On June 1, a US firm, manufacturing equipment, contracts to sell a piece of equipment (with an asking price of 2,000,000 krona) in Sweden (Hint: the equipment represents inventory for the US firm). The Swedish firm will take delivery and will pay for the equipment on August 1.
Spot rates were as follows (dollars per krona):
June 1: $0.107
August 1: $0.102
On August 1, the equipment was sold for 2,000,000 krona. The cost of the equipment was $100,000.
Supposed that on June 1, the firm believes, based on recent changes in the economy that there is high probability of exchange rate losses from the transaction. If the firm acquires an option to hedge the transaction, answer the following questions:
Required:
Does the firm believe that the krona is strengthening or weakening relative to the US dollar?
What kind of option should the firm use: a put or a call option?
Supposed the following options are available. Each option can only be exercised on August 1. Choose the option that should be used to hedge the transaction and record the journal entries needed by the company to record the hedge and the transaction to sell the equipment. Round all entries to the nearest whole dollar.
Option Type = Call Option ; Amount = 2,000,000 krona ; exercise rate = $0.1035 ; cost to acquire = $8,000
Option Type = put Option ; Amount = 2,000,000 krona ; exercise rate = $0.1035 ; cost to acquire = $15,000
Answer the following questions:
What is the accumulated net impact on the company's Stockholder equity related to this transaction on August 1?
What would have been the accumulated net impact on the company's Stockholder equity related to this transaction on August 1 if the company had not entered in the Option Contract?
Was the company better off or worse off with the derivative contract?