Chapter 07 – Foreign Currency Transactions and Hedging Foreign Exchange Risk
Answers to Questions
1. Under the two-transaction perspective, an export sale (import purchase) and the
2. Foreign currency receivables resulting from export sales are revalued at the end of
3. Foreign exchange gains and losses are created by two factors: having foreign currency
4. Hedging is the process of eliminating exposure to foreign exchange risk so as to avoid
5. A party to a foreign currency forward contract is obligated to deliver one currency in
6. Hedges of foreign currency denominated assets and liabilities are not entered into until a
8. All derivative financial instruments must be recognized as assets or liabilities on the
balance sheet, measured at fair value.
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Chapter 07 – Foreign Currency Transactions and Hedging Foreign Exchange Risk
9. The fair value of a foreign currency forward contract is determined by reference to
changes in the forward rate over the life of the contract, discounted to the present value.
10. Hedge accounting is defined as recognition of gains and losses on the hedging instrument
11. For hedge accounting to apply, the forecasted transaction must be probable (likely to
12. In both cases, (1) sales revenue (or the cost of the item purchased) is determined using
the spot rate at the date of sale (or purchase), and (2) the hedged asset or liability is
13. For a fair value hedge of a foreign currency asset or liability (1) sales revenue (cost of
purchases) is recognized at the spot rate at the date of sale (purchase) and (2) the
hedged asset or liability is adjusted to fair value based on changes in the spot exchange
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Chapter 07 – Foreign Currency Transactions and Hedging Foreign Exchange Risk
14. For a cash flow hedge of a foreign currency asset or liability (1) sales revenue (cost of
purchases) is recognized at the spot rate at the date of sale (purchase) and (2) the
hedged asset or liability is adjusted to fair value based on changes in the spot exchange
rate with a foreign exchange gain or loss recognized in net income. The forward contract
15. In accounting for a fair value hedge, the change in the fair value of the foreign currency
16. The accounting for a foreign currency borrowing involves keeping track of two foreign
Solutions to Exercises and Problems
1. C An import purchase causes a foreign currency payable to be carried on the books. If
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Chapter 07 – Foreign Currency Transactions and Hedging Foreign Exchange Risk
2. D A foreign currency receivable will generate a foreign exchange gain when the foreign
3. D The forward contract must be reported at its fair value discounted for two months at
4. C The 100,000 shekel receivable has changed in dollar value from $24,000 at 12/1/Y1 to
5. D The nominal value of the forward contract on December 31, Year 1 is a positive
The easiest way to solve problems 6, 7 and 8 is to prepare journal entries for the option
fair value hedge and the firm commitment. The journal entries are as follows:
9/1/Y1
12/31/Y1
6. B
3/1/Y2
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Chapter 07 – Foreign Currency Transactions and Hedging Foreign Exchange Risk
7. C
8. D Net cash inflow with the option: $75,000 – 1,700 = $73,300
9. C Option Expense decreases net income by $300.
2/1/Y2
Option Expense $ 900
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Chapter 07 – Foreign Currency Transactions and Hedging Foreign Exchange Risk
10. B
11. Garden Grove Corporation – Foreign Currency Sale/Receivable
12. El Primero Company – Foreign Currency Purchase/Payable
12/1/Y1 Inventory $34,800
13. Lester Company – Foreign Currency Borrowing
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Chapter 07 – Foreign Currency Transactions and Hedging Foreign Exchange Risk
9/30/Y2 Interest expense [15,000 markkas x $.23] $3,450
Year 1
Year 2
Year 3
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Chapter 07 – Foreign Currency Transactions and Hedging Foreign Exchange Risk
The net cash flow from this borrowing is:
14. Budvar Company (First Problem)
a. Forward Contract Cash Flow Hedge of Foreign Currency Receivable
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Chapter 07 – Foreign Currency Transactions and Hedging Foreign Exchange Risk
b. Forward Contract Fair Value Hedge of Foreign Currency Receivable
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Chapter 07 – Foreign Currency Transactions and Hedging Foreign Exchange Risk
Impact on net income over both periods: $19,823.64 + $976.36 = $20,800; equal to cash
inflow.
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Chapter 07 – Foreign Currency Transactions and Hedging Foreign Exchange Risk
15. Budvar Company (Second Problem)
a. Forward Contract Cash Flow Hedge of Foreign Currency Payable
12/1/Y1 Inventory $20,000
12/31/Y1 Foreign exchange loss $1,000
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Chapter 07 – Foreign Currency Transactions and Hedging Foreign Exchange Risk
Impact on Year 2 income:
b. Forward Contract Fair Value Hedge of Foreign Currency Payable
Impact on Year 1 income:
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Chapter 07 – Foreign Currency Transactions and Hedging Foreign Exchange Risk
Total $(20,976 .36)
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