Speculation and swaps

Speculation
Forward contract for speculation is valued at forward rates throughout the life of the contract.

Example: On November 2, 2007, a Philippine company enters into a 90-day contract with Metro Bank to purchase 100,000 Japanese Yen() when the forward rate for 90-day is P4400. The spot rate for Japanese Yen on November 2 is P.4400. Exchange rates at December 31, 2007 and January 30, 2008 are as follows:
December 31, 2007 30-day forward rate Spot Rate p.4450 P.4500 January 30, 2008 P.4480 P.4530

2007
Nov. 2 Forward Contract Receivable Forward Contract Payable 44,000 44,000

Dec. 31

Forward Contract Receivable

Forex gain

500
500

2008
Jan. 30 Cash Forwards Contract Receivable 45,300 44,500

Forex Gain
Forward Contract Payable 44,000

800

Cash

44,000

Swaps
Arrangement whereby two counter parties contractually agree to exchange one stream of cash flows for another over a period of time.

Example:
On June 30, Moon Corporation borrows 5,000,000 of three-year variable debt with interest payments equal to the six-month inter-bank interest rate swap for the prior six months. The company then enters into a three-year interest rate swap with Mbank to convert the debts variable rate to a fixed rate.

The swap agreement specifies that Moon Corporation will pay interest at a fixed rate of 7.5% and receive interest at a variable rate equal to the six-month inter-bank rate based on the notional amount of 5,000,000.

Example:
Both the debt and the swap require interest paid semiannually on June 30 and December 31. The six-month inter-bank interest rate and the market value of the swap agreement for the first year of the swap agreement is as follows:
Date June 30, 2007 Six-month Interbank Rate 6% Swap Agreement Fair value 0

December 31, 2007

June 30, 2008

7%
5.5%

165,000
(70,000)

Interest Payments
December 31, 2007 Variable-rate interest payment Interest rate swap payment Total cash payment 150,000 37,500 187,500 June 30, 2008 175,000 12,500 187,500

Journal Entries:
2007 June 30 Cash Debt Payable December 31 Interest Expense Cash Interest Expense Cash Swap Agreement
Other Comprehensive Income

5,000,000 5,000,000 150,000 150,000 37,500 37,500 165,000 165,000

2008 June 30 Interest Expense Cash Interest Expense Cash Other Comprehensive Income Swap Agreement

175,000 175,000 12,500 12,500 235,000 235,000