Exam 9: Futures, Options and Interest Rate Swaps

On December 1, 2020, a calendar-year company owns 10,000 lbs. of a commodity carried at a cost of $200,000, that it expects to sell on January 31, 2021 in the normal course of business. The company hedges its price risk on this commodity by selling commodity futures for delivery on January 31, 2021. The position requires a $2,000 margin deposit. The company closes its futures position on January 31, 2021 and sells the commodity to a customer for cash at the spot rate. Spot and futures prices/lb. for the commodity are: Spot Price Futures Price for January 31, 2021 Delivery December 1,2020 \ 21.00 \ 21.05 December 31, 2020 20.25 20.35 January 31, 2021 19.90 19.90 Required Prepare the journal entries to record the above events, including adjusting entries at December 31. The futures qualify as a fair value hedge of the commodity inventory, and all income effects are reported in cost of goods sold.

On July 1, 2020, a company borrows $1,000,000 at a variable rate of prime plus 2.5%, to be renewed every three months. Interest is payable upon renewal. Prime is 0.8% on July 1. The company hedges against increases in interest rates by selling short $1,000,000 face value of three-month Treasury bill (interest rate) futures at 99.2. The margin deposit is $500. The futures qualify as a fair value hedge of the firm commitment to roll over the loan. On October 1, prime is 1.3% and the futures price is 98.7. The company closes out its futures position and rolls over the loan as agreed. The company has a June 30 fiscal year-end and reports all income effects of the loan and the futures in interest expense. Required a. What rate does the company pay on the notes during the 3-month period beginning July 1? b. Prepare the entries necessary on July 1 to record the futures position, and October 1, when the short position is closed out and the loan is rolled over. c. Prepare the journal entry to record interest expense for the three months starting October 1. What is the effective annual interest rate during this period? d. In hindsight, should the company have invested in the futures contract? Explain.

A company has a soybean inventory carried at cost, $800,000. The market value of the inventory is currently $810,000. The company hedges against a decline in the market value of the inventory by taking a short position in soybeans, locking in a 60-day futures price of $810,000. The position requires a margin deposit of $10,000, and the hedge qualifies as a fair value hedge of the soybean inventory. Fifty days later, the market value of the inventory is $812,000, the 10-day futures price is $811,800, the company closes its short position and sells its soybean inventory. All events occur within the company's accounting year and income effects are reported in cost of goods sold. Required Make the required journal entries to record the above events.

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 does the company report the inventory acquired in 2021?

A company sells $1,000,000 face value interest rate futures (120-day Treasury bills) at 91, as an effective hedge of its firm commitment to roll over its variable rate debt in 120 days. The interest rate futures increase in value to 92.5. How is this reported by the company?

A company has fixed rate debt. It swaps the fixed payments for variable payments. If the company uses hedge accounting for the swap, how does the accounting differ from normal accounting?

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. -On January 1, 2020, the company records the swap agreement as a(n)

Jasper Jellies purchases debt securities on December 1, 2020 at a par value of $1,000,000, classified as available-for-sale. To protect their value, on December 1, 2020, Jasper pays $10,000 for put options on the securities with a $1,000,000 strike price, expiring on March 1, 2021, and designates their intrinsic value as the hedge instrument. Jasper closes its books on December 31. On March 1, 2021, Jasper exercises the options and delivers the securities to the option writer. All income effects of the securities and the put options are reported in the financial gains (losses) account. Relevant market prices for the securities and the put options are as follows: December 1, 2020 December 31, 2020 March 1,2021 Securities \ 1,000,000 \ 980,000 \ 975,000 Put options \ 10,000 \ 22,000 \ 25,000 Required a. Prepare the appropriate entries on December 1 to record purchase of the securities and options and on December 31 to adjust the accounts. b. What is the intrinsic value of the put options on December 1 and December 31? c. Make the appropriate entries on March 1 to adjust the accounts, exercise the put options and deliver the securities to the option writer. d. The options increased in value by $15,000 during this period, and the securities declined in value by $25,000. Were the options an effective hedge? Explain.

A company has a $1,000,000 loan with a variable interest rate, due December 31, 2021. The interest rate is set at the beginning of each year and interest is paid at year-end. On January 1, 2020, when the variable rate is 2.5%, Organic Farms enters a swap agreement whereby it pays a fixed rate of 2.8% and receives the variable rate required to pay interest on the loan. The swap qualifies as a cash flow hedge of the variable payments. On December 31, 2020, the variable rate is reset to 2.6%. The company has a December 31, year-end and all income effects of the loan and the swap are reported in interest expense. Required Prepare journal entries to record the swap liability at January 1, 2020, and all entries required at December 31, 2020 and 2021. The company records the swap liability at the present value of future expected net payments, discounted at the variable rate.

A company has fixed rate debt and enters a receive fixed/pay variable swap. Interest expense equals:

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. -Now assume the company sells the inventory for $1,980,000 immediately after selling the put options. Required a. Calculate the gross margin on the sale of the commodity under each of these conditions: i. The company did not hedge with the put options. ii. The company did hedge with the put options. b. Compare the gross margin achieved while hedging with the expected gross margin as of February 1, 2020. Is the expected gross margin maintained using the hedge? Explain any discrepancy.

On January 1, 2021, a company issued $5,000,000 in variable rate debt at the prime rate + 60 bp with interest payments due every six months. The variable rate is adjusted every six months. The prime rate is 1.7% on January 1, so the variable debt has an interest rate of 2.3% for the first six months of 2021. On January 1, the company enters into an interest rate swap in which it receives the variable rate and pays a fixed rate of 3% on the notional amount of $1,000,000 for the life of the debt. On June 30, 2021, the prime rate is 1.2% and the market value of the swap declines by $10,000. Required a. How much in interest expense will the company record for the first six months of 2021, after considering the effects of the swap? b. Is the swap a cash flow hedge or a fair value hedge? Explain. c. Where is the change in value of the swap reported?

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 net amount is the new loan initially reported on the company's balance sheet?

Which situation below accurately describes an instance of "hedge accounting"?

A company uses futures to hedge a forecasted purchase of inventory. Which statement is true concerning the hedge?

A company uses futures to hedge its inventory. Which statement is true concerning the hedge?

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 2020 financial gain (loss) of the securities and the hedge?

A U.S. company expects to purchase €1,000,000 in merchandise from an Italian supplier in 4 months. To protect against a weakening U.S. dollar, on June 1 the company pays $11,000 for September call options on €1,000,000, with a strike price of $1.23/€. The current spot rate is $1.22/€. The intrinsic value of the options is designated as a cash flow hedge of the forecasted purchase, and changes in time value are reported in income. Income effects of the purchase and the hedge are reported in the company's cost of goods sold. On September 30, the company takes delivery of the merchandise, sells the options for their intrinsic value, and pays the supplier by buying €1,000,000 on the spot market. The September 30 spot rate is $1.26/€. On October 25, the company sells the merchandise and records cost of goods sold. The company's accounting year ends December 31. Required Prepare the journal entries for the above transactions, including recognition of cost of goods sold on the sale of the merchandise.

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. -What is the net impact on the company's 2020 income?

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's net cash flow on the swap for the current year is