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680 Chapter 13 10. In which of the following instances would the holder of the instrument recognizes gain when the market rate or price increases? a. Futures contract where the holder is in the short position. b. Forward contract to sell foreign currency units C. "Receive fixed, pay variable" interest rate swap d. "Receive variable, pay fixed" interest rate swap PROBLEM 3: EXERCISES 1. On December 1, 20x1, Stair Box Co. enters into a 45-day forward contract to buy 1,000 kilograms of coffee beans at a forward price of P250 per kilogram. The market prices in the subsequent periods are as follows: December 31, 20x1........... .P285 January 15, 20x2.. .......1 245 Requirements: Provide the journal entries under each of the following scenarios: (a) the contract is settled by the actual purchase of the commodity, i.e., inventory; and (b) the contract is settled through net cash payment. 2. On December 15, 20x1, Star Glass Co. entered into a 30-day forward contract to buy 10,000 yens at the forward rate of P1.50. On December 31, 20x1, the forward rate was P1.25 and by January 15, 20x2, the spot rate moved to P1.60. Requirements: Provide the journal entries under each of the following scenarios: (a) the contract is settled by the actual purchase of yens; and (b) the contract is settled through net cash payment. 3. On December 1, 20x1, View Co. enters into a futures contract to sell 100,000 foreign currency units on January 31, 20x2 for P100 per unit. The broker requires an initial margin deposit of P10,000. The current rates are as follows:Basic Derivatives 681 Dec. 1, 20x1 Dec. 31, 20x1 100 Jan. 31, 20x2 98 103 Requirement: Provide the journal entries. 4. Brook Co. purchased a put option contract on March 1, 20x1 when Back Yard Co. shares were trading at P180 per share. Brook paid P720 for the option. The option contract gives Brook the right to sell 1,000 shares of Back Yard Co. at P180 per share. The option expires on July 1, 20x1. Mar. 1, 20x1 June 30, 20x1 Spot prices P180 P120 Time value of option 720 180 Requirements: Provide the journal entries. Assume net settlement of the contract. 5. Kelley Co. purchased a put option on Flynn common shares on July 7, 2004, for $170. The put option is for 200 shares and the strike price is $50. The option expires on January 31, 2005. The following data are available with respect to the put option: Date Market Price of Flynn Shares Time Value of Put Option September 30, 2004 $54 per share $88 December 31, 2004 $52 per share 35 January 31, 2005 $55 per share 0 (Adapted) Requirements: Prepare the journal entries. 6. On January 1, 2002, Eden Ventures, Inc., obtained a three-year, $1 million loan with interest payments due at the end of each year and the principal to be repaid on December 31, 2004. The interest rate for the first year is the prevailing market rate of 9 percent, and the rate each succeeding year will be equal to the682 Chapter 13 prevailing market rate on January 1 of that year. Eden also entered into an interest rate swap agreement related to this loan. Under the terms of the swap agreement, in the years 2003 and 2004, Eden will receive a swap payment based on the principal amount of $1 million. If the January 1 interest rate is greater than 9 percent, Eden will receive a swap payment for the difference; and if the January 1 interest rate is less than 9 percent, Eden will make a swap payment for the difference. The swap payments are made on December 31 of each year. On January 1, 2003, the interest rate is 8 percent, and on January 1, 2004, the interest rate is 12 percent. Requirement: Make the journal entries for the interest rate swap on Eden's books at the dates shown below (assume the interest rate swap is not designated as a hedging instrument; ignore the hedged item, i.e., the loan). For purposes of estimating future swap payments, assume that the current interest rate is the best forecast of the future interest rate (round all entries to the nearest dollar). 1) January 1, 2002 2) December 31, 2002 3) December 31, 2003 4) December 31, 2004 (Adapted) 7. Hay Co. enters into a "receive fixed, pay variable" interest rate swap on July 1, 20x1 for a notional amount of P3,000,000. The set rate is 12%, equal to the current rate on July 1, 20x1. Cash settlement is due on July 1, 20x3. Information on market rates follows: July 1, 20x1.....12% July 1, 20x2.. ..9% July 1, 20x3.. Requirements: a. How much is the derivative asset (liability) to be presented in Hay's June 30, 20x2 statement of financial position? b. Provide the entry on settlement date.ACTIVITY 2 PROBLEM 4: MULTIPLE CHOICE - COMPUTATIONAL 1. On Jan. 1, 20x1, Lights Co. forecasted the purchase of 1,000 units of a raw material. The expected date of purchase is on April 15, 20x1. Lights Co. expects the prices to fluctuate. Thus, on Jan. 1, 20x1, Lights Co. enters into a forward contract to purchase 1,000 units of the raw material at a forward rate of P600 per unit. If the market price on April 15, 20x1 is more than P600, Lights Co. shall receive the difference from the broker, whereas if the market price is less than P600, Lights Co. shall pay the difference. The forward contract will be settled net on April 15, 20x1. The discount rate is 10%. If the price of the raw material is P550 per unit on Mar. 31, 20x1, how much is the derivative asset (liability) to be recognized in Lights Co.'s first quarter financial statements? a. 50,000 b. (50,000) c. 45,455 d. (45,455) Use the following information for the next two questions: On Nov. 2, 20x1, Binbin Co. enters into a 90-day forward contract with a bank to purchase $100,000 at a set-price of P50 per dollar. The forward rate on Dec. 31, 20x1 is P52, while the spot exchange rate on Jan. 31, 20x2, settlement date, is P49. 2. What amount of derivative asset (liability) is reported in Binbin's Dec. 31, 20x1 statement of financial position? a. 200,000 b. (200,000) c. 100,000 d. (100,000) 3. How much is the gain (loss) recognized on Jan. 31, 20x2? a. 100,000 b. (100,000) c. 300,000 d. (300,000)684 Chapter 13 4. On March 1, 20x1, Banana Co. entered into a forward contract to sell 20,000 units of a commodity at a forward price of P50 per unit. The contract will be settled net on April 30, 20x1. The market prices were P65 per unit on March 31, 20x1 and P40 per unit on April 30, 20x1. What amount of gain (loss) is recognized on April 30, 20x1? a. 500,000 b. (500,000) c. 100,000 d. (100,000) 5. On Nov. 2, 20x1, Sta. Ana Co. entered into a forward contract to sell 20,000 units of a specified commodity at a forward price of P45 per unit. The contract is due on Feb. 2, 20x2. The current prices were P47 on Dec. 31, 20x1 and P44 on Feb. 2, 20x2. What amount of derivative asset (liability) is recognized on Dec. 31, 20x1 and how much is the net cash receipt (payment) on Feb. 2, 20x2? a. 40,000; 20,000 c. (40,000); 20,000 b. 40,000; (20,000) d. (40,000); (20,000) 6. On December 15, 20x1, Scaffolding Co. enters into a 30-day forward contract to sell 1,000,000 yens at the forward rate of P1.20. On December 31, 20x1, the forward rate was P1.25 and by January 15, 20x2, the spot rate moved to P1.27. How much is the total gain (loss) recognized on the forward contract? a. 70,000 b. (70,000) c. 30,000 d. (30,000) 7. Bitter Coffee Co. expects the value of the euro to decrease in the next 30 days. Accordingly, on December 15, 20x1, Bitter enters into a 30-day forward contract to sell 100,000 euros at the forward rate of P60.00. On December 31, 20x1, Bitter reported a derivative liability of P200,000. The forward rate on December 31, 20x1 must have been a. P58.00. b. P47.00. c. P62.00. d. P84.00. 8. Rome Co. enters into a futures contract to sell 10,000 units of a foreign currency for P100 per unit. The broker requires anBasic Derivatives 685 initial margin deposit of P20,000. The quoted prices per unit are as follows: Dec. 1, 20x1 Dec. 31, 20x1 100 Jan. 31, 20x2 98 97 On settlement date, how much cash did Rome Co. receive from or paid to the broker? a. 30,000 receipt c. 50,000 receipt b. 30,000 payment d. 50,000 payment 9. Ma'am Erl Co. acquired the following futures contracts for a specific commodity on Jan. 1, 20x1: Notional Futures price Market price figure - 1/1/x1 - 12/31/x1 5. "Long" futures contract 2,800 200 180 6. "Short" futures contract 1,300 230 220 How much is the net derivative asset (liability) on Dec. 31, 20x1? a. 43,000 b. (43,000) c. 69,000 d. (69,000) 10. Mingming Co. paid a premium of P15,000 for a call option on 10,000 units of a foreign currency at a strike price of P500 per unit. The subsequent market prices were P499 at the reporting date and P498 at exercise date. On expiration date, Mingming Co. recognizes a a. 20,000 gain. c. 10,000 gain. b. 5,000 loss. d. 10,000 loss. 11. On June 18, Edwards Corporation entered into a firm commitment to purchase specialized equipment from the Okazaki Trading Company for 180,000,000 on August 20. The exchange rate on June 18 is V100 = $1. To reduce the exchange rate risk that could increase the cost of the equipment in U.S. dollars, Edwards pays $12,000 for a call option contract. This contract gives Edwards the option to purchase V80,000,000 at an exchange rate of V100 = $1 on August 20. On August 20, the686 Chapter 13 exchange rate is 193 = $1. How much did Edwards save by purchasing the call option? a. $12,000 b. $48,215 c. $60,215 d. Edwards would have been better off not to have purchased the call option. (Adapted) 12. On March 1, Chow Corporation entered into a firm commitment to purchase specialized equipment from the Gifu Trading Company for V80,000,000 on June 1. The exchange rate on March 1 is V100 = $1. To reduce the exchange rate risk that could increase the cost of the equipment in U.S. dollars, Chow pays $20,000 for a call option contract. This contract gives Chow the option to purchase V80,000,000 at an exchange rate of V100 = $1 on June 1. On June 1, the exchange rate is V105 = $1. How much did Chow save by purchasing the call option (answers rounded to the nearest dollar)? a. $20,000 b. $27,619 C. $47,619 d. Chow would have been better off not to have purchased the call option. (Adapted) Use the following information for the next three questions: On January 1, 2002, Cougar Company received a two-year $500,000 loan. The loan calls for payments to be made at the end of each year based on the prevailing market rate at January 1 of each year. The interest rate at January 1, 2002, was 10 percent. Aggie Company also has a two-year $500,000 loan, but Aggie's loan carries a fixed interest rate of 10 percent. Cougar Company does not want to bear the risk that interest rates may increase in year two of the loan. Aggie Company believes that rates may decrease and it would prefer to have a variable debt. So the two companies enter into an interest rate swap agreement whereby Aggie agrees