Exam 9: Futures, Options and Interest Rate Swaps

A company has a firm commitment to roll over a variable rate loan every 90 days. It hedges its interest rate risk by selling 90-day Treasury bills at a fixed price, for delivery in 90 days. The hedge is determined to be effective. Which statement is true?

A company expects to sell 1,000,000 lbs. of a commodity in 90 days. To guard against potential declines in the price of this commodity, the company sells 1,000,000 lbs. of the commodity for delivery in 90 days at $4.00/lb., paying a margin deposit of $8,000 on the futures contract. The hedge qualifies as a hedge of the forecasted sale. At the company's year-end, 30 days later, the 60-day futures price is $4.02/lb. and the company pays cash to the broker to maintain its investment account at $8,000. 60 days later, the futures price converges to the spot price of $3.97/lb. and the company closes out its short futures position. The company sells 1,000,000 lbs. of the commodity on the spot market. All income effects of the commodity sale and the hedge are reported in sales revenue. Required Prepare the journal entries necessary to record the above events, including year-end adjusting entries.

A company has a receive fixed/pay variable interest rate swap that qualifies as an effective hedge of its fixed rate debt. If interest rates rise:

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

A company carries inventory at a cost of $400,000. When the inventory has a market value of $405,000, the company takes a short position in futures, at a price of $405,500. The futures position is a fair value hedge of the inventory. By the end of the year, the market price of the inventory is $404,000 and the futures price is $404,900. The company still holds the short position. The inventory is reported on the balance sheet at what amount?

On November 1, 2020, ABC Products forecasts that it will purchase 1,000,000 bushels of oats in 4 months for use in the manufacture of its cereal products. To hedge against rising costs, ABC Products buys 1,000,000 March 2021 call options for oats, with a strike price of $2.75/bushel. The options cost $0.10/bushel, and the spot price on November 1 is $2.72/bushel. Management designates the intrinsic value of the options as the hedge, and the options qualify as a cash flow hedge of the forecasted purchase. ABC Products records all income effects of the inventory and the hedge in cost of goods sold. On December 31, 2020, ABC Products' year-end, the spot price for oats is $2.77/bushel and the options are selling for $0.13/bushel. On March 1, 2021, the spot price for oats is $2.80/bushel and ABC Products sells the options for their intrinsic value of $0.05/bushel. On March 3, 2021, ABC Products purchases 1,000,000 bushels of oats at the spot price of $2.81/bushel. It sells products containing the oats on June 5, 2021. Required Prepare entries to record the above events, including the December 31, 2020 adjusting entry. Assume ABC Products reports the change in option time value directly in income.

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 time value of the options on December 31, 2020?

A company has investments in debt securities classified as available-for-sale. The January 1, 2020 balance sheet carries these investments, originally purchased at a cost of $3,700,000, at $3,750,000. To protect against anticipated declines in the value of these investments, the company takes a short position in stock index futures, at a price of $3,745,000, that are highly correlated with the value of its investments. The futures qualify as a fair value hedge of the securities investment. No margin deposit is required. When the books are closed on December 31, 2020, the market value of the investments is $3,730,000, and the company closes out its short position at the futures price of $3,727,000. Required a. Prepare the entry to record closing the futures, and the adjusting entry required at December 31, 2020. The company records all income effects in financial gains (losses). b. At what amount will the AFS investments appear on the company's December 31, 2020 balance sheet? c. The company sells the AFS investments on January 5, 2021 for $3,728,000. Prepare the journal entry to record the sale. d. What is the total net gain (loss) on holding the securities and the hedge? How much of this gain (loss) is reported in 2020? In 2021?

On October 1, 2020, Pilgrim Foods, a U.S. company, issued a purchase order to a Danish company for kr1,000,000 in merchandise, to be delivered in 4 months. Pilgrim will pay the supplier in Danish krone. On October 1, the spot rate was $0.165/kr and the 4-month forward rate was $0.168/kr. Pilgrim invests in call options on kr1,000,000 at a strike price of $0.165/kr, costing $0.005/kr. Pilgrim designates the intrinsic value of the calls as a fair value hedge of a firm commitment. On December 31, 2020, Pilgrim's year-end, the spot rate is $0.171/kr, the 1-month forward rate is $0.173/kr and the options sell for $0.009/kr. On February 1, 2021, the spot rate is $0.175/kr. Pilgrim takes delivery of the merchandise, sells the options at their intrinsic value of $0.010/kr, and pays the Danish supplier by buying kr1,000,000 in the spot market. Required Prepare entries to record the above events, including the December 31, 2020 adjusting entries. Pilgrim records all income effects of inventory and related hedges in cost of goods sold.

On January 1, a company issues $1,000,000 in 3-month 3% notes and plans to reissue the notes in 3 months at the prevailing market interest rate. To hedge against rising interest rates, the company sells short $1,000,000 in Treasury bill futures, due in 3 months, at 97.5. The futures are a qualified cash flow hedge of the forecasted renewal of the notes. There is no margin deposit. The market interest rate for the company's level of risk declines to 2.8% on April 1, the company 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. 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 and compute its effective interest rate on the notes for that period.

A company has variable rate debt. It swaps the variable payments for fixed payments. If interest rates increase during the year:

The difference between futures and spot rates is called

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 change in the value of the loan

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 income effect from the inventory and the hedge over the two years?

If a derivative does not qualify for hedge accounting:

Use the following information to answer bellow Questions A company carries an inventory of corn at cost, $500,000. The inventory has a fair value of $525,000. The company hedges the inventory's value by selling commodity futures for delivery in 60 days for $525,000. There is no margin deposit. In 30 days, at the firm's year end, the futures price for delivery in 30 days is $530,000 and the inventory's fair value increased to $532,000. -If the firm closes its futures position at year-end, how much does it receive from/pay to the broker?

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 sales revenue?

Use the following information to answer bellow Questions A company carries an inventory of corn at cost, $500,000. The inventory has a fair value of $525,000. The company hedges the inventory's value by selling commodity futures for delivery in 60 days for $525,000. There is no margin deposit. In 30 days, at the firm's year end, the futures price for delivery in 30 days is $530,000 and the inventory's fair value increased to $532,000. -Assuming the futures are qualified hedges of the inventory, at what value does the firm report its corn inventory at year-end?

A company hedges its purchases of oats, expected to occur in 3 months, using oat futures expiring in 3 months. Which statement is true concerning value changes in the oat futures?

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. -The company sold the inventory for $850,000 in 2021. By what amount is 2021 income increased by the inventory sale and the hedge?