Fair Value Hedge: Short in Interest Rate Futures On June 1, 2021, Domino Foods borrows $5 million in a floating rate term loan that rolls over every 91 days. The interest rate is set at the current Treasury bill rate plus 0.95 percent, and is payable at the end of each 91-day period. To hedge the risk that interest rates will increase, Domino sells $5 million face value 91-day Treasury bill futures at 98.5; the price reflects the current Treasury bill rate of 1.5 percent. The futures position requires a $6,000 margin deposit, and qualifies as an effective hedge of a firm commitment to roll over the floating rate loan. On August 30, 2021, the end of the 91-day period, the Treasury bill rate is 1.25 percent and the interest rate futures sell for 98.75. Domino rolls over the loan and closes its futures position. Domino is scheduled to roll the loan over again on November 29, 2021, but does not hedge during this second period. Assume that Domino is not required to pay additional cash to the broker to cover hedging losses before it closes its position. Required Prepare the entries necessary to record the above events. Include entries to record interest expense at the end of the first 91-day period and the second 91-day period. Income effects of the hedge are reported in interest expense.
Fair Value Hedge: Short in Interest Rate Futures On June 1, 2021, Domino Foods borrows $5 million in a floating rate term loan that rolls over every 91 days. The interest rate is set at the current Treasury bill rate plus 0.95 percent, and is payable at the end of each 91-day period. To hedge the risk that interest rates will increase, Domino sells $5 million face value 91-day Treasury bill futures at 98.5; the price reflects the current Treasury bill rate of 1.5 percent. The futures position requires a $6,000 margin deposit, and qualifies as an effective hedge of a firm commitment to roll over the floating rate loan. On August 30, 2021, the end of the 91-day period, the Treasury bill rate is 1.25 percent and the interest rate futures sell for 98.75. Domino rolls over the loan and closes its futures position. Domino is scheduled to roll the loan over again on November 29, 2021, but does not hedge during this second period. Assume that Domino is not required to pay additional cash to the broker to cover hedging losses before it closes its position. Required Prepare the entries necessary to record the above events. Include entries to record interest expense at the end of the first 91-day period and the second 91-day period. Income effects of the hedge are reported in interest expense.
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
Related questions
Question
Transcribed Image Text:Fair Value Hedge: Short in Interest Rate Futures
On June 1, 2021, Domino Foods borrows $5 million in a floating rate term loan that rolls over every 91 days. The
interest rate is set at the current Treasury bill rate plus 0.95 percent, and is payable at the end of each 91-day
period. To hedge the risk that interest rates will increase, Domino sells $5 million face value 91-day Treasury bil|
futures at 98.5; the price reflects the current Treasury bill rate of 1.5 percent. The futures position requires a
$6,000 margin deposit, and qualifies as an effective hedge of a firm commitment to roll over the floating rate
loan. On August 30, 2021, the end of the 91-day period, the Treasury bill rate is 1.25 percent and the interest
rate futures sell for 98.75. Domino rolls over the loan and closes its futures position. Domino is scheduled to roll
the loan over again on November 29, 2021, but does not hedge during this second period. Assume that Domino
is not required to pay additional cash to the broker to cover hedging losses before it closes its position.
Required
Prepare the entries necessary to record the above events. Include entries to record interest expense at the end
of the first 91-day period and the second 91-day period. Income effects of the hedge are reported in interest
expense.
Date
Description
Debit
Credit
6/1/21
Cash
5,000,000
Short-term loan payable
5,000,000
To record the floating rate loan.
Investment in futures
6,000 v
Cash
6,000 v
To record the margin deposit on the sale of Treasury bill futures.
8/30/21
Interest expense
0 x
Cash
Investment in futures
6,000 v
To record the loss on the futures position and close it.
Firm commitment
0 x
Interest expense
To record the gain or loss due to the change in the borrowing cost of the loan.
Interest expense
Cash
To record interest on the floating rate loan.
Short-term payable (old)
5,000,000 v
Discount on short-term loan payable
0 x
Firm commitment
Short-term loan payable (new)
5,000,000 v
To roll over the floating rate loan and reclassify the firm commitment.
11/29/21 Interest expense
Discount on short-term loan payable
0 x
Cash
To record interest on the floating rate loan.
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
This is a popular solution!
Trending now
This is a popular solution!
Step by step
Solved in 2 steps
Recommended textbooks for you
Accounting
Accounting
ISBN:
9781337272094
Author:
WARREN, Carl S., Reeve, James M., Duchac, Jonathan E.
Publisher:
Cengage Learning,
Accounting Information Systems
Accounting
ISBN:
9781337619202
Author:
Hall, James A.
Publisher:
Cengage Learning,
Accounting
Accounting
ISBN:
9781337272094
Author:
WARREN, Carl S., Reeve, James M., Duchac, Jonathan E.
Publisher:
Cengage Learning,
Accounting Information Systems
Accounting
ISBN:
9781337619202
Author:
Hall, James A.
Publisher:
Cengage Learning,
Horngren's Cost Accounting: A Managerial Emphasis…
Accounting
ISBN:
9780134475585
Author:
Srikant M. Datar, Madhav V. Rajan
Publisher:
PEARSON
Intermediate Accounting
Accounting
ISBN:
9781259722660
Author:
J. David Spiceland, Mark W. Nelson, Wayne M Thomas
Publisher:
McGraw-Hill Education
Financial and Managerial Accounting
Accounting
ISBN:
9781259726705
Author:
John J Wild, Ken W. Shaw, Barbara Chiappetta Fundamental Accounting Principles
Publisher:
McGraw-Hill Education