswamy immediately acquired a forward contract to sell on 24th April, 2009 US $ 40,000 @ Rs. 43.70. Chinnaswamy closed his books of n29 account on 31st March, 2009 when the spou ale was Rs. 43.20 per US $. On 24th April, 2009, the date of receipt of money by Chinnaswamy, the spot rate was Rs. 42.70 per US $. Pass journal entries in the books of Chinnaswamy to record the effect of all the above mentioned effects