Exam 9: Futures, Options and Interest Rate Swaps

On January 1, 2020, a company borrowed $1 million of variable rate debt at an annual rate equal to the Treasury bill rate plus 50 bp, interest paid semiannually on June 30 and December 31 of each year. The variable rate is reset every six months. To hedge against increasing interest rates, the company entered a receive variable/pay fixed interest rate swap, agreeing to pay a 2.4% fixed rate on a notional amount of $1 million. The swap qualifies as a cash flow hedge of the variable payments. The present value of the expected future net swap payments was $6,000. The treasury bill rate was 1.5% on January 1, 2020. On June 30, the treasury bill rate is 1.6% and the swap has a fair value of $2,300. On December 31, 2020, the treasury bill rate is 1.7% and the swap has a present value of $600. Required Prepare the journal entries to record the events for the year 2020. The company has a December 31 year-end, and income effects of the debt and the swap are reported in interest expense.

A company with fixed rate debt swaps the fixed interest payments on the loans for variable payments. The company's adjusting entries to report the impact of an interest rate decline will include:

On January 1, 2021, a company has a loan of $1,000,000 on which it pays a 2% fixed rate annually on December 31. On January 1, 2021, the company enters an interest rate swap whereby it receives the 2% fixed rate and pays the prime rate + 90 bp. At the inception of the swap, the prime rate is 1.3%. 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 increased, and the change in the value of the swap and the debt is each $4,000. Prepare the journal entry or entries to record this information.

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 amount is reported for the investment in securities at December 31, 2020?

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. -What is the change in the intrinsic value of the cap in 2021?

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. -What is total cost of goods sold for the year?

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. -What is the change in the time value of the cap in 2020?

A company with a June 30 year-end invests in bonds, paying $1,000,000 face value on February 1, 2020. On April 1, 2020, the bonds are selling for 98. To guard against a decline in the value of the bonds, the company purchases put options on the bonds with a strike price of 100, expiring in 6 months. The puts cost $2.15 per $100 in bonds. When the company's books are closed on June 30, 2020, the bonds are selling for 95 and the puts are selling for $5.08. All income effects of the securities and the options are reported in financial gains (losses). Required Prepare the journal entries to record the above events on February 1, April 1 and adjusting entries at June 30, 2020, assuming the investment in bonds is classified as: a. Available-for-sale b. Trading c. Held-to-maturity

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. -Total interest expense for 2020 is

Which item below is reported differently using U.S. GAAP versus IFRS?

On January 1, 2021, Fresh Foods issues $5,000,000 in 3-month 2% notes. Fresh Foods wants to hedge against higher interest rates when it renews its notes on April 1, so on January 1, 2021, the company sells short $5,000,000 in Treasury bill futures, due in 3 months, at 98.5. The futures are a qualified cash flow hedge of the forecasted renewal of the notes. There is no margin deposit. The market interest rate increases to 2.8% on April 1, 2021, Fresh Foods closes out its futures position at 97.7 and issues new notes at 2.8%. Required a. Compute the gain or loss on the futures contract for the 3-month period beginning January 1, 2021. b. On April 1, Fresh Foods closes its position and settles with the broker. Prepare the journal entry to record this transaction. c. Prepare the journal entry to report Fresh Foods' interest expense for the 3-month period beginning April 1, 2021 and compute its effective interest rate on the notes for that period.

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. -What is the carrying value of the inventory as of March 25?

A company enters a receive variable/pay fixed interest rate swap, and the market interest rate increases. Which of the following statements is true from the company's perspective?

On June 1, a company holds an inventory of a commodity that it expects to sell in two months. It paid $600,000 for the inventory, and the company carries it at cost. To hedge the price risk on this inventory, the company takes a short futures position in the commodity, for delivery on August 1, paying a margin deposit of $400. The company's accounting year ends December 31, and the futures qualify as a fair value hedge of the commodity inventory. The company closes its futures position on August 1 and sells the inventory on August 2 for $585,000. All income effects are reported in cost of goods sold. Spot and futures values for the commodity are: Spot Price Futures Price for August 1 Delivery June 1 \ 590,000 \ 591,000 August 1 585,000 585,000 Required a. How much cash will the company receive or pay on August 1, when it closes its futures position? b. Prepare the entries to record the above events. c. What is the company's gross margin? What was the expected gross margin on June 1? Were the futures effective? Explain.

A U.S. company issues a purchase order for £1,000,000 in merchandise, to be delivered in 60 days and paid for in 90 days. The current spot rate is $1.32/£ and the 90-day forward rate is $1.33/£. The company purchases 90-day call options on £1,000,000 with a strike price of $1.32/£, paying $0.02/£ for the call options. The options qualify as a fair value hedge of the firm commitment to buy currency. After 60 days, the spot rate is $1.34, the 30-day forward rate is $1.342, and the calls are worth $0.033. The company takes delivery of the merchandise. Thirty days later, the spot rate is $1.36, and the calls are worth their intrinsic value of $0.04. The company uses the options to pay for the merchandise. All income effects of these transactions are reported in cost of goods sold. Required Prepare the journal entries to record the above events.

A company with an investment in equity securities hedges this position by investing in short futures on the stock. This hedging relationship will generally have some effect on income, even though the terms match exactly, because:

Use the following information to answer bellow Questions A company has $1,000,000 in variable rate debt, with interest due on December 31 of each year. Interest is set at the Treasury bill rate plus 1.2%. The principal of the loan is due December 31, 2021. On January 1, 2020, the company enters a two-year receive variable/pay fixed interest rate swap, at a fixed rate of 2.2%. The swap is settled at the end of each year. The Treasury bill rate for 2020 is 0.8%, and it is 0.7% in 2021. The company records the swap at the expected future receipts/payments, equal to the receipt/payment for the current year, discounted at the variable rate. The swap qualifies as a cash flow hedge of the variable interest payments, and income effects of the debt and the swap are reported in interest expense. -At the end of 2020, the company adjusts the swap to its current value. The effect on other comprehensive income is a

Use the following information to answer bellow Questions In 2020, a U.S. company issued a purchase order to a Singapore supplier for merchandise priced at S$1,000,000. At the time of the purchase order, the spot and relevant forward rate for Singapore dollars was $0.76. The company paid $3,000 for call options locking in the cost of S$1,000,000 at $760,000. The investment is a fair value hedge of the firm commitment to purchase the currency. All income effects of the purchase and the hedge are reported in cost of goods sold. At the end of the year, the spot rate was $0.80/S$, the relevant forward rate was $0.81/S$, and the call options had a market value of $41,000. In 2021, the options came due. The spot rate was $0.83/S$, and the company sold the options at their intrinsic value of $70,000. The company then took delivery of the merchandise and paid the supplier with Singapore dollars purchased on the spot market. -At what value is the investment in options reported on the company's 2020 balance sheet?

A company has a receive variable/pay fixed interest rate swap that qualifies as an effective hedge of its variable rate debt. When it enters the swap agreement, it records the swap investment at what amount?

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. -How much cash will the company receive upon closing the futures contract?