Question:
On 1st September, 2011, Jensen Company gets an order to sell a machine to a customer in Canada at a price of 100,000 Canadian dollars. Jensen shipped the machine and gets payment on 1st March, 2012. On September 1, 2011, Jensen purchased a put option providing it the right to sell 100,000 Canadian dollars on March 1, 2012, at a price of $80,000. Jensen appropriately designated the option as a fair value hedge of the Canadian dollar firm commitment. The option cost $2,000 and had a fair value of $2,300 on Jensen Company's incremental borrowing rate is 12%. The present value factor for two months at an annual interest rate of 12% (1 percent per month) is 0.9803.
1. Evaluate the net impact on Jensen Company's 2011 income as a consequence of this fair value hedge of a firm commitment?
a. $-0-.
b. $300 increase in income.
c. $680.30 decrease in income.
d. $980.30 increase in income.
2. Evaluate the net impact on Jensen Company's 2012 income as a result of this fair value hedge of a firm commitment?
a. $-0-.
b. $1,319.70 decrease in income.
c. $77,980.30 increase in income.
d. $78,680.30 increase in income.
3. What was the total increase or decrease in cash flow from having purchased the foreign currency choice to hedge this exposure to foreign exchange risk?
a. $-0-.
b. $1,000 increase in cash flow.
c. $1,500 decrease in cash flow.
d. $3,000 increase in cash flow.
4. On 1st August, Jackson Corporation (a U.S.-based importer) placed an order to buy merchandise from a foreign supplier at a price of 200,000 rupees. Jackson can get and make payment for the products in three months on 31st October. On August 1, Jackson entered into a forward contract to purchase 200,000 rupees in three months at a forward rate of $0.30. It appropriately designates the forward contract as a fair value hedge of a foreign currency firm commitment. The fair value of the firm commitment is calculated by referring to changes in the forward rate. Relevant exchange rates for the rupee are as given:
Forward Rate
Date Spot Rate (to October 31)
August 1 $0.300 $0.300
September 30 0.305 0.325
October 31 0.320 N/A
Jackson's incremental borrowing rate is 12 %. The existing value factor for one month at an annual interest rate of 12%(1 percent per month) is 0.9901. Jackson has to close its books and purpose its third-quarter financial statements on September 30.
a. Purpose journal entries for the forward contract and firm commitment.
b. Evaluate the impact on net income over the two accounting periods?
c. Evaluate net cash outflow results from the purchase of merchandise from the foreign customer?