Interest rate, foreign currency exchange rate, commodity prices and stock prices are common types of prices and rate risks that companies hedge.. The current rate for foreign currency tr
Trang 1Chapter 12
Derivatives and Foreign Currency: Concepts and Common Transactions
Answers to Questions
1 Derivative is the name given to a broad range of financial securities Their common characteristic is that
the derivative contract’s value to the investor is directly related to fluctuations in price, rate, or some other variable that underlies it Interest rate, foreign currency exchange rate, commodity prices and stock prices are common types of prices and rate risks that companies hedge
2 A Forward is negotiated directly with a counterparty, while a future is a standard contract traded on an
exchange The exchange traded instrument has less risk of non-performance, and is commonly cheaper to transact But standard contracts might not fit all companies’ needs The forward carries the risk of
counterparty default, but each contract can be tailored to exact needs
3 An option gives the holder the right to buy or sell the underlying at a set price The writer of an option has
the obligation to either buy or sell Options are often traded on exchanges and have low transaction costs Because an option is an agreement on a single transaction, they are not helpful in managing the risk of a stream of future transactions A swap is an agreement to exchange a series of future cash flows These are often negotiated, but there are some standardized exchange-traded swaps
4 Net settlement means the instrument can be settled in cash for the net value The parties in a net settlement
do not have to buy or sell physical products and then realize the cash flows Only one payment needs to be made, either from the holder or the writer of the instrument
5 A transaction is measured in a particular currency if its magnitude is expressed in that currency Assets and
liabilities are denominated in a currency if their amounts are fixed in terms of that currency
6 Direct quotation: 1.20/1 = $1.20
Indirect quotation: 1/1.20 = 83 euros per dollar
7 Official or fixed rates are set by a government and do not change as a result of changes in world currency
markets Free or floating exchange rates are those that reflect fluctuating market prices for currency based
on supply and demand factors in world currency markets The United States changed from fixed to floating (free) exchange rates in 1971 But the U.S dollar is sometimes described as a “filthy float” because the United States has frequently engaged in currency transactions to support or weaken the dollar against other currencies Such action is taken for economic reasons, such as to make U.S goods more competitive in world markets Both Japan and Germany have engaged in currency transactions in an attempt to support the U.S dollar In February 1987, the United States and six other industrial nations (the Group of 7 or G-7) entered the Louvre accord to cooperate on economic and monetary policies in support of agreed upon exchange rate levels
8 Spot rates are the exchange rates for immediate delivery of currencies exchanged The current rate for
foreign currency transactions is the spot rate in effect for immediate settlement of the amounts denominated in foreign currency at the balance sheet date Historical rates are the rates that were in effect
on the date that a particular event or transaction occurred Spot rates could be fixed rates if the currency
Trang 210 At the transaction date, assets and liabilities denominated in foreign currency are translated into dollars by
use of the exchange rate in effect at that date, and they are recorded at that amount
At the balance sheet date, cash and amounts owed by or to the enterprise that are denominated in foreign currency are adjusted to reflect the current rate Assets carried at market whose current market price is stated in a foreign currency are adjusted to the equivalent dollar market price at the balance sheet date
11 Exchange gains and losses occur because of changes in the exchange rates between the transaction date
and the date of settlement Both exchange gains and exchange losses can occur in either foreign import activities or foreign export activities The statement is erroneous
12 Exchange gains and losses on foreign currency transactions are reflected in income in the period in which
the exchange rate changes except for hedges of an identifiable foreign currency commitment where deferral is possible if certain requirements are met Also hedges of a net investment in a foreign entity are treated as equity adjustments from translation Intercompany foreign currency transactions of a long-term nature are also treated as equity adjustments
13 There will be a $20 exchange loss in the period of purchase and a $10 exchange gain in the period of
settlement:
Billing date
Year-end adjustment
Accounts payable (fc) $ 20
Settlement date
Trang 3SOLUTIONS TO EXERCISES
Solution E12-1
1 b
2 c
3 d
4 a
Solution E12-2
1 c
2 a
3 d
4 b
Solution E12-3
1 b
2 d
3 d
Solution E12-4
1 The dollar has weakened against the yen because it now costs more
dollars to buy one yen
2 10,000,000 yen $.0075 = $75,000
4 Zimmer would have entered a contract to purchase yen for future receipt
This would assure that Zimmer had the yen available at that date to pay their obligation, and would have ‘locked in’ the amount of US dollars needed to satisfy that obligation
Solution E12-5
December 16, 2011
To record purchase of merchandise from Wing Corporation for 30,000 euros at $1.20 spot rate
December 31, 2011
Accounts payable (euros) $ 1,500
To adjust accounts payable to Wing: ($1.25 - $1.20) 30,000
Trang 4To record payment of 30,000 euros at $1.24 spot rate in settlement
of account payable and to recognize gain
Solution E12-6
Adjustment in value of account receivable for 2011:
($.84 - $.80) 90,000 C$ = $3,600 exchange gain
Adjustment in value of account receivable at settlement in 2012:
($.83 - $.84) 90,000 C$ = $900 exchange loss
Solution E12-7
May 1, 2011
Accounts receivable (fc) $333,333
To record sale of inventory items to Royal for 200,000 pounds: 200,000 pounds/.6000 pounds (indirect quotation)
May 30, 2011
To record receipt of 200,000 pounds from Royal in settlement of accounts receivable: 200,000 pounds/.6050 pounds
Solution E12-8 [Based on AICPA]
1
Receivable at 10/15/08 $420,000
Euros received and sold for
U.S dollars on 11/16/08
415,000 Foreign exchange loss 2011 5,000
2 On December 31, 2011 Yumi Corp adjusts its account payable denominated
in euros from $12,000 (10,000*.$1.20) to $12,400 (10,000 $1.24) and recognizes a loss of $400 [10,000 LCU ($1.24 - $1.20)]
3
December 31, 2011 note payable $240,000 July 1, 2012 note payable 280,000
4
Note receivable December 31, 2011 $140,000 Amount collected July 1, 2012
Trang 5Solution E12-9
1 Exchange gain or loss in 2011: Gain or (Loss)
Account receivable December 16 $103,500
December 31 adjusted balance
150,000 C$ $0.68 102,000 $(1,500) Account payable December 2 $195,250
December 31 adjusted balance
275,000 C$ $0.68 187,000 8,250
Net exchange gain for 2011 $ 6,750
2 Exchange gain or loss in 2012: Gain or (Loss)
Account receivable adjusted 12/31 $102,000
Account receivable 1/15/09
150,000 C$ x $0.675 101,250 $ (750) Account payable adjusted 12/31 $187,000
Account payable 1/30/09
275,000 C$ x $0.685 188,375 (1,375) Net exchange loss for 2012 $(2,125)
Solution E12-10
1 December 12, 2011
Purchase from Toko Company (50,000,000 yen $.00750)
December 15, 2011
Accounts receivable (pounds) $ 66,000
Sale to British Products Company (40,000 pounds $1.65)
2 December 31, 2011
Accounts payable (yen) $ 5,000
To adjust accounts payable denominated in yen for exchange rate change: 50,000,000 yen ($.00760 - $.00750)
Accounts receivable (pounds) $ 2,000
To adjust accounts receivable denominated in pounds for exchange rate change: 40,000 pounds ($1.65 - $1.60)
3 January 11, 2012
Accounts payable (yen) $380,000
To record payment to Toko Company (50,000,000 yen $.00765)
January 14, 2012
Trang 7Solution E12-11
Comment: The contract receivable and payable are both recorded instead of
recording the contract net because Martin must deliver the euros to the
exchange broker, net settlement is not allowed
October 2, 2011
To record contract to sell 1,000,000 euros to exchange broker in
180 days for the forward rate of $.6530
December 31, 2011
Contract payable (fc) $ 12,000
To adjust contract payable in euros to the 90-day forward rate of
$.6410
March 31, 2012
Contract payable (fc) $641,000
To record payment of 1,000,000 euros to exchange broker when spot rate is $.6550
To record receipt of U.S dollars from exchange broker in settlement of account
SOLUTIONS TO PROBLEMS
Solution P12-1
TCO would receive $8,000 from XYZ = 100,000(2.48-2.40)
Solution P12-2
There is a typo in the problem, Sue's cost should be $5.90
The expected profit for Sue is 300,000 (6.20 - 5.90) = 90,000
Market Price
per Bushel
Forward Price per Bushel
Unhedged Gain/(Loss)
Economic Gain/(Loss) on Forward
Economic Income with Hedge
Trang 8$6.00 $6.20 30,000 60,000 90,000
Solution P12-3
The expected profit for Sue is 300,000(6.20 - 5.90 - 0.05) = 75,000
Market Price
per Bushel
Option Price per Bushel
Unhedged Gain/(Loss)
Economic Gain/(Loss) on Option
Economic Income (Loss) with Cost of Option
$6.20 $6.20 90,000 — 75,000
Solution P12-4
1, 2 Per Balance Exchange Gain
Books Sheet or (Loss)
Accounts receivable
Swedish Krona (20,000 $.66) 11,800 13,200 $1,400
British pounds(25,000 $1.65) 41,000 41,250 250
Accounts payable
U.S dollars $ 6,850 $ 6,850
Canadian dollars (10,000 $.70) 7,600 7,000 $ 600
British pounds (15,000 $1.65) 24,450 24,750 (300)
3 Collect receivables:
To record collection of accounts receivable
Trang 9Cash $13,400
Accounts receivable (Krona) $13,200
To collect 20,000 Krona at $.67 spot rate
Accounts receivable (pounds) $41,250
To collect 25,000 pounds at $1.63 spot rate
4 Settlement of accounts payable:
To record payment of accounts denominated in dollars
Accounts payable (Canadian $) $ 7,000
To record payment of account denominated in Canadian dollars at
$.71 spot rate
Accounts payable (pounds) $24,750
To record payment of 15,000 pounds at $1.62 spot rate
Solution P12-5
Accounts receivable
British pounds (100,000 1.660) $165,000 $166,000 $1,000
Euros (250,000 $.670) 165,000 167,500 2,500
Swedish krona (160,000 $.640) 105,600 102,400 (3,200)
Japanese yen (2,000,000 $.0076) 15,000 15,200 200
Accounts payable
Canadian dollars(150,000 $.69) $105,000 $103,500 $1,500
Swedish krona (220,000 $.135) 28,600 29,700 (1,100)
Japanese yen (4,500,000 $.0076) 33,300 34,200 (900)
3 The company would need to enter into a contract to deliver 250,000 euros
(sell them) since it would be receiving euros and would need to convert
them into US dollars