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IFR - Tutorial W4 - Questions

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28 views2 pages

IFR - Tutorial W4 - Questions

Uploaded by

s.h.j.braamhaar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Tutorial W4: Questions

Question 1
Phillips is a Dutch manufacturer and sold an MRI scanner to a US hospital. The contract was
concluded on December 1, Year 1, and delivery took place on the same day. The sales price is
US $300,000 and the payment term is three months. The relevant exchange rates are summa-
rized in the below table:

Date Spot Rate Forward Rate as of March 1, Year 2


December 1, Year 1 €1.13 €1.15
December 31, Year 1 €1.12 €1.14
March 1, Year 2 €1.19 €1.19

• Phillip’s annual borrowing rate is 12% (1% per month). Accordingly, the present value
factor is: for one month 0.9900, for two months 0.9803, and for three months 0.9705. The
financial year ends on December 31, Year 1.
• The controller of Phillips enters into a forward contract on December 1, Year 1, to sell US
$300,000 on March 1, Year 2. The controller designates the forward contract as a fair
value hedge. Also, applies the straight-line method. The cash related to the sales contract is
properly received on March 1, Year 2.

1) Prepare all journal entries for the above hedge transaction in €.


2) The controller of Phillips decided hedge contract related to the sales transaction. Are there
other possibilities to deal with the foreign currency exposure and which ones? What is the
best solution?
3) Was it smart to designate the hedge as a fair value hedge? Explain your answer.

Question 2
Specialty Machines Inc., a U.S. manufacturer of industrial melting equipment, sells on
December 1, Year 1, melting equipment to a Belgian customer. The sales price is €500,000 to
be received on March 1, Year 2. Specialty Machines Inc. purchases a three-month put option
on December 1, Year 1, and designates the option properly as a cash flow hedge of a foreign-
currency-denominated asset. The purchase price of the option is $4,500. The financial year ends
on December 31, Year 1.

The relevant exchange rates are summarized in the below table:


Date Spot Rate Option premium for 3/1/Y2 Fair value option
December 1, Year 1 $1.50 $0.009 $4,500
December 31, Year 1 $1.51 $0.006 $3,000
March 1, Year 2 $1.48 $0.020 $10,000

1) Prepare all journal entries in U.S. dollars as of December 1, Year 1, and December 31,
Year 1. Note: no journal entries are required for March 1, Year 2.
2) Advise whether Specialty Machines Inc. should exercise the put option on March 1, Year 2.
Support your answer with an explanation.

1
Question 3
Catfood Inc, a Canadian company, invested 2,000,000 Swiss Francs in a foreign subsidiary on
January 1, Year 1. The subsidiary commences operations on that date and generates a net
income of 500,000 Swiss Francs during its first year of operations. No dividends are sent to the
parent this year. Relevant exchange rates between Catfood Inc’s reporting currency (C$) and
the Swiss Franc are as follows:

January 1, Year 1 C$ 0.30


Average, Year 1 0.34
December 31, Year 1 0.42

1) Determine the amount of translation adjustment that Catfood Inc. will report on the
December 31, Year 1, balance sheet.
2) Which translation method did Catfood Inc. apply? Explain how you determined the
tranlation method.

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