Prepare a schedule to determine the earnings effect of various hedging relationships. During the third quarter of
Question:
a. Call Option A €”This option was purchased on July 10 and provided for the purchase of 10,000 units of commodity A in October at a strike price of $45 per unit. The company designated the option as a hedge of a commitment to sell 10,000 units of commodity A in October at a fixed price of $45 per unit. Information regarding the option and commodity A is as follows:
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b. Call Option B €”This option provided for the purchase of 10,000 units of commodity B in October at a strike price of $30 per unit. The company designated the option as a hedge of a forecasted purchase of commodity B in October. Information regarding the option and commodity B is as follows:
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c. Put Option C €”This option provided for the sale of 10,000 units of commodity C in September at a strike price of $30 per unit. The company designated the option as a hedge of a forecasted sale of 10,000 units of commodity C on September 10. Information regarding the option and commodity C is as follows:
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The company settled the option on September 10 and sold 10,000 units of commodity C at the spot price. The manufacturing cost of the units sold was $20 per unit.
d. Futures Contract D €”The contract calls for the sale of 10,000 units of commodity D in October at a future price of $10 per unit. The company designated the contract as a hedge on a forecasted sale of commodity D in October. Information regarding the contract and commodity D is as follows:
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e. Interest Rate Swap €”The Company has a 12-month note receivable with a face value of $10,000,000 that matures on June 30 of next year. The note calls for interest to be paid at the end of each month based on the LIBOR variable interest rate at the beginning of each month. On July 31, the company entered into an agreement to receive a 7% fixed rate of interest beginning in August in exchange for payment of a variable rate based on LIBOR.
The reset date is at the beginning of each month, and net settlement occurs at the end of each month. LIBOR rates and swap values are as follows:
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In all of the above cases, the change in the time value of the derivative instrument is excluded from the assessment of hedge effectiveness. Furthermore, the company assesses hedge effectiveness on a continuing basis. Such an assessment at the end of June concluded that call option B was not effective.
Required
Prepare a schedule to reflect the effect on current earnings of the above hedging relationships. The schedule should show relevant amounts for each month from July through September.
In finance, the strike price of an option is the fixed price at which the owner of the option can buy, or sell, the underlying security or commodity. Face Value
Face value is a financial term used to describe the nominal or dollar value of a security, as stated by its issuer. For stocks, the face value is the original cost of the stock, as listed on the certificate. For bonds, it is the amount paid to the...
Step by Step Answer:
July August September Total a Call Option A Unrealized gain loss on commitment 10000 45 46 10000 10000 10000 45 44 10000 10000 10000 45 4650 15000 15000 Less previously recognized gain loss 10000 10000 Net unrealized gain loss 10000 20000 25000 15000 Unrealized gain loss on hedge 10000 10000 15000 15000 Change in time value excluded from effectiveness Time value of 2000 at beg vs 2400 at end 400 400 Time value of 2400 at beg vs 1000 at end 1400 1400 Time value of 1000 at beg vs 1000 at end Net gain loss 400 8600 10000 1000 b Call Option B hedge not effectivedoes not qualify for special hedge accounting Unrealized gain loss on option 900 1100 200 200 600 900 300 300 200 600 400 400 Net gain loss 200 300 400 900 July August September Total c Put Option C Sales revenue 287500 287500 Cost of sales 200000 200000 Adjustment to cost of salesIntrinsic value at July 1 of 0 versus intrinsic value at 910 of 12500 10000 30 2875 12500 12500 Gross profit on sales 100000 100000 Change in time value excluded from effectiveness Time value of 500 at beg vs 600 at end 100 100 Time value of 600 at beg vs 200 at end 400 400 Time value of 200 at beg vs 100 at end 100 100 Net gain loss 100 400 99900 99600 d Futures Contract D Change in time value excluded from effectiveness 994 995 vs 990 992 10000 100 ...View the full answer
Advanced Accounting
ISBN: 978-0538480284
11th edition
Authors: Paul M. Fischer, William J. Tayler, Rita H. Cheng
