Chapter 12
Derivatives and Foreign Currency: Concepts and Common Transactions Answers to Questions
1
The common characteristics characteristics of derivative derivative is t hat the contract’s contract’s value to the investor investor is directly directly related to fluctuations fluctuations in price, rate, or some other variables variables that underlies underlies it. This means that the derivative derivative is used for maintaining the business’s exposure to the fluctuations by managing and controlling the economic risk of the fluctuations.
2
There are four basic types of hedging contracts: a. Forard Forard contracts. contracts. !egotiate !egotiated d contract contract betee beteen n to parties at at a pre"agreed pre"agreed price. b. Future contracts. #tandardi$ed contract beteen to parties at a pre"agreed price. c. %ptions. %ptions. Contract betee beteen n to parties parties at a pre"agre pre"agreed ed price, price, here only only one one party can either either have rights to call or put. & call gives the right to buy, and a put gives the right to sell. 'hen the rights are exercised the other party is obligated to comply. d. #aps. #aps. !egotiated !egotiated or standardi$ed standardi$ed contract contract beteen beteen to to parties parties (the other party party usually usually have have to be be a market maker) to exchange an ongoing stream of cash flos.
3
The transaction exchange rate can be considered as the floating exchange rate, in hich the rate represent the fluctuating market prices. This rate can be different on a daily basis depending on the supply and demands and any other factors affecting the currency markets. The tax exchange rate can be considered as the fixed rate, hich is the rate that is set by the government. This rate can be different based on the applications set by the government, for example one rate for taxation, another rate for import, and a different rate for export.
4
!et settlement means the instrument can be settled in cash for the net value. The parties in a net settlement do not have to buy or sell physical products and then reali$e the cash flos. %nly one payment needs to be made, either from the holder or the riter of the instrument.
5
& transactio transaction n is measured measured in a particu particular lar currenc currency y if its magnitude magnitude is expres expressed sed in that curren currency cy.. & transaction is measured in a particular currency hen it is recorded in the financial records in that currency. &ssets and liabilities are denominated in a currency if their amounts are fixed in terms of that currency, and they are settled ith that currency.
6
Direct *uotation: +.-+ / 0+.1ndirect *uotation: ++.- / .23 euros per dollar
7
%fficial or fixed rates are set by a government and do not change as a result of changes in orld currency markets. Free or floating exchange rates are those that reflect fluctuating market prices for currency based on supply and demand factors in orld currency markets. The 4nited #tates changed from fixed to floating (free) exchange rates in +56+. 7ut the 4.#. dollar is sometimes described as a 8filthy float9 because the 4nited #tates has fre*uently engaged i n currency transactions to support or eaken the th e dollar against other currencies. #uch action is taken for economic reasons, such as to make 4.#. goods more competitive in orld markets. 7oth apan and ;ermany have engaged in currency transactions in an attempt to support the 4.#. dollar. 1n February +526, the 4nited #tates and six other industrial nations (the ;roup of 6 or ;"6) entered the
8
#pot rates are the exchange rates for immediate delivery of currencies exchanged. The current rate for forei foreign gn curren currency cy transac transactions tions is the spo spott rate in effe effect ct for for immediat immediatee settlem settlement ent of the amounts amounts denominated in foreign currency at the balance sheet date. =istorical rates are the rates that ere in effect on the date that a particular event or transaction occurred. #pot rates could be be fixed rates if the currency as a fixed rate currency as determined by the government issuing the currency. Copyright > -+? @earson Aducation
12-2
Derivatives and Foreign Currency: Concepts and Common Transactions
9
The transaction is a foreign transaction because it involves import activities, but it is not a foreign currency transaction for the 4.#. firm because it is denominated in local currency. 1t is a foreign currency transaction for the apanese company.
10
&t the transaction date, assets and liabilities denominated in foreign currency are translated into dollars by use of the exchange rate in effect at that date, and they are recorded at that amount. &t the balance sheet date, cash and amounts oed by or to the enterprise that are denominated in foreign currency are adBusted to reflect the current rate. &ssets carried at market hose current market price is stated in a foreign currency are adBusted to the e*uivalent dollar market price at the balance sheet date.
11
Axchange gains and losses occur because of changes in the exchange rates beteen the transaction date and the date of settlement. 7oth exchange gains and exchange losses can occur in either foreign import activities or foreign export activities. The statement is erroneous.
12
Axchange gains and losses on foreign currency transactions are reflected in income in the period in hich the exchange rate changes except for hedges of an identifiable foreign currency commitment here deferral is possible if certain re*uirements are met. &lso hedges of a net investment in a foreign entity are treated as e*uity adBustments from translation. 1ntercompany foreign currency transactions of a long"term nature are also treated as e*uity adBustments.
13
There ill be a 0- exchange loss in the period of purchase and a 0+- exchange gain in the period of settlement: Billing date Inventory Accounts payable (fc) Year-end adjustment Exchange loss Accounts payable (fc) Settlement date Accounts payable (fc) !ash Exchange ga#n
$1,450 $1,450 $
$
20
$1,40
Copyright > -+? @earson Aducation
20
$1,4"0 10
Chapter 12
12-3
SOLUTIONS TO EXERCISES Solution E12-1 1 2 3 4
b c a
Solution E12-2
December 10, 2013 Accounts rece#vable (%A) &ales (%', %&E) o recor sale to ou# &A* #nvo#ce #s $20,000+ Accounts rece#vable (fc) (%A) &ales (%', %&E) o recor sale to r#t -t+* $0+2. / $14,4"0)+
20,000 20,000
14,4"0 b#ll#ng #s
December 31, 2013 Exchange loss (%-o, &E) Accounts rece#vable (fc) (A) o aust accounts rece#vable to euros3($0+1 $0+2.)
14,4"0 for 20,000 euros (20,000 euros
100 100 rate at
exchange
January 10, 2014 !ash (%A) 20,000 Accounts rece#vable (A) o recor collect#on #n full fro6 ou# &A !ash (%A) Accounts rece#vable (fc) (A) Exchange ga#n (%7a, %&E) o
recor
collect#on #n
full
fro6
x
yearen
20,000
20,000
14,"00 14,."0 240 r#t
-t+
recogn#8e exchange ga#n for 2014 20,000 Euros
(20,000
Euros
$0+.0)
an
($0+.0 $0+1)
Solution E12-3
December 20, 2013 Inventory (%A) 10,000 Accounts payable (fc) (%-) 10,000 o recor purchase of 6erchan#se fro6 9e#n A7* b#ll#ng #s $10,000 Inventory (%A) 10,":5 Accounts payable (fc) (%-) 10,":5 o recor purchase of 6erchan#se fro6 -e6o ;<* b#ll#ng #s for 15,000 Euros (15,000 Euros x $0+1. / $10,":5)+ December 31, 2013 Exchange loss (%-o, &E) Accounts payable (fc) (%-)
5
Copyright > -+? @earson Aducation
5
Derivatives and Foreign Currency: Concepts and Common Transactions
12-4
o aust accounts ($0+1 $0+1.)+
payable
to
exchange
January 15, 2014 Accounts payable (-) !ash (A) o recor pay6ent #n full to 9e#n A7+ Accounts payable (fc) (-) !ash (A) Exchange ga#n (%7a, &E)
rate
at
yearen
euros
10,000 10,000
10,0 10,"50 120
o recor pay6ent #n full to -e6o ;< (15,000 Euros exchange ga#n for 2014 15,000
15,000
$0+10) an recogn#8e
Euros ($0+10 $0+1)+
Solution E12-4 1
he ollar has =ea>ene aga#nst the yen because #t no= costs 6ore ollars to buy one yen+
2
10,000,000 yen
3
Accounts payable(yen) Exchange loss !ash
4
$+005 / $5,000
?#66er =oul have h#s =oul assure the#r obl#gat#on, neee to sat#sfy
$5,000 1,000
entere a contract to purchase yen for future rece#pt+ that ?#66er ha the yen ava#lable at that ate to pay an =oul have @loc>e #n the a6ount of B& ollars that obl#gat#on+
Copyright > -+? @earson Aducation
$",000
Chapter 12
12-5
Solution E12-5
otal -u6ber !osts
Car>et r#ce
Exerc#se r#ce
$ 120
$ 100
es
$ 100,000
$ 20,000
$ 100
$ 100
;o
$ 100,000
$ 20,000
$ 0
$ 100
;o
$ 0,000
$ 20,000
Exerc#se
Dpt#on !osts
Dther !osts $ 10,000 $ 10,000 $ 10,000
&ell#ng r#ce $ 150,000 $ 150,000 $ 150,000
Econo6#c Inco6e $ 20,000 $ 20,000 $ 40,000
Solution E12-6
Aust6ent #n value of account rece#vable for 2011F ($+4 $+0)
:0,000 !$ / $.,"00 exchange ga#n
Aust6ent #n value of account rece#vable at settle6ent #n 2012F ($+. $+4)
:0,000 !$ / $:00 exchange loss
Solution E12-7
May 1, 2011 Accounts rece#vable (fc) $...,... &ales $...,... o recor sale of #nventory #te6s to 'oyal for 200,000 pounsF 200,000 pounsG+"000 pouns (#n#rect Huotat#on)+ May 30, 2011 !ash (fc) $..0,5: Exchange loss 2,54 Accounts rece#vable (fc) $...,... o recor rece#pt of 200,000 pouns fro6 'oyal #n settle6ent of accounts rece#vableF 200,000 pounsG+"050 pouns+
Copyright > -+? @earson Aducation
Derivatives and Foreign Currency: Concepts and Common Transactions
12-6
Solution E12-8 ase
on AI!A
1
'ece#vable at 10G15G11 Euros rece#ve an sol for B+&+ ollars on 11G1"G11 ore#gn exchange loss 2011 2
$420,000 415,000 5,000
Dn Jece6ber .1, 2011 u6# !orp+ austs #ts account payable eno6#nate #n euros fro6 $12,000 (10,000 x $1+20) to $12,400 (10,000 recogn#8es a loss of $400 10,000 -!B
$1+24) an
($1+24 $1+20)
3
Jece6ber .1, 2011 note payable Kuly 1, 2012 note payable 2012 exchange loss
$240,000 20,000 $(40,000)
;ote rece#vable Jece6ber .1, 2011 A6ount collecte Kuly 1, 2012
$140,000
(40,000 -!B ) 2012 exchange loss
105,000
4
$ .5,000
Solution E12-9 1
Exchange ga#n or loss #n 2011F Account rece#vable Jece6ber 1" Jece6ber .1 auste balance 150,000 !$ $0+" Account payable Jece6ber 2 Jece6ber .1 auste balance 25,000 !$ $0+" ;et exchange ga#n for 2011
2
Exchange ga#n or loss #n 2012F Account rece#vable auste 12G.1 Account rece#vable 1G15G12 150,000 !$ x $0+"5 Account payable auste 12G.1 Account payable 1G.0G12 25,000 !$ x $0+"5 ;et exchange loss for 2012
7a#n or (-oss) $10.,500 102,000 $1:5,250 1,000
,250 $ ",50 7a#n or (-oss)
$102,000 101,250 $1,000 1,.5
Copyright > -+? @earson Aducation
$(1,500)
$
(50)
(1,.5) $(2,125)
Chapter 12
12-7
Solution E12-10 1
December 12, 2011 Inventory Accounts payable (yen)
$.5,000 $.5,000
urchase fro6 o>o !o6pany (50,000,000 yen December 15, 2011 Accounts rece#vable (pouns) &ales
$+0050)+
$ "",000 $ "",000
&ale to r#t#sh roucts !o6pany (40,000 pouns 2
$1+"5)+
December 31, 2011 Exchange loss $ 5,000 Accounts payable (yen) $ 5,000 o aust accounts payable eno6#nate #n yen for exchange rate
changeF 50,000,000 yen ($+00"0 $+0050)+ Exchange loss $ 2,000 Accounts rece#vable (pouns) $ 2,000 o aust accounts rece#vable eno6#nate #n pouns for exchange rate changeF 40,000 pouns 3
($1+"5 $1+"0)+
January 11, 2012 Accounts payable (yen) Exchange loss !ash
$.0,000 2,500 $.2,500
o recor pay6ent to o>o !o6pany (50,000,000 yen January 14, 2012 !ash Accounts rece#vable (pouns) Exchange ga#n
$+00"5)+
$ "5,200 $ "4,000 1,200
o recor rece#pt fro6 r#t#sh roucts !o6panyF 40,000 pouns $1+".+
Copyright > -+? @earson Aducation
Derivatives and Foreign Currency: Concepts and Common Transactions
12-8 Solution E12-11 Comment he
contract rece#vable an payable are both recore #nstea of recor#ng the contract net because Cart#n 6ust el#ver the euros to the exchange bro>er, net settle6ent #s not allo=e+ ct!ber 2, 2011 !ontract rece#vable $"5.,000 !ontract payable (fc) $"5.,000 o recor contract to sell 1,000,000 euros to exchange bro>er #n 10 ays for the for=ar rate of $+"5.0+ December 31, 2011 !ontract payable (fc) $ 12,000 Exchange ga#n $ 12,000 o aust contract payable #n euros to the :0ay for=ar rate of $+"410+ Marc" 31, 2012 !ontract payable (fc) $"41,000 Exchange loss 14,000 !ash (fc) $"55,000 o recor pay6ent of 1,000,000 euros to exchange bro>er =hen spot rate #s $+"550+
!ash
$"5.,000 !ontract rece#vable $"5.,000 o recor rece#pt of B+&+ ollars fro6 exchange bro>er #n settle6ent of account+
Copyright > -+? @earson Aducation
Chapter 12
12-9
SOLUTIONS TO !RO"LE#S Solution !12-1
!D =oul rece#ve $,000 fro6 L? / 100,000 x (2+42+40)
Solution !12-2
he expecte prof#t for &ue #s .00,000 x ($"+20 $5+:0) / $:0,000
#nhe"$e" %ain&'(oss)
*cono+ic %ain& '(oss) on !orwar"
*cono+ic ,nco+e with e"$e
Market Price per Bushe
!orwar" Price per Bushe
0.-
0.-
0+?-,---
0(-,---)
05-,---
0.3-
0.-
+-,---
(3-,---)
5-,---
0.-
0.-
5-,---
E
5-,---
0.+-
0.-
-,---
3-,---
5-,---
0.--
0.-
3-,---
-,---
5-,---
Copyright > -+? @earson Aducation
Derivatives and Foreign Currency: Concepts and Common Transactions
12-10 Solution !12-3
he expecte prof#t for &ue #s .00,000($"+20 $5+:0 $0+05) / $5,000
#nhe"$e" %ain&'(oss)
*cono+ic %ain& '(oss) on .ption */ercise
Market Price per Bushe
.ption Price per Bushe
0.-
0.-
0+?-,---
"""
0+3?,---
0.3-
0.-
+-,---
"""
+-?,---
0.-
0.-
E
6?,---
0.+-
0.-
-,---
3-,---
6?,---
0.--
0.-
3-,---
-,---
6?,---
5-,---
Copyright > -+? @earson Aducation
*cono+ic ,nco+e '(oss) with ost o .ption
Chapter 12
12-11
Solution !12-4
September 14, 2013 Accounts rece#vable (fc) (%A) &ales (%', %&E)
,200 ,200
o recor sale to ernano &A* b#ll#ng #s for 10,000 Euros (10,000 Euros $0+20 B&J / $,200 B&J)+
October 12, 2013 Inventory (%A) 15,44 Accounts payable (fc) (%-) 15,44 o recor purchase of 6erchan#se fro6 Car> A7* b#ll#ng #s for 12,000 &=#ss franc (12,000 &=#ss franc x $1+.12 B&J / $15,4 B&J)+ December 31, 2013 Accounts rece#vable (fc) (%A) Exchange ga#n (%7a, %&E)
10 10
o aust accounts rece#vable to ($0+21B&J $0+20 B&J)+
exchange rate at yearen 10,000 Euros
Accounts payable (fc) (-) Exchange ga#n (%7a, %&E)
24 24
o aust accounts payable to exchange rate at yearen 12,000 &=#ss franc ($1+.12 B&J $1+.10 B&J)+ January 18, 2014 !ash (%A) Accounts rece#vable (fc) (A) Exchange ga#n (%7a, %&E)
,240 ,210 .0
o recor collect#on #n full fro6 ernano &A (10,000 Euros recogn#8e exchange ga#n for 2014 10,000 Euros
$0+24 B&J) an
($0+24 $0+21)
Accounts payable (fc) (-) Exchange loss (%-o, 'E) !ash (A)
15,5" ." 15,5"
o recor collect#on #n full fro6 Car> A7 (12,000 &=#ss franc an recogn#8e $1+.10 B&J)+
exchange loss
for 2014
August 11, 2014 !ash (%A) Exchange loss (%-o, &E) !ash (fc) (A)
12,000
&=#ss franc
$1+.1. B&J)
($1+.1.
B&J
,1:0 50 ,240
o convert 10,000 Euros #nto B&J (10,000 Euros exchange loss 10,000 Euros
$0+1:) an to recogn#8e
($0+24 $0+1:)
Copyright > -+? @earson Aducation
Derivatives and Foreign Currency: Concepts and Common Transactions
12-12 Solution !12-5
December 1, 2014 Accounts rece#vable (fc) (%A) &ales (%', %&E) o recor sale to #ng te+ &7J3$0+: B&J / $14,4"0 B&J)+
15,:"0 -t+*
b#ll#ng
Accounts rece#vable (fc) (%A) &ales (%', %&E)
15,:"0 for $20,000
#s
&7J
($20,000
2",250 2",250
o recor sale to &atr#a b>+* b#ll#ng #s for 'p.00,000,000 ('p.00,000,000 $0+00005 B&J / $2",250 B&J)+
Inventory (%A) 15,500 Accounts payable (fc) (%-) 15,500 o recor purchase of 6erchan#se fro6 atay Inc+* b#ll#ng #s for 500,000 baht (500,000 baht
$0+0.1 B&J / $15,500 B&J)+
December 31, 2014 Exchange loss (%-o, &E) Accounts rece#vable (fc) (A) o aust accounts rece#vable to ($0+" B&J $0+: B&J)
"0 "0 exchange rate at
yearen
Accounts rece#vable (fc) (%A) 1,00 Exchange ga#n (%7a, %&E) o aust accounts rece#vable to exchange 'p.00,000,0003($0+0000:11 B&J $0+00005 B&J) Accounts payable (fc) (-) Exchange ga#n (%7a, %&E) o aust accounts payable ($0+02: B&J $0+0.1)
to
$20,000 &7J
1,00 rate at
yearen
1,000 1,000 exchange
January 15, 2015 !ash (%A) Accounts rece#vable (fc) (A) Exchange ga#n (%7a, %&E)
rate
at
yearen
500,000
1",040 15,200 40
o recor collect#on #n full fro6 #ng te+ -t+ ($20,000 &7J an recogn#8e exchange ga#n for 2015 $20,000 &7J !ash (%A) Exchange loss (%-o, 'E) Accounts rece#vable (fc) (A)
baht
$0+02 B&J)
($0+02 $0+")
24,150 .,10 2,..0
o recor collect#on #n full fro6 &atr#a b>+ ('p.00,000,000 $0+000005 B&J) an recogn#8e exchange loss for 2015 'p.00,000,0003($0+000005 B&J $0+0000:11 B&J) Accounts payable (fc) (-) Exchange loss (%-o, 'E) !ash (A)
14,500 1,400 15,:00
o recor collect#on #n full fro6 atay Inc+ (500,000 aht $0+.1 B&J) an recogn#8e exchange loss for 2015 500,000 aht3($0+0.1 B&J $0+02: B&J)
Copyright > -+? @earson Aducation
Chapter 12
12-13
Copyright > -+? @earson Aducation
