Chapter 07 – Foreign Currency Transactions and Hedging Foreign Exchange Risk
Case 7-1 Zorba Company
1. Unhedged Foreign Currency Liability
12/1/Y1 Inventory $50,000
Case 7-1 Zorba Company (continued)
2. Forward Contract Fair Value Hedge of a Recognized Foreign Currency Liability
Accounts Payable (€) Forward Forward Contract
Spot U.S. Dollar Change in U.S. Rate to Change in
Date Rate Value Dollar Value 1/31/Y2 Fair Value Fair Value
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Chapter 07 – Foreign Currency Transactions and Hedging Foreign Exchange Risk
Case 7-1 Zorba Company (continued)
3. Forward Contract Fair Value Hedge of a Foreign Currency Firm Commitment
12/1/Y1 There is no formal entry for the forward contract or the purchase order.
Case 7-1 Zorba Company (continued)
4. Option Cash Flow Hedge of a Recognized Foreign Currency Liability
The following schedule summarizes the changes in the components of the fair value of the
crown call option with a strike price of $1.00 for January 31, Year 2.
Change Change
Spot Option Fair in Fair Intrinsic Time in Time
Date Rate Premium Value Value Value Value Value
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Chapter 07 – Foreign Currency Transactions and Hedging Foreign Exchange Risk
12/1/Y1 Inventory $50,000
12/31/Y1 Foreign Exchange Loss $5,000
1/31/Y2 Foreign Exchange Loss $2,500
Case 7-1 Zorba Company (continued)
4. (continued)
Option Expense $1,000
Case 7-1 Zorba Company (continued)
5. Option Fair Value Hedge of a Foreign Currency Firm Commitment
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Chapter 07 – Foreign Currency Transactions and Hedging Foreign Exchange Risk
Firm Commitment Option Foreign Currency Option
Spot Change in Premium Change in
Date Rate Fair Value Fair Value for 1/31/Y2 Fair Value Fair Value
12/1/Y1 $1.00 $0 – $.04 $2,000 –
1/31/Y2 Foreign Currency Option $1,500
Case 7-2 Portofino Company
1. Below are spreadsheets for the calculation of the foreign exchange gains (losses) related to
Portofino Company’s foreign currency accounts payable. Note: These exchange rates were
obtained by using the “Historical Exchange Rates” link found under “Foreign Exchange
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Chapter 07 – Foreign Currency Transactions and Hedging Foreign Exchange Risk
Foreign
Currency
Account
Payable
Exchange
Rate on
12/15/2012
U.S. Dollar
Value on
12/15/2012
Exchange
Rate on
12/31/2012
U.S. Dollar
Value on
12/31/2012
Foreign
Exchange
Gain (Loss)
on 12/31/2012
Foreign
Currency
Account
Payable
Exchange
Rate on
12/31/2012
U.S. Dollar
Value on
12/31/2012
Exchange
Rate on
1/15/2013
U.S. Dollar
Value on
1/15/2013
Foreign
Exchange
Gain (Loss)
on 1/15/2013
Total
0
0
)
Case 7-2 Portofino Company (continued)
2. Portofino would have reported a net foreign exchange loss of $427.00 in 2012 and a net
foreign exchange loss of $654.00 in 2013 related to these three foreign currency payables.
The cumulative gain/loss recognized on each of the three foreign currency payables was:
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Chapter 07 – Foreign Currency Transactions and Hedging Foreign Exchange Risk
3. Portofino would have benefited from the purchase of a call option on the transactions in
Brazilian reais and Mexican pesos. The net cash outflow on the BRL payable would have
Case 7-3 Better Food Corporation
Memorandum
To: Harvey Carlisle, CEO
The advantage of using forward contracts is that there is no cost to enter into the contract. The
disadvantage is that the company is obligated to exchange foreign currency for dollars at the
contracted forward rate. Depending upon the future spot rate, this may or may not be
advantageous for the company.
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