Question: On September 1, Year 1, Keefer Company received an order to sell a machine to a customer in Canada at a price of 100,000 Canadian dollars. The machine was shipped and payment was received on March 1, Year 2. On September 1, Year 1, Keefer Company purchased a put option giving it the right to sell 100,000 Canadian dollars on March 1, Year 2, at a price of $75,000. Keefer Company properly designates the option as a fair value hedge of the Canadian-dollar firm commitment. The option cost $1,700 and had a fair value of $2,800 on December 31, Year 1. The fair value of the firm commitment is measured through reference to changes in the spot rate. The following spot exchange rates apply:
Date U.S. Dollar Per Canadian Dollar
September 1, Year 1 ...................................... $0.75
December 31, Year 1 ......................................... 0.73
March 30, Year 2 ........................................ 0.71
Keefer Company's incremental borrowing rate is 12 percent. The present value factor for two months at an annual interest rate of 12 percent (1 percent per month) is 0.9803.
What was the net increase or decrease in cash flow from having purchased the foreign currency option to hedge this exposure to foreign exchange risk?
a. $0.
b. A $1,000 increase in cash flow.
c. A $1,700 decrease in cash flow.
d. A $2,300 increase in cash flow.