Answered: Determine the impact on earnings of the…

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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I have a problem with questions below. Impact on earnings of an option and an interest rate swap. Millikin Corporation decided to hedge two transactions. The first transaction is a forecasted transaction to buy 500 tons of inventory in 60 days. The company was concerned that selling prices might increase, and it acquired a 60-day option to buy inventory at a price of $1,200 per ton. Upon acquiring the option, the company paid a premium of $10 per ton when the spot price was $1,201. At the end of 30 days, the option had a value of $19 per ton and a current spot price of $1,214 per ton. Upon expiration of the option, the spot price was $1,216 per ton.

In another transaction, the company borrowed $3,000,000 at a fixed rate of 8%; after three months, the company became concerned that variable rates would be lower than 8%. In response, the company entered into an interest rate swap whereby it paid variable rates to a counterparty in exchange for a fixed rate of 8%. The reset rate for the first 30 days of the swap was 8.1% and was 7.8% for the second 30 days of the swap. The fair value of the swap was $3,000 after the first 30 days and $3,300 after 60 days.

Determine the impact on earnings of the above hedges for the first and second 30-day period.

Textbooks
Fischer, Taylor & Cheng (2012) Advanced financial accounting (11th ed.). Cincinnati, OH:South-
Western College Publishing. ISBN: 9780538480284

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