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Option Contracts – is a financial derivative contract that provides the holder the right to buy or sell an
underlying in the future, for a price set today. The price of the option is separate from the price of the
underlying.
Foreign Currency Option – gives the holder of the option the right but not the obligation to trade foreign
currency in the future.
Underlying – is the asset, financial instrument or any other basis (e.g., forex rates) to which the option is linked,
and from where its value is derived.
Premium – is the option price. This is the sum of money that the option buyer pays the option seller to obtain
the right being sold in the option. This money is paid when the option contract is initiated.
Intrinsic value – is the difference between the current market price and the option price of the hedged item.
SPOT RATE STRIKE PRICE INTRINSIC V.
Date of transaction Dec 1, 2021 P 51 P 51 -0-
BS date Dec 31, 2021 51.5 51 0.5
Date of settlement Jan 31, 2022 52 51 1.0
Type of transaction Purchase
FCU $1,000
Time value – is the difference between the options market price and its intrinsic value. Changes in the time
value are taken to profit or loss.
Strike price – is the price at which the holder has the option to buy or sell the item.
Option to buy “in the money” – exists when the market price is more than the strike price.
Option to buy “out the money” – exists when the market price is less than the strike price.
Option to sell “in the money” – exists when the market price is less than the strike price.
Option to sell “out the money” – exists when the market price is more than the strike price.
Option to buy/sell “at the money” – exists when the market price is equal to the strike price.
Problem 1: On November 1, 2018, Hunt Philippines took delivery from Thailand firm of inventory costing
1,140,000 baht. Payment is due on January 30, 2019. Concurrently, Hunt Philippines paid P15,700 cash to
acquire an at-the-money call option for 1,140,000 baht. Strike price is P12.40
Questions:
1. The foreign exchange gain/loss on hedging instrument due to change in the ineffective portion on
December 31, 2018? P13,720 loss
2. The foreign exchange gain/loss on hedging instrument due to change in the effective portion on
December 31, 2018? P26,220 gain
3. The December 31, 2018 net foreign exchange gain/loss in the hedging activity amounted to: P12,500
gain
4. The foreign exchange gain/loss on hedging instrument in 2019 if changes in the time value will be
included from the assessment of hedge effectiveness is: P2,580 gain
SOLUTIONS:
Market
Price/ Strike FC Option Element Intrinsic Time
Spot Rate Price Situation Existing Value Value
11/1/18 P 12.400 P 12.40 At-the-money TV 0 P15,700*
12/31/1 12.423 12.40 In-the-money TV, IV 26,220 1,980**
8
1/30/19 12.427 12.40 In-the-money IV 30,780 0
*The time value at the date of option is equivalent to the payment to acquire the option which is the initial fair value since there is no intrinsic
value on this date.
The time value at the settlement date is zero since there is no more need for option.
Changes in Intrinsic Values (Effective Portion):
1/1/18 P 15,700
P 13,720 loss
12/31/18 1,980
P 1,980 loss
1/30/19 -0-
Entries:
November 1, 2018:
Inventory (1,140,000 x P12.40) P 14,136,000
A/P P 14,136,000