Module—Derivatives and Related Accounting Issues Key
1. Which of the following statements is true?
2. A critical characteristic of a derivative is that the instrument
3. The underlying amount of a derivative instrument is
4. The notional amount of a derivative instrument is
5. The total value of a derivative is determined by the
6. Forward contracts are contracts to buy or sell a specified amount of an asset at a specified, fixed price with
delivery at a specified future point in time. Which of the following is true about these contracts?
D. A forward contract requires an initial deposit of funds with the transacting broker.
7. A forward contract
8. On September 1st of the current year, Mooney Company writes a contract agreeing to sell to Berry Company
200,000 foreign currency (FC) units at a specific price of $2.14 per FC with delivery in 30 days. The spot rate at
the end of 30 days is $2.17. The appropriate discount rate for both Mooney Company and Berry Company is
9%, and Mooney’s year end is December 31.
On the settlement of the contract, Mooney would record a
9. On August 1st of the current year, Lenz Company writes a contract agreeing to sell to Hindman Company
15,000 British pounds at a specific price of $0.69 per pound with delivery in 60 days. Throughout the 60-day
period the forward rate varies as follows:
60 days remaining on the contract
$0.69
30 days remaining on the contract
$0.68
0 days remaining on the contract
$0.675
Assume an 8% discount rate for Lenz Company and Hindman Company. For the first 30 day period, Lenz Company would recognize a:
10. On August 1st of the current year, Lenz Company writes a contract agreeing to sell to Hindman Company
15,000 British pounds at a specific price of $0.69 per pound with delivery in 60 days. Throughout the 60-day
period the forward rate varies as follows:
60 days remaining on the contract
$0.69
30 days remaining on the contract
$0.68
0 days remaining on the contract
$0.675
The spot rate at the end of 60 days is $0.675. Assume an 8% discount rate for both Lenz Company and Hindman Company. For the second thirty day
period, Hindman would recognize a:
11. A futures contract
12. Both forward contracts and futures contracts provide for the receipt or payment of a specific amount of an
asset at a specific price with delivery at a specified future point in time. Which combination of characteristics is
true for a futures contract?
Subject to Subject to
margin call discounting
13. Jenson Company buys 20 contracts on the Chicago Board of Trade to receive October delivery of soybeans
to a certified warehouse. Each contract is in units of 3,000 bushels at a futures price of $2.75 per bushel. The
owner of the contract requires a margin account with an initial margin of $8,000, with a maintenance margin of
$6,000. What entry will Jenson Company make to establish the margin account?
14. Which of the following is not true regarding using an option to hedge financial risks versus a forward
contract?
15. An option
16. Based on the relationship between the strike price and the current price, an option may be at-the-money,
out-of-the-money or in-the-money. Which of the following statements is true?
17. The difference between the strike price of an option and spot price of the item being hedge at any one time
represents the option’s:
18. Which of the following is true about options?
19. On April 4, Alam Company purchased a call option on 10,000 bushels of corn with delivery on June 30. The
strike price is $2.15 per bushel. The value of the option and the market value of the corn are as follows.
Value of the option
Value of the corn
April 4
$1,830
$20,400
April 30
2,010
22,500
May 31
2,530
23,800
June 30
2,700
24,200
20. Clark Company holds several options:
Strike Price
Call option on Ionics
$27.90
Call option on Kimberly
64.84
Put option on Motorola
16.40
Put option on Nortek
32.10
The intrinsic value of Clark Company’s options is
21. On May 11, McElroy Inc. purchased a call option on 5,000 bushels of wheat with delivery on August 31 for
a premium of $750. The strike price is $1.85 per bushel. The values of the option at the end of May and June are
$790 and $810, respectively. The option is sold on July 26 for $804. McElroy Inc. prepares quarterly and annual
financial statements. Its year end is June 30. McElroy Inc. will
22. On May 1 of the current year, Orr Company purchases a call option on 15,000 bushels of corn with delivery
in July for a premium of $1,200 and a strike price of $3.05 per bushel. The values of the option at the end of
May and June are $1,125 and $1,007, respectively. The option is sold on July 7th for $1,133. Orr Company
prepares monthly financial statements.
23. A swap
24. Interest rate swaps
25. Which of the following has an asymmetric return profile?
26. A fair value hedge may be used for all of the following except:
27. An advantage of a fair value hedge is that:
28. A hedge to avoid the potential unfavorable effects of changing prices associated with all of the following
would qualify for special fair value hedge accounting except:
29. In order for a fair value hedge to receive special accounting treatment, the
30. On August 1, an oil producer decided to hedge the fair value of its inventory by acquiring a futures contract
to sell 100,000 barrels of oil on November 1 for $85.00 each. Price data follow:
Spot Price
Futures Price
August 1
$84.00
$85.00
September 1
82.80
83.50
October 1
82.20
82.40
November 1
81.00
81.00
What was the fair value of the contract on October 1?
31. On August 1, an oil producer decided to hedge the fair value of its inventory by acquiring a futures contract
to sell 100,000 barrels of oil on November 1 for $85.00 each. Price data follow:
Spot Price
Futures Price
August 1
$84.00
$85.00
September 1
82.80
83.50
October 1
82.20
82.40
November 1
81.00
81.00
What is the current period change in time value that would be recognized in earnings as of October 1?
32. On January 1, 20X3, Shuey Company borrowed $1,000,000 at the fixed rate of 10% for 10 years with
interest payable semi-annually. Shuey anticipates that interest rates will fall and has also arranged to receive a
10% rate of interest in exchange for the payment of variable rates based on LIBOR + 1.5%. LIBOR rates were
as follows on the reset dates:
LIBOR rate
FV of swap
January 1, 20X3
8.5%
July 1, 20X3
8.3%
$40,000
January 1, 20X4
8.2%
$38,000
How much interest expense is recognized for the six months ended December 31, 20X3?
33. All of the following are examples of cash flow hedges except:
34. At the beginning of 20X5, a derivative loss associated with a forecasted purchase of equipment will plus the
expected cost of the equipment is $211,000. The fair value of the equipment is $199,000. The equipment has a
useful life of 5 years.
35. Under special accounting treatment for cash flow hedge of a forecasted transaction, the relationship between
the change in value of a derivative instrument and the change in value of the forecasted transaction affects the
amount of gain(loss) that should be in Other Comprehensive Income (OCI). If the amount of gain on derivatives
that is classified as OCI is $17,500 and the cumulative loss on the remaining forecasted transaction is ($13,200),
the amount of OCI to be reclassified as a component of current earnings is
36. On January 1, 20X3, Shuey Company borrowed $1,000,000 at a variable rate based on LIBOR + 1.5% for
10 years with interest payable semi-annually. Shuey anticipates that interest rates will rise and has also
arranged to receive a variable rate based on LIBOR + 1.5% in exchange for the payment of a 10% rate of
interest. LIBOR rates were as follows on the reset dates:
LIBOR rate
FV of swap
January 1, 20X3
8.5%
July 1, 20X3
8.7%
$40,000
January 1, 20X4
8.8%
$37,000
How much interest expense is recognized for the six months ended December 31, 20X3?
37. Which of the following is true of the financial statement presentation of gains/losses from cash flow hedges
and fair value hedges?
Cash flow hedge Fair value hedge
gains/losses are reported in: gains/losses are reported in:
38. With respect to derivative instruments that are designated as hedges, the FASB calls for which of the
following general disclosures?
39. On February 1, Durham Company writes a forward contract to sell Rubright Company 3,000,000 yen at a
specific, fixed price of $0.00875 per yen with delivery in 60 days. The spot rate at the end of the 60 days is
$0.00913 per yen. The following is the forward rates information throughout the 60-day term.
Remaining Term of Contract
Forward Rate
Notional Amount
60 days
$0.00875
3,000,000
30 days
0.00891
3,000,000
0 days
0.00913
3,000,000
Assume the discount rate is 7%.
Required:
a.
Compute the gain or loss for Rubright Company over the life of the contract.
b.
Assume the contract is settled at the end of the 60 days, prepare the journal entries to account for this contract on Rubright’s books.
Remaining
Total
Cumulative
Term of
Forward
Notional
Forward
Change in
Contract
Rate
Amount
Value
Forward Value
60 days
$0.00875
3,000,000
$26,250
30 days
0.00891
3,000,000
26,730
$ 480
0 days
0.00913
3,000,000
27,390
1,140
30 day
Total Life
Remaining
of Contract
Cumulative change in forward value
$480.00
$1,140.00
Present value of cumulative change
30 days at 7% [$480 – ($480 ´ 7% ´ 1/12)]
$477.20
0 days at 7%
$1,140.00
Less previously recognized gain or loss
0
477.20
Current period gain or loss
$477.20
$ 662.80
Feb
28
Investment in forward contract
477.20
Gain on contract
477.20
Mar
31
Cash
1,140.00
Investment in forward contract
477.20
Gain on contract
662.80
40. On September 23, Gensil Company buys 40 contracts on the Chicago Board of Trade to deliver orange juice
to a certified warehouse in November. Each contract is in units of 15,000 pounds at a futures price of $0.851 per
pound. The initial margin on the contract is set at $18,000, with a maintenance margin of $14,000. The futures
prices are as follows:
Sept. 23
Sept. 24
Sept. 25
$0.851
$0.847
$0.850
Required:
a.
Journalize the entries for Gensil Company for the first three days of the contract.
b.
What is meant by the maintenance margin and how could it affect Gensil Company?
a.
Journal entries:
Sept
23
Futures contract – margin account
18,000
Cash
18,000
Sept
24
Loss on contract
2,400
Futures contract – margin account
2,400
[40 contracts ´ 15,000 pounds ´
($0.851 vs. $.847)]
Sept
25
Futures contract – margin account
1,800
Gain on contract
1,800
[40 contracts ´ 15,000 pounds ´
($0.847 vs. $.850)]
41. On August 9, Jacobs Company buys 25 contracts on Nymex to receive December delivery of Brent Crude
Oil. Each contract is in units of 1,000 bbls at a futures price of $24.85 per bbl. The initial margin on the contract
is set at $25,000, with a maintenance margin of $19,000. The futures prices are as follows:
Aug. 9
Aug. 10
Aug. 11
$24.85
$24.63
$24.56
Required:
a.
Journalize the entries for Jacobs Company for the first three days of the contract.
b.
Why are forward prices discounted and future prices are not discounted?
Journal entries:
Aug
9
Futures contract – margin account
25,000
Cash
25,000
Aug
10
Loss on contract
5,500
Futures contract – margin account
5,500
[25 contracts ´ 1,000 bbls ´
($24.85 vs. $24.63)]
Aug
11
Loss on contract
1,750
Futures contract – margin account
1,750
[25 contracts ´ 1,000 bbls ´
($24.63 vs. $24.56)]
Futures contract – margin account
7,250
Cash
7,250
$25,000 – $5,500 – $1,750 = $17,750
which is below maintenance margin
of $19,000.
Bring margin account up to initial
margin ($25,000 – $17,750).
necessary.