problem 6-1 lo 5 fc

Question

Problem  6-1  (LO  5)  FC  transactions,  commitments,  forcasted  transactions earnings impact. Jarvis Corporation transacts business with a number of foreign vendors and customers. These transactions are denominated in FC, and the company uses a number of hedging strategies to reduce the exposure to exchange rate risk. Several such transactions are as follows:

Transaction A: On November 30, the company purchased inventory from a vendor in the amount of 100,000 FC with payment due in 60 days. Also on November 30, the company purchased a forward contract to buy FC in 60 days. Changes in the value of the commitment are based on changes in forward rates.

Transaction B: On November 1, the company committed to provide services to a foreign customer in the amount of 100,000 FC. The services will be provided in 30 days. On November 1, the company also purchased a forward contract to sell 100,000 FC in 30 days.

Transaction C: On November 1, the company forecasted a purchase of equipment in 30 days.The forecasted cost is 100,000 FC, and the equipment is to be depreciated over ?ve years using the straight-line method of depreciation. On November 1, the company acquired a forward contract to buy 100,000 FC in 30 days.

Transaction D: On November 30, the company purchased an option to sell 100,000 FC in 60 days to hedge a forecasted sale to a customer in 60 days. The option sold for a premium of $1,200 and had a strike price of $1.155. The value of the option on December 31 was $2,000.

The time value of all hedging instruments is excluded from the assessment of hedge effectiveness. Relevant spot and forward rates are as follows:

Spot Rate            Forward Rate for 30

Daysfrom November 1    Forward Rate for 60

Daysfrom November 30

November 1 .. . . . . ... .. .. ..  1 FC ¼ $1.12               1FC ¼ $1.132

November 15 . . . . . ... .. .. ..  1 FC ¼ $1.13

November 30 . . . . . ... .. .. ..  1 FC ¼ $1.15              1 FC ¼$1.146

December 31.. . . . . ... .. .. ..  1 FC ¼ $1.14              1 FC ¼$1.138

Assuming that the company's year-end is December 31, for each of the above transactions

determine the current-year effect on earnings. All necessary discounting should be determined

by using a 6% discount rate. For transactions C and D, the time value of the hedging instru-

ment is excluded from hedge effectiveness and is to be separately accounted for.

 

Problem 6-3 (LO 3, 5) Income statement effects of transactions, commitments, and hedging. Clayton Industries sells medical equipment worldwide. On March 1 of the current year, the company sold equipment, with a cost of $160,000, to a foreign customer for 200,000 euros payable in 60 days. At the same time, the company purchased a forward contract to sell 200,000 euros in 60 days. In another transaction, the company committed, on March 15, to deliver equipment in May to a foreign customer in exchange for 300,000 euros payable in June. This equipment is anticipated to have a completed cost of $210,000. On March 15, the company hedged the commitment by acquiring a forward contract to sell 300,000 in 90 days. Changes in the value of the commitment are based on changes in forward rates and all discounting is based on a 6% discount rate.

Various spot and forward rates for the euro are as follows:

Spot Rate            Forward Rate for60

Days from March 1 Forward Ratefor 90

Daysfrom March15

March1.... .. . . . . ... .. .. .... .. . .. .              $1.180  $1.181

March15 .. .. . . . . ... .. .. .... .. . .. . 1.181  1.180    $1.179

March31 .. .. . . . . ... .. .. .... .. . .. . 1.179  1.178    1.177

April30.... .. . . . . ... .. .. .... .. . .. . 1.175    1.174

 

 

Problem 6-3 Template
The Foreign Currency Transaction
Part 1						March		April
Sales						36000
Cost of Goods Sold						160000
Gross Profit
Exchange Gain (Loss)
Net Income Effect
Part 2
The Hedge on the Foreign
Currency Transaction
Gain(Loss) on Forward Contract
Net Income Effect
Part 3
The Foreign Currency Commitment
Gain or loss on Firm Commitment
Net Income Effect
Part 4
The Hedge on the Foreign
Currency Commitment
						01-Mar	31-Mar	30-Apr
Number of FC
Forward Rate Remaining Time-1FC
Fair Value of Original Contract
Original Forward Rate
Current Forward Rate
Gain or (Loss) in Forward Rate
Present Value of Change
N=1 i= .5%
N=0 i=.5%
Change in Value From
Prior Period
Current Present Value
Prior Present Value
Change in Present Value
Schedule B for Part 3 and 4
						15-Mar	31-Mar	30-Apr
Number of FC
Forward Rate Remaining Time-1 FC
Fair Value of Original Contract
Original Forward Rate
Current Forward Rate
Gain or Loss in Forward Rate
Present Value Change
	n=2.5 i=.5%
	n=1.5 i=.5%
Current Change from Prior Period
	Current Present Value
	Prior Present Value
	Change in Present Value