On September 1, 2017, Jensen Company received an order to sell a machine to a customer in Canada at a price of 100,000 Canadian dollars. Jensen shipped the machine and received payment on March 1, 2018. On September 1, 2017, Jensen purchased a put option giving it the right to sell 100,000 Canadian dollars on March 1, 2018, at a price of $80,000. Jensen properly designated the option as a fair value hedge of the Canadian dollar firm commitment. The option cost $2,000 and had a fair value of $2,300 on December 31, 2017. The fair value of the firm commitment was measured by referring to changes in the spot rate. The following spot exchange rates apply:Date U.S. Dollar per Canadian DollarSeptember 1, 2017 $0.80December 31, 2017 0.79 March 1, 2018 0.77 Jensen Company’s incremental borrowing rate is 12 percent. The present value factor for two months at an annual interest rate of 12 percent (1 percent per month) is 0.9803. Choose the correct. What was the net increase or decrease in cash flow from having purchased the foreign currency option to hedge this exposure to foreign exchange risk?a. $–0–.b. $1,000 increase in cash flow.c. $1,500 decrease in cash flow.d. $3,000 increase in cash flow.
On September 1, 2017, Jensen Company received an order to sell a machine to a customer in Canada
at a price of 100,000 Canadian dollars. Jensen shipped the machine and received payment on March 1, 2018. On September 1, 2017, Jensen purchased a put option giving it the right to sell 100,000 Canadian dollars on March 1, 2018, at a price of $80,000. Jensen properly designated the option as a fair value hedge of the Canadian dollar firm commitment. The option cost $2,000 and had a fair value of $2,300 on December 31, 2017. The fair value of the firm commitment was measured by referring to changes in
the spot rate. The following spot exchange rates apply:
Date U.S. Dollar per Canadian Dollar
September 1, 2017 $0.80
December 31, 2017 0.79
March 1, 2018 0.77
Jensen Company’s incremental borrowing rate is 12 percent. The present value factor for two months at
an annual interest rate of 12 percent (1 percent per month) is 0.9803. Choose the correct. What was the net increase or decrease in
option to hedge this exposure to foreign exchange risk?
a. $–0–.
b. $1,000 increase in cash flow.
c. $1,500 decrease in cash flow.
d. $3,000 increase in cash flow.
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