Exam 9: Futures, Options and Interest Rate Swaps

A company uses options to hedge its forecasted purchase of merchandise. If the options qualify as a cash flow hedge of the forecasted purchase, and analysis of hedge effectiveness excludes option time value, which statement is true concerning reporting for changes in the value of the options?

Bluewave Foods holds $1,000,000 par value of Gallo Company bonds, classified as available-for-sale. The bonds were purchased at par on October 2, 2020. They are currently reported at cost and have a market value of 99.2 on December 1, 2020. To protect against further declines in value, on December 1, 2020, Bluewave purchased for $4,500 3-month put options at an exercise price of 99.6. The puts qualify as a fair value hedge of the bond investment. Bluewave designates the intrinsic value of the puts as the hedge instrument and reports all income effects of the investment and its hedge in nonoperating gains (losses). On December 31, 2020, Bluewave's year-end, the bonds are selling for 99.1, and the options are selling for $5,200. On March 1, 2021 Bluewave sells the bonds for their current value of 98.9 and sells the put options for their intrinsic value of $7,000. Required Prepare the journal entries to record the events above, including December 31, 2020 year-end adjustments.

Use the following information to answer bellow questions A U.S. company expects to sell £100,000 in merchandise to a customer in the U.K. in 3 months. To protect against a strengthening U.S. dollar, on November 1 the company pays $3,000 for January put options on £100,000, with a strike price of $1.40/£. The current spot rate is $1.38/£. The intrinsic value of the options is designated as a cash flow hedge of the forecasted sale, and changes in time value are reported in income. Income effects of the sale and the options are reported in sales revenue. On December 31, the company's year-end, the spot rate is $1.375/£ and the options have a market value of $3,200. On January 31, the spot rate is $1.35/£, and the company sells the options for their intrinsic value. The company delivers the merchandise, receives payment in pounds sterling, and converts the currency to U.S. dollars at the spot rate. The company's year-end is December 31. -When the options are adjusted to their December 31 market value, what is the effect on other comprehensive income?

Use the following information to answer bellow questions On January 1, a company holds an inventory of a commodity carried at a cost of $100,000. The commodity's current market value is $110,000. To guard against a potential decline in the value of that inventory, the company purchases put options with a total strike price of $110,000 exercisable in 3 months, paying a total of $500 for the options. The puts qualify as a fair value hedge of the inventory. All income effects of the inventory and the hedge are reported in cost of goods sold. On March 25, the commodity's market price is $108,000 and the company closes the hedge by selling the put options for $2,200. The company sells its inventory later in the year. The company has a December 31 year-end. -How is cost of goods sold affected by the sale of the options on March 25?

Use the following information to answer questions bellow. On February 1, 2020, a company holds an inventory of a commodity carried at a cost of $2,000,000. The commodity's current market value is $2,100,000. To guard against a potential decline in the value of that inventory, the company purchases put options with a total strike price of $2,100,000 exercisable in 2 months, paying a total of $5,000 for the options. The puts qualify as a fair value hedge of the inventory. All income effects of the inventory and the hedge are reported in cost of goods sold. On March 15, 2021, the commodity's market price is $1,980,000 and the company closes the hedge by selling the put options for $122,000. The company sells its inventory later in the year for $2,000,000. The company has a December 31 year-end. -Required Prepare the journal entries to record the following events: a. Purchase of the puts b. Closing of the hedge, including related adjusting entries c. Sale of the inventory, assuming a perpetual inventory system

Use the following information to answer bellow Questions A jewelry manufacturer anticipates purchasing 1,000 ounces of gold in 90 days. To hedge against increases in the price of gold, it purchases 1,000 ounces of gold futures for delivery in 90 days at $1,350 per ounce, also the current market price. The futures investment qualifies as a cash flow hedge of the forecasted purchase. The company makes a $20,000 margin deposit. In 90 days, the market price of gold is $1,400; the company closes out its futures position and purchases the gold several days later for $1,395 per ounce. A few months later, the company sells jewelry products containing the gold. -Prior to its sale, at what amount will the purchased gold inventory be carried on the company's books?

Use the following information to answer bellow questions A firm carries a commodity inventory at a cost of $750,000 and plans to sell it in 60 days. Its market value is currently $800,000. To hedge against a decline in value of the commodity, the company sells commodity futures for delivery in 60 days at a price of $800,000. There is no margin deposit. At the company's 2020 year-end, 30 days later, the 30-day futures price is $780,000 and the inventory value declined to $779,000. Income effects of the inventory and the futures are reported in cost of goods sold. -What is the net effect of value changes in the futures and the inventory on cost of goods sold?

IFRS 9 requires that changes in the value of hedges of equity investments reported at FV-OCI be reported:

Use the following information to answer bellow Questions. On January 1, 2020, Teller Corporation borrows $1 million for three years at the prime rate plus 1.5%, with the rate adjusted annually. The interest is due December 31 of each year. The prime rate is currently 0.5%. To hedge against rising interest rates, Teller buys a three-year, 2% interest rate cap for $5,000, paid in full immediately. Teller's loan was renewed December 31, 2020, when the prime rate was 0.7%, and the fair value of the cap declines by $800. By the end of 2021, the cap's value increases by $300. The cap qualifies as a hedge of the future variable interest payment, and all income effects of the loan and the cap are reported in interest expense. -When Teller is reimbursed in 2021 by the cap writer, what account is credited?

A company holds inventory carried at cost, $100,000. The inventory has a current market value of $105,000. To hedge against possible declines in the value of the inventory, the company pays $200 for put options with a strike price of $105,000. The options qualify as a fair value hedge of the inventory. All income effects of the inventory and the hedge are reported in cost of goods sold. Before the options expire, the company sells the inventory for $104,000, and sells the put options for $1,120. Required a. Prepare the journal entries to record the above events. b. Calculate the change in intrinsic value and the change in time value of the options during the time the company holds the options. c. Does the change in option value allow the company to maintain the $5,000 gross margin expected at the time the company buys the options? Explain why or why not.

Use the following information to answer bellow questions Continue with the information used for questions . Thirty days after year-end, it is now 2021 and the market value of the inventory is $785,000. The company closes the futures contract and sells the inventory on the spot market for $785,000. -What is the net cash inflow from the inventory and the hedge over the two years, assuming the inventory was purchased during this period?

Use the following information to answer bellow questions A U.S. company expects to sell £100,000 in merchandise to a customer in the U.K. in 3 months. To protect against a strengthening U.S. dollar, on November 1 the company pays $3,000 for January put options on £100,000, with a strike price of $1.40/£. The current spot rate is $1.38/£. The intrinsic value of the options is designated as a cash flow hedge of the forecasted sale, and changes in time value are reported in income. Income effects of the sale and the options are reported in sales revenue. On December 31, the company's year-end, the spot rate is $1.375/£ and the options have a market value of $3,200. On January 31, the spot rate is $1.35/£, and the company sells the options for their intrinsic value. The company delivers the merchandise, receives payment in pounds sterling, and converts the currency to U.S. dollars at the spot rate. The company's year-end is December 31. -What amount is reported as sales revenue on January 31?

Use the following information to answer bellow Questions. A company bought debt securities, classified as available-for-sale, on August 1, 2020 for $105,000. On November 15, 2020, the market value of the securities is $100,000, and the company buys put options for $500, locking in the selling price of the securities at $100,000. The options qualify as a fair value hedge of the securities. All income effects of the securities and the hedge are reported in financial gains (losses). At December 31, 2020, the reporting year-end, the market value of the securities is $98,000, and the options have a fair value of $2,600. On March 1, 2021, when the market value of the securities is $95,000, the company sells the options for $5,400, and also sells the securities. -What is the net effect on the company's 2021 financial gain (loss) of the securities and the hedge?

On January 1, 2021, a company has a loan of $1,000,000 on which it pays a 3% fixed rate annually on December 31. On January 1, 2021, the company enters an interest rate swap whereby it receives the 3% fixed rate and pays the prime rate + 100 bp. At the inception of the swap, the prime rate is 1.8%. The swap qualifies as a fair value hedge of the fixed payments. The company's accounting year ends December 31, and all income effects of the loan and the swap are reported in interest expense. Required a. Prepare the journal entry to record the company's interest expense for 2021 and the net cash payment from the swap. b. On December 31, 2021, the prime rate has declined, and the change in the value of the swap and the debt is each $10,000. Prepare the journal entry or entries to record this information.

Use the following information to answer Questions bellow A company has $1,000,000 in 2.8% fixed rate debt, with interest due on December 31 of each year. On January 1 it swaps its fixed interest payments for variable payments at the Treasury bill rate plus 0.7%. The current Treasury bill rate is 1.9%. The swap qualifies as a fair value hedge of the fixed payments. The company's accounting year ends December 31, and all income effects of the loan and the swap are reported in interest expense. On December 31, the Treasury bill rate has increased to 2.2%, increasing the variable payments on the swap for the following year. The swap value and the loan value each change by $80,000. -The company reports interest expense for the current year in the amount of

On January 1, a company receives a purchase order from a customer for 1,000,000 lbs. of a commodity, to be delivered in 90 days at the spot rate prevailing on the delivery date. The company sells 1,000,000 lbs. of commodity futures at a price of $3/lb. for delivery in 90 days, as a hedge of the sale proceeds, and pays a margin deposit of $30,000. The futures qualify as a fair value hedge of the sales commitment, and income effects of the sale and the futures are reported in sales revenue. On April 1, the company settles the futures contract and delivers the commodity to the customer at the current spot rate of $2.92/lb. Required Prepare the journal entries to record the events of January 1 and April 1. The company's accounting year ends December 31.

A company expects to purchase 1,000,000 lbs. of a commodity in 30 days for resale to customers. To guard against potential increases in the cost of this commodity, the company purchases 1,000,000 lbs. of the commodity for delivery in 30 days at $2.75/lb., paying a margin deposit of $2,000 on the futures contract. The hedge qualifies as a hedge of the forecasted purchase. After 30 days, the futures price converges to the spot price of $2.80/lb. and the company closes out its long futures position. The company purchases 1,000,000 lbs. of the commodity on the spot market and subsequently sells the commodity to a customer for $2.82/lb. All income effects of the commodity inventory and the hedge are reported in cost of goods sold. Required Prepare the journal entries necessary to record the above events.

Use the following information to answer questions bellow. A company obtains a $1,000,000 variable rate loan on January 1, 2021, at a 2.1% interest rate. The loan is renewable every 3 months, and the interest rate is reset at each renewal. The company hedges against rising interest rates by taking a short futures position in $1,000,000 of 3-month Treasury bills at 99. There is no margin deposit, and the hedge qualifies as a fair value hedge of a firm liability commitment. At the end of 3 months, the Treasury bills sell for 98.2 and the loan renews at 2.9%. The company closes the futures contract and renews the loan. All income effects of the loan and the futures are reported in interest expense. -At what amount will interest expense be reported for the new loan?

U.S. GAAP requires disclosure of the impact of hedges on income, classified in these categories:

A company has $1,000,000 in variable rate debt, at a current rate of 2.5%. The rate is reset annually, and interest is due at the time the rate is reset for the following year. For the current year, the company swaps its variable payments for fixed payments of 2.3%. At the end of the current year, the company makes the variable rate payment of $25,000. For the net receipt/payment of $2,000 on the swap, the company