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3. In part (2), assume that the two hedged items involved the purchase of inventory. Explain how the changes in value of the hedging instruments would affect the basis of the inventory.

3. In part (2), assume that the two hedged items involved the purchase of inventory. Explain how the changes in value of the hedging instruments would affect the basis of the inventory.

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Exercise 3 (LO 5, 6) Measuring changes in the value of derivatives and account- ing for such changes. A company has acquired two derivatives: an option to buy foreign currency (FC) and a forward contract to buy FC. Both derivatives were acquired on the same day, for the same notional amount and expire on May 31. Relevant information involving the derivatives is as follows: February 1 April 30 May 31 Notional amount in FC ... 100,000 $ $ $ 2.05 $ 1,000 100,000 $ 2.08 $ 2.09 $ 2.05 $ 3,400 100,000 $ 2.10 $ 2.10 $ 2.05 $ 5,000 Spot rate ... Forward rate 2.05 2.07 Strike price.. Value of option 1. Calculate the intrinsic and the time value of the option for each of the above dates and indi- cate how the changes in each of these values would be accounted for if the option hedged: (a) a forecasted FC transaction and (b) a recognized FC-denominated liability. 2. Calculate the value of the forward contract at each of the above dates and indicate how the changes in each of these values would be accounted for if the contract hedged: (a) an unrec- ognized FC firm commitment (b) a recognized FC-denominated liability. Assume a 6% interest rate for any discounting purposes. 3. In part (2), assume that the two hedged items involved the purchase of inventory. Explain how the changes in value of the hedging instruments would affect the basis of the inventory.
Transcribed Image Text:Exercise 3 (LO 5, 6) Measuring changes in the value of derivatives and account- ing for such changes. A company has acquired two derivatives: an option to buy foreign currency (FC) and a forward contract to buy FC. Both derivatives were acquired on the same day, for the same notional amount and expire on May 31. Relevant information involving the derivatives is as follows: February 1 April 30 May 31 Notional amount in FC ... 100,000 $ $ $ 2.05 $ 1,000 100,000 $ 2.08 $ 2.09 $ 2.05 $ 3,400 100,000 $ 2.10 $ 2.10 $ 2.05 $ 5,000 Spot rate ... Forward rate 2.05 2.07 Strike price.. Value of option 1. Calculate the intrinsic and the time value of the option for each of the above dates and indi- cate how the changes in each of these values would be accounted for if the option hedged: (a) a forecasted FC transaction and (b) a recognized FC-denominated liability. 2. Calculate the value of the forward contract at each of the above dates and indicate how the changes in each of these values would be accounted for if the contract hedged: (a) an unrec- ognized FC firm commitment (b) a recognized FC-denominated liability. Assume a 6% interest rate for any discounting purposes. 3. In part (2), assume that the two hedged items involved the purchase of inventory. Explain how the changes in value of the hedging instruments would affect the basis of the inventory.
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