...Donivan Tan Part A - Cash Flow Hedge of Foreign Currency Receivable 11/1/Y1 Accounts receivable (Pesos) [400,000 x $0.23] $92,000 Sales $92,000 No journal entry for the forward contract. Memo entry. 12/31/Y1 Foreign exchange loss $12,000 Accounts receivable (pesos) [400,000 x ($0.23-$0.20)] $12,000 Forward contract [400,000 x ($0.22-$0.18)] x .9610 $15,376 AOCI $15,376 AOCI $12,000 Gain on forward contract $12,000 Premium Expense [($0.22-$0.23) x 400,000]/3 $1,333.33 AOCI $1,333.33 Impact on Year 1 income: Foreign exchange loss (12,000.00) Gain on forward contract 12,000.00 Premium Expense (1,333.33) Impact on net income (1,333.33) 4/30/Y2 Cash – Foreign currency (pesos) (400,000 x $0.19) $76,000 Foreign exchange currency loss $4,000 Accounts receivable (pesos) [20,000 x ($1.12-$1.05)] $80,000 AOCI [400,000 x ($0.22-$0.19) = $12,000 – $15,376] $3,376 Forward contract $3,376 AOCI $4,000 Gain on forward contract $4,000 Premium Expense [($0.22-$0.23) x 400,000] x 2/3 $2,666.67 AOCI $2,666.67 Cash USD [400,000 x $0.22] $88,000 Forward contract $12,000 Cash - Foreign currency (pesos) $76,000 The impact on net income for Year 2 is: Foreign Exchange Loss $(4,000.00) Gain on Forward Contract $ 4,000.00 Premium Expense (2,666.67) Impact on net income (2,666.67) Notes: ...
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...Stuart Graham International Finance Mid Term Paper Student ID: 810110116 This case analyzes the business transaction between DC Inc (US seller) and CR Limited (UK purchaser) for 100,000 pounds. DC Inc has determined that its minimum acceptable sale price was 170,000 which therefore implied that its budget exchange rate was $1.70/pound. The transaction risk here is that the exchange rate could fall below $1.70 resulting in a loss to DC. Inc. This paper will analyze four options available to DC Inc to manage its currency exposure: 1. Remain Unhedged 2. Hedge in the forward market 3. Hedge in the money market 4. Hedge in the Options market Option # 1 – Remain unhedged The first option for DC is to accept the risk of the transaction and assume that the advisory forecast of $1.76/pound is correct. In this instance DC can expect to receive: |Amount in £ |Rate $/£ |$ Received in September | | 100,000.00 |1.76 | 176,000.00 | Although this may seem acceptable, it is not a certainty that the forecast of 1.76/pound would be correct. For example we can shock the exchange rate up and down to see varied result both positive and negative for DC. |Amount in £ |Rate $/£ |$ Received in September |Shock | | 100,000.00 |1.76 | 176,000.00 |None | | 100,000.00 |1.86 | ...
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...How to Hedge Currency Risk A reliable way to hedge currency risk is to use forex options. This approach works for businesses that need to make purchases with foreign currencies, currency speculators who engage in strategies such as the carry trade and anyone who wants to use a safe haven currency to protect their wealth. How to hedge currency risk is by purchasing calls on the currency that you will or may need to buy with the currency that you have. How does this work? Forex and Forex Options There are two kinds of options that one can purchase or sell. These are calls and puts. A call gives the buyer the right to purchase one currency with another at a set price called the strike price. He has a base currency and purchases a call option on the reference currency. The buyer is under no obligation to so and will only execute the options contract and make the purchase if it is profitable to do so. The seller of a call is, however, obligated to sell the base currency and purchase the reference currency if the buyer executes the options contract. The seller receives a premium for taking on this risk. A put gives the buyer the right to sell one currency for another at a set price called the strike price. He has a base currency and buys a put option that will allow him to sell the base currency and purchase the reference currency if doing so will make a profit or hedge against loss. The seller of a put contract is obligated to purchase the base currency with the reference...
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...CHAPTER 11 FINANCIAL INSTRUMENTS AS LIABILITIES CHAPTER OVERVIEW An astounding variety of financial instruments, derivatives, and nontraditional financing arrangements are now used to fund corporate activities and to manage risk. Statement readers face a daunting task when trying to fully grasp the economic implications of some financial innovations. Off-balance sheet obligations and loss contingencies are difficult to evaluate because the information needed is often not disclosed. Derivatives—whether used for hedging or speculation—are problematic because of both their complexity and the involved details of hedge accounting. For many companies, however, the single most important long-term obligation is still traditional debt financing. GAAP in this area is quite clear. Noncurrent monetary liabilities are initially recorded at the discounted present value of the contractual cash flows—that is, the issue price. The effective interest method is then used to compute interest expense and net carrying value each period. Interest rate changes occurring after the debt has been issued are ignored. GAAP accounting for long-term debt makes it possible to “manage” reported income statement and balance sheet numbers. The opportunity to do so comes from the difference between debt book value and market value when interest rates have changed. The incentives for “managing” income statement and balance sheet numbers may be related to debt covenants, compensation, regulation...
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...other derivative instruments allow speculators to take positions in an asset with much less capital than would be required to achieve the same position in the cash market. Speculators add liquidity to the derivatives markets. Hedgers want to eliminate or reduce an exposure to movements in the price of an asset. Forward contracts, say, allow hedgers to reduce their exposure or eliminate it without an initial payment. Hedging using forwards or futures makes the outcome more certain but does not necessarily make it better relative to the unhedged position. Option strategies allow hedgers to insure (upside benefits only — for a premium) their positions against adverse market movements for the payment of an up-front premium. Hedger: A hedge is a position taken in order to offset the risk associated with some other position. A hedger is someone who faces risk associated with price movement of an asset and who uses derivatives as a means of reducing that risk. A hedger is a trader who enters the futures market to reduce a pre-existing risk. Speculators: While hedgers are interested in reducing or eliminating risk, speculators buy and sell derivatives to make profit and not to reduce risk. Speculators willingly take increased risks. Speculators wish to take a position in the market by betting on the future price movements of an asset. Futures and options contracts can increase both the potential gains and losses in a speculative venture. Speculators are important to derivatives...
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...types of orders used in Indian Derivatives Exchanges. 3. Explain what is meant by a perfect hedge. Does a perfect hedge always lead to a better outcome then an imperfect hedge? Explain your answer. 4. What do you understand by commodity futures? What are the benefits of commodity futures at national level? 5. Compare between forward, future and option. 6. Explain the regulatory framework of futures trading in India. 7. Explain carefully differences between hedging, speculation and arbitrage in the context of financial derivatives. 8. Explain the term ‘Financial derivative’. What are the important features .Explain with suitable examples. Which are different types of instruments ? 9. What do you mean by SWAPs? Explain the different type of Swaps in detail that are used to hedge different risks. 10. Explain what do you mean by long hedges and short hedges with example. 11. Discuss in detail what do you understand by hedge ratio and hedging effectiveness. 12. “Derivative contracts are used as a tool of hedging in financial market” . Explain the different types of risk that occur in a financial market. 13. Clearing house is the ‘de facto’ guarantor for all the transactions in futures. Describe briefly the functions of a clearing house. 14. What is currency Swap? Classify the different types of currency rate Swaps . How a person can do “Arbitrage” using currency future? 15. OTC derivatives v/s. Exchange traded derivatives 16. What are T-bill futures...
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...corporations to adjust to exposure to currency risk, interest rate risks, commodity price risks, and security holdings risk. Largely, companies are currently exposed to risks caused by unexpected movements in exchange rates and interest rates. Companies with a growing global presence are especially exposed to a wide range of financial risks, in particular foreign exchange risks and interest rate risk. Although, financial risks are the center of business operations of financial service firms, but they also impact the risk exposure of non-financial corporations. The management and supervision of these risks has become vital for the existence of companies in today’s unpredictable financial markets. The major financial risks that most firms are exposed to are interest rate risk, currency rate risk, commodity price risk, and security holdings risk. Interest rate risk is a very common type of risk, and result from a discrepancy in the sensitivity of a firms assets and liabilities to interest rate movements. On the other hand, currency risk exposure is virtually encountered by all firms, even if their exposure is not from a transaction or a translation risk. Many firms are also likely to face competitive risk due to foreign companies using weak home currencies to their advantage (Triantis). In 1944, the original global financial order was established and the Bretton Wood system was created. The system created an international basis for exchanging one currency for another and also led to the...
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...By: ATTIKA RAJ, ROLL NO: MS10A009, MBA- 2012 BATCH, DOMS, IITM 2/21/2012 I. Case Analysis – Risk management Policy of Lufthansa Submitted in Assignment 1 II. Case Analysis: Commodity Market Derivatives Case Solutions: 1. Discuss the risk exposure of Amarnath hedge fund. Ans: The Amaranth hedge fund was exposed to following risks: a. Market risk: The risk that occurs from the volatility of investment returns b. Liquidity risk: It measures the degree of difficulty in exiting a given trading position c. Funding risk: It measures the extent to which they were able to meet margin calls on their natural gas position d. Capacity risk: The risk due to putting too much money into one particular strategy 2. What are the negatives to rolling a spread position? Ans: Negatives to rolling a spread position are: When rolling a spread position the investor expects the following months to which the contract was rolled over to be favourable and thus be able to unload its positions. But, if the market moves in a direction opposite to the one anticipated by the investor it can result in huge losses. Also, if the risk increases for a spread position with the increase in the leverage. In the case of Amaranth hedge fund, it had rolled its short positions prior to august into the next month, hoping that market conditions would change and enable it to unload its positions. There were now no more summer months into which it could roll these positions. By late August, with hurricane season...
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...Why do companies use derivatives? How can these be beneficial to a company? How can they hurt a company? Derivatives are used by a company to hedge risk. Risk can come in different flavors and so can derivatives. There are three main risks, which are hedged using derivatives. The first is interest rate risk. Many seemingly good investments can suffer at the hands of the fluctuations in interest rates. There are a few ways to hedge interest rate risk, one being a long-term lock on the interest rate by purchasing a treasury future and another is to use an interest rate swap whereby the company literally swaps their payment obligations by “swapping” a variable rate payment for a fixed rate. A second risk is exchange rates. If a company bids on a contract to sell a product for a fixed price, 6 months in the future but be paid in a currency different from their own, they run the risk of the exchange rate between the two currencies changing to their detriment resulting in the company receiving a relatively lower fee in their home currency. To hedge against this risk, companies can buy foreign exchange futures AGAINST the change in the exchange rate, which would positively affect the outcome for them and thereby providing them with insurance against the negative change. The third risk example is that of a commodity risk. Many products have dependent input commodities such as fuel, raw material etc. whose prices are critical in the company’s final profit. A company that signs...
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...To: | George Saoud | From: | Peter Zarin | CC: | Stephen Heath, George Saoud and Salesh Nischal | Date: | Xxxxx | Re: | Hedge Accounting – Designation and Effective Testing as at 30 June 2015 | Executive Summary In Q4 FY15, FHL Group decided to elect to adopt IFRS 9 Hedge Accounting which will enable the Group to more effectively mitigate the adverse foreign exchange movements involved with importing of raw materials and finished goods for our leading retail business units, c $120M per year. The identification of foreign exchange risk has been formally identified as a key financial risk to the Group and as such compliments this decision to adopt hedge accounting as a method by which to minimise the volatility of the AUD against the USD contracts. The risk likelihood and impact are considered high in both cases. FHL has chosen to hedge with Forwards Exchange Contracts to hedge the foreign exchange risk. A forward contract is a contract to exchange a fixed amount of f financial assets on a fixed future date at a fixed price. The fair value of a forward contract is affected by changes in the spot rate and changes in the forward points. Although the Group has used forward contracts in the past, the adoption of IFRS 9 Hedge Accounting has not been applied because the tenure of the contracts was hedging against AUD/USD FX rates three months out from the accounting period. The Board has decided that the tenure should now look prospectively 6 months out which brings...
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...Chapter 10 Accounting for Derivatives and Hedge Accounting IFRS 9 defines a derivative as a financial instrument or other contract within the scope of IFRS 9 that meets three criteria: 1. Its value changes in response to a change in an "underlying". The underlying can be the price of a commodity, such as soybeans, or a financial instrument, such as a fixed rate bond. It can also be a rate such as a foreign exchange rate or a specified interest rate, for example, the London Interbank Offer Rate; It requires little or no initial net investment; and It is settled at a future date. 2. 3. Chapter 10 Page 1 TABLE 10.1 Examples of derivative instruments and their underlying Type of derivative instruments Options contract (call and put) Underlying Security price Used by Producers, trading firms. financial institutions and speculators Various companies Producers and consumers Financial institutions Forward contracts, e.g. foreign Foreign exchange rates exchange forward contracts Futures contracts, e.g. Commodity prices commodity futures Swaps. e.g. interest rate swap Interest rate Uses of Derivatives Generally, firms or individuals transact in derivatives to: 1. Manage market risks such as foreign exchange risk and interest rate risk; 2. 3. Reduce borrowing costs; or Profit from trading or speculation. Chapter 10 Page 2 Types of derivatives Ø Forward-type derivatives o Forward contract o Future contract o Swaps...
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...fiscal year ends on December 31. The direct exchange rates follow: Date | Spot Rate | Forward Rate for March 31, 2014 | December 1, 2013 | $ 0.600 | 0.609 | December 31, 2013 | 0.610 | 0.612 | January 30, 2014 | 0.608 | 0.605 | March 31, 2014 | 0.602 | | Instructions Prepare all journal entries for Stark Industries for the following independent situations: a. The forward contract was to manage the foreign currency risk from the purchase of furniture for A$ 100,000 on December 1, 2013, with payment due on March 31, 2014. The forward contract is not designated as a hedge b. The forward contract was to hedge a firm commitment agreement made on December 1, 2013. To purchase furniture on January 31, with payment due on March 31, 2014. The derivatives is designated as a fair value hedge c. The forward contract was to hedge an anticipated purchase of furniture on January 30. The purchase took place on January 30. With payment due on March 31, 2014. The derivatives is designated as a cash flow hedge. The company uses the forward exchange rate to measure hedge effectiveness d. The forward contract was for speculative purposes only Problem 2 – Futures Peny One Inc. is a jewelry trading company. On November 1, 2013, Peny One Inc has 1,000,000 ounces of Gold carried at cost of $ 5,000,000 ($5 per ounce). Peny One Inc believes that the price of gold will decrease in the coming month due to bad economic recession. Therefore it decides to enter futures contract which has maturity...
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...American Barrick Resources Corporation Managing Gold Price Risk Gold Demand Supply 1. Jewelry (80%) 1. Expanding Production 2. Commercial and Soviet Union Industrial use South Africa 3. Back-up for currencies North America Australia 2. Central Banks Liquidation Factors that may increase gold price: 1. Large government deficits 2. Financial and economic crisis 3. Wars and doomsday scenarios 4. Increase in gold jewelry demand ? 5. Commercial and Industrial demand ? Factors that may decrease gold price: 1. Financial and economic stability 2. Trends towards democracy and free markets 3. Effective use of monetary policy by central banks 4. Liquidation by central banks Long-term trend? Should Gold Producers Hedge Gold Price Risk? Pros Cons 1. Protect downside 1. Sacrifice Upside 2. Share price premium? 2. Unsystematic risk? 3. Specialize in gold production 3.Share price penalty? not gold risk taking 4. High operating leverage and high sunk costs 5. Limited ability to adjust production 6. Lock-in the low total costs (see exhibit 3) Managing Gold Price Risk – The Evolution 1. Gold Financing Barrick-Cullaton Gold Trust Bullion loans (denominated in gold – e.g., to finance Goldstrike mine) Gold-indexed Eurobond offerings The main disadvantage Conservative financial...
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...1.) Explain how futures contracts could be used to hedge a bond portfolio against the risk of rising interest rates. Then explain how futures could be used by exporters and by importers to hedge against their foreign-exchange exposures. Someone with a large bond oprtfolio may want to hedge against future interest rate movements. When interest rates rise, bond prices decline. The use of futures can be used to hedge against the likelihood of rising interest rates. When the hedging is balanced, the gains/losses in the cash holdings will be offset by gains/losses in futures account. Hedging bond portfolios with futures contracts, will be done by holding short positions. Futures could be used to establish an offsetting currency position so that whatever is lost or gained on the original currency exposure is exactly offset corresponding foreign exchange gain or loss on the currency hedge. Regardless of what happens to the future exchange rate, therefore, hedging locks in a dollar value for the currency exposure. In this way, hedging can protect a firm from foreign exchange risk, which is the risk of valuation changes resulting from unforeseen currency movements. 2.) Explain how the manager of a bond portfolio could use options to hedge against the risk of rising interest rates. Then explain how exporters and importers could use options to hedge against their foreign-exchange exposures. 3.) Assume that Baker Adhesives, sold 2.6 million Brazilian reals of adhesives to...
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...AFW3050 Tutorial 5 Solutions Chapter 15 15.1 AASB 132 Financial Instruments: Disclosure and Presentation defines a financial instrument as any contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity. Such a definition, in turn, generates a need to define a financial asset; a financial liability; and, an equity instrument. According to paragraph 11 of AASB 132, ‘financial asset’ means any asset that is: (a) cash; (b) an equity instrument of another entity; (c) a contractual right: (i) to receive cash or another financial asset from another entity; or (ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; or (d) a contract that will or may be settled in the entity’s own equity instruments and is: (i) a non-derivative for which the entity is or may be obliged to receive a variable number of the entity’s own equity instruments; or (ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments. For this purpose the entity’s own equity instruments do not include instruments that are themselves contracts for the future receipt or delivery of the entity’s own equity instruments. A financial liability, on the other hand, means any liability that is (a) a contractual obligation: (i) to deliver cash or another...
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