Case $11-2$ Value at Risk: What Are Our Options?

The scene is a conference room on the $10$th floor of an office building on Wall Street, occupied by Anthes Enterprises, a small, rapidly growing manufacturer of electronic trading systems for equities, commodities, and currencies.

The agenda for the $8$:$00$ A$.$M$.$ meeting concerns reporting issues associated with a potential sales contract for the stock exchange in the Slovak Republic, which wants to upgrade its technology to effectively participate in the globalization of financial markets. In attendance are Anthes Enterprise$$s COO Shevon Estwick, Controller Sy Jones, Treasurer, Bebi Karimbaksh, and Vice President of Marketing Autherine Allison.

SHEVON: Thank you for agreeing to meet on such short notice. Autherine, are you ready to give us an update on Slovakia?

AUTHERINE: You mean the Slovak Republic.

SHEVON: Yes.

AUTHERINE: I think there is a $90$ percent chance we$$ll land the con$-$ tract. Things move a little slowly over there and they$$re still concerned about some of the legal details of our sales contract. I think they find the legalese a bit intimidating and I can$$t say I blame them. I$$ve scheduled another trip next month to go over contract details. This time I$$m taking our legal counsel and have asked him to prepare another draft expressed in terms that are easier to understand. They$$re also waiting for approvals from their Central Bank, which has to approve major transactions such as this one.

SHEVON: Good. Are we prepared to deliver on the contract?

AUTHERINE: Yes, we$$ve lined up the financing; have done our credit checks, and the equipment and installation teams are ready to proceed on two weeks$$ notice.

SHEVON: Given the size of the contract, are we hedged against the possibility of a devaluation?

BEBI: Yes, we$$ve written a put option on the koruna for $90$ days.

SHEVON: Do we think we$$ll close on the deal before then?

BEBI: Autherine doesn$$t think so$,$ but you never know. The problem is no one will write an option for a longer term. We$$ll renew the option as we have other transactions of this extended duration.

SHEVON: Sy$,$ are we all right on the reporting front?

SY: Not really.

SHEVON: How$$s that?

SY: It looks like we$$re up against a reporting standard that requires that gains or losses on cash flow hedges whose maturities do not match that of the underlying be recognized in current earnings.

SHEVON: Come again?

SY: The bottom line is that we won$$t be able to treat gains or losses on our put options as a part of comprehensive income, but we$$ll have to recognize them in current earnings.

SHEVON: Won$$t that mess up our bottom line?

SY: I$$m afraid so$.$ There would be no offsetting gain or loss from our anticipated sale.

BEBI: It$$s taken me a whole year to get to know the right people and win their trust and friendship. I now have that. There$$s no doubt in my mind that this sale is a done deal and I anticipate closing the transaction within the next six to nine months.

SY: That may be$,$ but we just can$$t find anyone who$$s willing to write an option for more than $90$ days at a time.

SHEVON: I don$$t want to think about what the accounting will do to our stock price! I mean, we$$re about to float our first Euro$-$equity issue. A lower offering price would be disastrous at this stage of our development, not to mention the effect on our shareholders.

AUTHERINE: Given the nature of our business, I don$$t think the transactions side of our business will change much.

SHEVON: Do you think it would be worthwhile having a consultant advice us on this one?

SY$,$ AUTHERINE, AND BEBI $($IN UNISON$)$

Why not?

SHEVON: When you do$,$ would you show that individual the following pages that I ripped out from annual report I just received as a share$-$ holder and see if it has any information value? $($see attachment$)$

Required

As a consultant for Anthes Enterprises, identify what you believe are promising hedge accounting options.