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Chapter 24 - Teacher's Manual - Aa Part 2
Chapter 24 - Teacher's Manual - Aa Part 2
2. B
3. A
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4. Solution:
Hedged item – None Futures contract (Derivative)
Dec. 1, 20x1
Deposit with broker ……..80K
Cash………………………..80K
5. Solution:
Hedged item – Highly probable Hedging instrument –
forecast transaction Futures contract
Nov. 1, 20x2 Nov. 1, 20x2
No entry No entry
2
Accumulated OCI …2,000
Cost of goods sold ………..2,000
6. D
7. Solution:
Hedged item – Highly probable Hedging instrument –
forecast transaction Put option (Derivative)
Nov. 1, 20x2 Nov. 1, 20x2
No entry Call option ……..……..1.2K
Cash………..………………1.2K
8. D
9. D
10. A
11. B
12. Solution:
Analysis:
Eden has a variable interest rate loan. However, Eden wants to pay
fixed interest instead. Therefore, Eden enters into a “receive variable,
pay fixed” interest rate swap.
Regardless of the movements in interest rates, Eden’s cash outflow for
interest will be fixed at the 9% pre-agreed rate.
The risk being hedged is Eden’s exposure to variability in cash flows.
Therefore, the hedge is a cash flow hedge.
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Solution:
Hedged item – Hedging instrument –
Variable interest payments Interest rate swap (Derivative)
Jan. 1, 20x2 Jan. 1, 20x2
Cash……………….1M No entry
Loan payable………...………1M
to recognize loan payable
to recognize interest expense on the to recognize the change in the fair value
variable-rate loan of the interest rate swap
to recognize interest expense on the to record the periodic net cash settlement
variable-rate loan on the interest rate swap - (see previous
computation)
Dec. 31, 20x2
Interest expense……...10,000
Accumulated OCI……10,000
Net cash receipt (due on Dec. 31, 20x3 – maturity date) 30,000
Multiply by: PV of 1 @12%, n=1 0.892857
Fair value of derivative - 12/31/x2 (asset) 26,786
The change in the fair value of the interest rate swap is determined as
follows:
Fair value of interest rate swap – Dec. 31, 20x2 - (asset) 26,786
Less: Carrying amount of interest rate swap – Dec. 31,
20x2
(17,833 liability – 10,000 net cash settlement) - (liability) 7,833
34,61
Change in fair value – gain
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to recognize interest expense on the to record the final net cash settlement
variable-rate loan on the interest rate swap
Dec. 31, 20x3 Dec. 31, 20x2
Loan payable……….1M Accumulated OCI……30,000*
Cash………………………….1M Interest expense……....30,000
*26,786 balance on Dec. 31, 20x2 + 3,214, the amount squeezed above =
30,000
Notice that with the hedging instrument, Eden has effectively fixed its
cash outflows for interests at the fixed rate of 9% (i.e., 1M x 9% x 3
years = ₱270,000).
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2. D
Explanations:
Choice (d) is correct because the hedged item (highly probable
forecasted purchase transaction) is in the amount of DM400,000 only
while the hedging instrument is at DM800,000. Therefore, the excess
DM400,000 is regarded as speculative investment.
Choice (a) is incorrect. There is insufficient information that would
support Choice (a). There are two risks that are being hedged: (1) The
risk that the expected purchase price in DM will increase and (2) The risk
that the value of DM in U.S. dollars will change.
Choice (b) is incorrect: See explanation for Choice (a).
The hedging instrument fixes the amount of outflow in U.S. dollars.
Therefore, the futures contract is a contract to purchase 800,000DM at
$400,000, not sell.
4. B
Solution:
Savings 60,215.05
5. D
Solution:
Payment without the call option (¥80M ÷ ¥105)
761,904.76
Payment by exercising the call option (¥80M ÷ ¥100)
800,000.00
Loss from exercising the option
(38,095.24)
6. C
Solution:
(10% pay fixed - 8% receive variable) x 500,000 = 10,000 payment
7. C
Solution:
(12% receive variable - 10% pay fixed) x 500,000 = 10,000 receipt
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PROBLEM 24-6: EXERCISES: COMPUTATIONAL
1. Solution:
Hedged item – None Put option (Derivative)
July 7, 20x4 July 7, 20x4
Put option ……..…….. 170
Cash………..……………… 170
The entity need not recognize a loss from the change in intrinsic value
because the option is not designated as a hedging instrument. Only the
change in the time value is accounted for. The maximum loss that would be
recognized in an option is the premium paid (i.e., $170) which is equal to the
time value of the option on initial recognition.
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Hedged item – None Put option (Derivative)
Jan. 31, 20x5 Jan. 31, 20x5
No entry (see explanation above)
2. Solution:
Hedged item – None Put option (Derivative)
Jan. 7, 20x4 Jan. 7, 20x4
Put option ……..…….. 270
Cash………..……………… 270
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Hedged item – None Put option (Derivative)
June 30, 20x4 June 30, 20x4
Loss on put option… 600
[(60 – 62) x 300]
Put option ……..…….. 600
Variation 1: Short-cut
Hedged item – None Put option (Derivative)
July 31, 20x4 July 31, 20x4
Cash………….. 1,800
[(64 - 58) x 300]
Put option…………………. 668*
Gain on put option ……. 1,132
*
Put option
1/7/x4 270
3/31/x4 1,200 120 3/31/x4
600 6/30/x4
82 6/30/x4
668 balance
Variation 2: Long-cut
Hedged item – None Put option (Derivative)
July 31, 20x4 July 31, 20x4
10
Put option………….. 1,200
[(62 - 58) x 300]
Gain on put option ……. 1,200
**
Put option
1/7/x4 270
3/31/x4 1,200 120 3/31/x4
600 6/30/x4
82 6/30/x4
7/31/x4 1,200 48 7/31/x4
1,820 balance
The net gain or loss recognized on July 31, 20x4 under each of the
“short-cut” and “long-cut” methods are analyzed as follows:
Short-cut method: net gain of 1,132
Long-cut method: (1,200 – 48 – 20) = net gain of 1,132
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