Exam 22: Derivatives and Related Accounting Issues

The notional amount of a derivative instrument is

On January 1, 20X3, Shuey Company borrowed $1,000,000 at the fixed rate of 10% for 10 years with interest payable semi-annually.Shuey anticipates that interest rates will fall and has also arranged to receive a 10% rate of interest in exchange for the payment of variable rates based on LIBOR + 1.5%.LIBOR rates were as follows on the reset dates: ? LIBOR rate FV of swap January 1,203 8.5\% July 1,203 8.3\% \ 40,000 January 1,204 8.2\% \ 38,000 How much interest expense is recognized for the six months ended December 31, 20X3?

Which of the following is true about options?

The total value of a derivative is determined by the

If both increases and decreases in the value of a recognized asset or liability are recognized in current earnings according to existing accounting principles, special hedge accounting is necessary.

An advantage of a fair value hedge is that:

All of the following are examples of cash flow hedges except:

Forward contracts are contracts to buy or sell a specified amount of an asset at a specified, fixed price with delivery at a specified future point in time.Which of the following is true about these contracts?

On August 1st of the current year, Lenz Company writes a contract agreeing to sell to Hindman Company 15,000 British pounds at a specific price of $0.69 per pound with delivery in 60 days.Throughout the 60-day period the forward rate varies as follows: ? 60 days remaining on the contract \ 0.69 30 days remaining on the contract \ 0.68 0 days remaining on the contract \ 0.675 The spot rate at the end of 60 days is $0.675.Assume an 8% discount rate for both Lenz Company and Hindman Company.For the second thirty day period, Hindman would recognize a:

On March 1, 20X1, Adler Company issued a 5 year, $150,000 note at 7% fixed interest, payable semiannually on August 31st and February 28th.Based on the economic conditions on March 1, 20X3, Adler Company believes the interest rate will decline over the next few years.As a result Adler Company enters into an interest rate swap where it agrees to pay the LIBOR of 6.75% for the first 6 months.At the end of each 6-month period the variable rate will be reset to the current LIBOR.The LIBOR on September 1, 20X3 is 7.75%. ? Required: ? a.For August 31, 20X3 and February 28, 20X4, determine the net interest expense.? ? b.Identify the type of hedge.

Clark Company holds several options: ? Spot Price Strike Price Call option on Ionics \ 29.80 \ 27.90 Call option on Kimberly 60.41 64.84 Put option on Motorola 14.25 16.40 Put option on Nortek 32.10 32.10 The intrinsic value of Clark Company's options is

The FASB requires entities that hold or issue derivative instruments that are designated and qualify as hedging instruments to disclose information that allows users to understand in the case of both fair value and cash flow hedges, how the derivative instruments and the related hedged items affect the reporting entity's financial position, financial performance and cash flows.

The FASB requires entities that hold or issue derivative instruments that are designated and qualify as hedging instruments to disclose information that allows users to understand in the case of both fair value and cash flow hedges, how the derivative instruments and the related hedged items are accounted for.

Pearson Industries uses platinum in its manufacturing process.The company will need 1,500 troy ounces of platinum for a production run in June.The company is concerned that platinum prices will rise over the next several months.On May 14, in order to hedge against rising prices, Pearson Industries purchases 30 June call options on platinum.Each option is for 50 troy ounces and has a strike price of $477 per troy ounce.The company excludes changes in the time value of the options from hedge effectiveness.Spot prices and option value per troy ounce of platinum are as follows: ? ? May 14 May 31 June 8 Spot price \ 479 \ 486 \ 492 Option value per oz. 9.60 14.38 16.34 On June 8, the company settled the options and on June 9 purchased 3,250 troy ounces of platinum on account for $493 per ounce.The platinum was used in the production process through the end of September.Platinum used during June was 325 troy ounces.Assume that the hedge satisfies all necessary criteria for special hedge accounting. ? Required: ? Prepare all journal entries necessary to account for the above transactions and events.

An option

Jenson Company buys 20 contracts on the Chicago Board of Trade to receive October delivery of soybeans to a certified warehouse.Each contract is in units of 3,000 bushels at a futures price of $2.75 per bushel.The owner of the contract requires a margin account with an initial margin of $8,000, with a maintenance margin of $6,000.What entry will Jenson Company make to establish the margin account?

Paton Company has an $11,000,000, note payable outstanding with a variable rate equal to LIBOR of 8.4% which matures on June 30, 20X3.The variable rates are reset each 6 months for the following 6-month period.The company believes that interest rates have bottomed, and they will begin to rise.At the end of June 20X1, Paton Company negotiated an interest rate swap with York National Bank of Bellingham that would allow Paton to pay a fixed rate of 7.75% in exchange for receiving interest based on the LIBOR.The swap is effective July 1, 20X1.The settlement date for the swap coincides with the company's interest payment dates. ? The criteria for special accounting have been satisfied, and the hedging relationship has been properly documented.Management of Paton Company has concluded that the hedge will be highly effective.Paton Company's fiscal year end is June 30.The LIBOR and swap values are as follows: ? ? LIBOR Swap Value June 30,201 8.40\% December 31,201 8.55\% \ 19,300 June 30,202 8.10\% (8,010) Required: ? Present the journal entries to record the above events from December 31, 20X1 through June 30, 20X2. ?

Identify the various types of information that should be included in disclosures regarding derivative instruments and hedging.

The difference between the strike price of an option and spot price of the item being hedge at any one time represents the option's:

North Shore Railroad operates between Chicago and upper Michigan and Wisconsin.Dallas Ingold, purchasing manager of North Shore Railroad, anticipates the price of diesel fuel will increase over the next few months.On September 4th, Ingold purchased an out-of-the-money November call option for $1,100.The option has a notional amount of 80,000 barrels and a strike price of $2.16 per barrel.Diesel fuel spot rates and option values at selected dates follow: ? ? Spot Rate Option Date per Barrel Value September 30 \ 2.17 \ 1,130 October 31 2.13 1,026 November 27 2.19 2,400 a.For each of the above dates, calculate the intrinsic value and the time value of the option.? ? b.If the price of diesel fuel remained below $2.16 per barrel through November, calculate the effect on earnings traceable to the hedge.