Question

1. Lawrence Company ordered parts costing FC100,000 from a foreign supplier on May 12 when the spot rate was $0.20 per FC. A one-month forward contract was signed on that date to purchase FC100,000 at a forward rate of $0.21. The forward contract is properly designated as a fair value hedge of the FC100,000 firm commitment. On June 12, when the company receives the parts, the spot rate is $0.23.
At what amount should Lawrence Company carry the parts inventory on its books?
a. $20,000.
b. $21,000.
c. $22,000.
d. $23,000.


Use the following information for Problem 2.
MNC Corp. (a U.S.-based company) sold parts to a South Korean customer on December 1, 2011, with payment of 10 million South Korean won to be received on March 31, 2012. The following exchange rates apply:

.:.
MNC’s incremental borrowing rate is 12 percent. The present value factor for three months at an annual interest rate of 12 percent (1 percent per month) is 0.9706.

2. Assuming that MNC did not enter into a forward contract, how much foreign exchange gain or loss should it report on its 2011 income statement with regard to this transaction?
a. $5,000 gain.
b. $3,000 gain.
c. $2,000 loss.
d. $1,000 loss.



3. Palmer Corporation, operating as a U.S. corporation, expects to order goods from a foreign supplier at a price of 200,000 pounds, with delivery and payment to be made on April 15. On January 15, Palmer purchased a three-month call option on 200,000 pounds and designated this option as a cash flow hedge of a forecasted foreign currency transaction. The option has a strike price of $0.25 per pound and costs $2,000. The spot rate for pounds is $0.25 on January 15 and $0.22 on April 15.
What amount will Palmer Corporation report as an option expense in net income during the period January 15 to April 15?
a. $600.
b. $1,000.
c. $2,000.
d. $4,400.

Use the following information for Problem 4.
On September 1, 2011, Jensen Company received an order to sell a machine to a customer in Canada at a price of 100,000 Canadian dollars. Jensen shipped the machine and received payment on March 1, 2012. On September 1, 2011, Jensen purchased a put option giving it the right to sell 100,000 Canadian dollars on March 1, 2012, at a price of $80,000. Jensen properly designated the option as a fair value hedge of the Canadian dollar firm commitment. The option cost $2,000 and had a fair value of $2,300 on December 31, 2011. The fair value of the firm commitment was measured by referring to changes in the spot rate. The following spot exchange rates apply:
Date ....... U.S. Dollar per Canadian Dollar
September 1, 2011 ............. $0.80
December 31, 2011 .............. 0.79
March 1, 2012 ............... 0.77
Jensen Company’s incremental borrowing rate is 12 percent. The present value factor for two months at an annual interest rate of 12 percent (1 percent per month) is 0.9803.

4. What was the net impact on Jensen Company’s 2011 income as a result of this fair value hedge of a firm commitment?
a. $–0–.
b. $680.30 decrease in income.
c. $300 increase in income.
d. $980.30 increase in income.


5. What was the net increase or decrease in cash flow from having purchased the foreign currency option to hedge this exposure to foreign exchange risk?
a. $–0–.
b. $1,000 increase in cash flow.
c. $1,500 decrease in cash flow.
d. $3,000 increase in cash flow.

Use the following information for Problems 6 and 7.
On March 1, 2011, Werner Corp. received an order for parts from a Mexican customer at a price of 500,000 Mexican pesos with a delivery date of April 30, 2011. On March 1, when the U.S. dollar–Mexican peso spot rate is $0.115, Werner Corp. entered into a two-month forward contract to sell 500,000 pesos at a forward rate of $0.12 per peso. It designates the forward contract as a fair value hedge of the firm commitment to receive pesos, and the fair value of the firm commitment is measured by referring to changes in the peso forward rate. Werner delivers the parts and receives payment on April 30, 2011, when the peso spot rate is $0.118. On March 31, 2011, the Mexican peso spot rate is $0.123, and the forward contract has a fair value of $1,250.

6. What is the net impact on Werner’s net income for the quarter ended June 30, 2011, as a result of this forward contract hedge of a firm commitment?
a. $–0–.
b. $59,000 increase in net income.
c. $60,000 increase in net income.
d. $61,500 increase in net income.

7. What is the net increase or decrease in cash flow from having entered into this forward contract hedge?
a. $–0–.
b. $1,000 increase in cash flow.
c. $1,500 decrease in cash flow.
d. $2,500 increase in cash flow.

Use the following information for Problem 8.
On November 1, 2011, Dos Santos Company forecasts the purchase of raw materials from a Brazilian supplier on February 1, 2012, at a price of 200,000 Brazilian reals. On November 1, 2011, Dos Santos pays $1,500 for a three-month call option on 200,000 reals with a strike price of $0.40 per real. Dos Santos properly designates the option as a cash flow hedge of a forecasted foreign currency transaction. On December 31, 2011, the option has a fair value of $1,100. The following spot exchange rates apply:

Date . U.S. Dollar per Brazilian Real
November 1, 2011 ..... $0.40
December 31, 2011 ..... 0.38
February 1, 2012 ...... 0.41

8. What is the net impact on Dos Santos Company’s 2012 net income as a result of this hedge of a forecasted foreign currency transaction? Assume that the raw materials are consumed and become a part of the cost of goods sold in 2012.
a. $80,000 decrease in net income.
b. $80,600 decease in net income.
c. $81,100 decrease in net income.
d. $83,100 decrease in net income.




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