Problem 1
Hedge with forward contract a commitment and subsequent transaction.
Kaiser Exporters buys used medical equipment and sells it to various foreign health care institutions. On June 15, the company committed to sell medical equipment to a foreign hospital for 800,000 FC. The equipment, with a cost of $325,000, was shipped to the customer on August 15 with terms FOB shipping point and payment due on October 15. At the time of the commitment, Kaiser acquired a forward contract to sell 800,000 FC in 120 days. Selected spot and forward rates are as follows:
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June 15
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June 30
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August 15
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September 30
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Spot rate
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$0.500
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$0.485
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$0.480
|
$0.470
|
|
Forward rate
|
0.510
|
0.490
|
0.475
|
0.468
|
The relevant discount rate is 6% and changes in the value of the firm commitment are measured as changes in the forward rate over time. Assume that the hedge is accounted for as a fair value hedge and that the time value of the hedge is included in the assessment of effectiveness.
Required
Assuming that financial statements are prepared for the second and third quarters, identify all relevant income statement and balance sheet accounts for the above transactions and determine the appropriate quarterly balances.
Problem 2
Cash flow hedges of a commitment, a forecasted transaction and a recognized liability.
On March 1, a company committed to acquire 10,000 units of inventory to be delivered on May 31. The purchase price is to be paid in foreign currency (FC) in the amount of 200,000 FC. Assume that the commitment's negative values are $7,960 and $14,000 as of March 31 and May 31, respectively. Also assume that the inventory will be processed further during the month of June at a cost of $12.50 per unit and will be sold on July 10 to a customer for $90 per unit. On March 1, the company also forecasted the purchase of a piece of equipment to be delivered on May 31 with a cost of 200,000 FC. The equipment was placed into service at the beginning of July and has a useful life of 10 years and a salvage value of $74,000. On March 1, the company borrowed 200,000 FC from a foreign bank at an interest rate of 6.0% with interest and principal to be repaid on May 31.
Assume that on March 1 the company acquired three identical options to buy FC on May 31 with each option to be designated as a hedge for each of the three situations described above. Information relating to each option is as follows:
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For each option
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March 1
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March 31
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May 31
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Notional amount
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200,000
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200,000
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200,000
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|
Strike price
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$ 2.52
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$ 2.52
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$ 2.52
|
|
Spot price
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$ 2.50
|
$ 2.54
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$ 2.57
|
|
Value of option
|
$ 1,300
|
$ 5,000
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$ 10,000
|
Required
For each of the three hedged situations, prepare a schedule to show the impact on earnings for each of the first three calendar quarters of the year noting that all hedges are to be considered cash flow hedges.