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Hedging a foreign

Hedging a foreign

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 1 (LO 3, 6) Hedging a foreign currency liability with an option desig- nated as a fair value hedge. Williams Corporation imports, from a number of German manufacturers, large machining equipment used in the tooling industry. On June 1, the com- pany received delivery of a piece of machinery with a cost of 450,000 euros when the spot rate was 1 euro equals $1.370. Williams had already paid 50,000 euros, when the spot rate was 1 euro equals $1.350, to the German company at the time of placing the order, and the balance of the invoice was due in 60 days after delivery. On June 15, the company became concerned that the dollar would weaken relative to the euro and proceeded to purchase an option to buy euros on July 31 at a strike price of 1 euro equals $1.375. The hedge was designated as a fair value hedge. At the time of purchase, the out-of-the-money option had a value of $1,400 and a value of $2,600 at June 30. Euro spot rates are as follows: 1 euro = $1.373 1.381 June 15 June 30 July 31... 1.385 On July 31, the option was settled and the foreign currency was remitted to the German vendor. Assuming that financial statements are prepared for June and July, identify all relevant income statement and balance shecet accounts for the above transactions and determine the appropriate monthly balances.
Transcribed Image Text:Exercise 1 (LO 3, 6) Hedging a foreign currency liability with an option desig- nated as a fair value hedge. Williams Corporation imports, from a number of German manufacturers, large machining equipment used in the tooling industry. On June 1, the com- pany received delivery of a piece of machinery with a cost of 450,000 euros when the spot rate was 1 euro equals $1.370. Williams had already paid 50,000 euros, when the spot rate was 1 euro equals $1.350, to the German company at the time of placing the order, and the balance of the invoice was due in 60 days after delivery. On June 15, the company became concerned that the dollar would weaken relative to the euro and proceeded to purchase an option to buy euros on July 31 at a strike price of 1 euro equals $1.375. The hedge was designated as a fair value hedge. At the time of purchase, the out-of-the-money option had a value of $1,400 and a value of $2,600 at June 30. Euro spot rates are as follows: 1 euro = $1.373 1.381 June 15 June 30 July 31... 1.385 On July 31, the option was settled and the foreign currency was remitted to the German vendor. Assuming that financial statements are prepared for June and July, identify all relevant income statement and balance shecet accounts for the above transactions and determine the appropriate monthly balances.
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