Chapter 09 – Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e
9-52
Education.
42. (continued)
Part d. Option Cash Flow Hedge of a Foreign Currency Liability
The following schedule summarizes the changes in the components of the fair
value of the euro call option with a strike price of $1.00 for October 31.
Change Change
Spot Option Fair in Fair Intrinsic Time in Time
Date Rate Premium Value Value Value Value Value
09/15 $1.00 $.035 $7,000 – $0 $7,0001 –
1 Because the strike price and spot rate are the same, the option has no intrinsic
value. Fair value is attributable solely to the time value of the option.
2 With a spot rate of $1.05 and a strike price of $1.00, the option has an intrinsic
9/15 Inventory 200,000.00
Accounts Payable (euro) 200,000.00
Foreign Currency Option 7,000.00
Cash 7,000.00
Chapter 09 – Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e
42. (continued)
10/31 Foreign Exchange Loss 10,000.00
Accounts Payable (euro) 10,000.00
Foreign Currency Option 6,000.00
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Education.
42. (continued)
Part e. Option Fair Value Hedge of a Foreign Currency Firm Commitment
(Purchase)
Firm Commitment Option Foreign Currency Option
Spot Change in Premium Change in
Date Rate Fair Value Fair Value for 10/31 Fair Value Fair Value
9/15 $1.00 $0 – $.035 $ 7,000 –
9/30 $1.05 $ (9,901) –$ 9,9011 $.070 $14,000 +$7,000
Loss on Firm Commitment 9,901.00
Firm Commitment 9,901.00
10/31 Foreign Currency Option 6,000.00
Gain on Foreign Currency Option 6,000.00
Chapter 09 – Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e
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Chapter 9 Develop Your Skills
Research Case—International Flavors and Fragrances
The responses to this assignment might change over time as the company
changes its use of foreign currency derivatives or changes the manner in
which it discloses its foreign currency hedging activities in the annual report.
The following responses are based on IFF’s 2014 annual report.
1. In 2014, IFF provided information in the annual report related to its
2. Note 14 (page 80) indicates that IFF uses “foreign currency forward
contracts with the objective of reducing exposure to cash flow volatility
associated with our intercompany loans, foreign currency receivables and
3. Toward the end of Note 14 (page 82), the company indicates that “the
Chapter 09 – Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e
Education.
Accounting Standards Case—Forecasted Transactions
Questions asked in the case are:
• Is management’s intent sufficient to assess that a forecasted transaction is
likely to occur?
• If not, what additional evidence must be considered?
Source of guidance: FASB ASC 815–20–55–24 Derivatives and Hedging; Hedging–
transaction will occur.
a. The frequency of similar past transactions
b. The financial and operational ability of the entity to carry out the transaction
c. Substantial commitments of resources to a particular activity (for example, a
The answers to the specific questions asked in the case are:
Chapter 09 – Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e
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Education.
Excel Case—Determine Foreign Exchange Gains and Losses
Note to Instructors: At the time this case is assigned to students, please verify
that www.x-rates.com still reports the exchange rates used in the solution
below. These exchange rates were obtained from www.x-rates.com in
January 2016. For unexplained reasons, in the past, www.x-rates.com has
made changes over time to the historical exchange rates that it reports.
1., 2. and 3. Spreadsheet for the calculation of the foreign exchange gains
(losses) related to Import/Export Company’s foreign currency
transactions for the year 2015.
Foreign
Currency
Type of
Transaction
Amount in
Foreign
Currency
Trans-
action
Date
$ Value on
Transaction
Date
Settle-
ment
Date
Exchange
Rate at
Settlement
Date
$ Value on
Settlement
Date
Foreign
Exchange
Gain
(Loss)
Brazilian
real
(BRL)
Import
purchase
(130,000)
1/10/15
0.380286
$(49,437.18)
5/10/15
0.335345
$(43,594.85)
$5,842.33
Chilean
peso
(CLP)
Import
purchase
(30,000,000)
1/10/15
(48,810.00)
5/10/15
0.001654
(49,620.00)
(810.00)
Swiss
franc
(CHF)
Export sale
50,000
1/10/15
49,295.10
4/10/15
1.019833
50,991.65
1,696.55
Swiss
franc
(CHF)
Import
purchase
(50,000)
4/10/15
(50,991.65)
7/10/15
1.062713
(53,135.65)
(2,144.00)
Euro
Export sale
45,000
1/10/15
53,289.14
4/10/15
1.05972
47,687.40
(5,601.74)
Euro
Export sale
45,000
4/10/15
47,687.40
7/10/15
1.115184
50,183.28
2,495.88
Chinese
yuan
(CNY)
Import
purchase
(300,000)
1/10/15
(48,348.60)
7/10/15
0.161071
(48,321.30)
27.30
Total Net
Foreign
Exchange
Gain
(Loss)
$1,506.33
Source of exchange rates: www.x-rates.com, Historical Lookup
Import/Export Company reported a net foreign exchange gain of $1,506.33 in
2015 net income.
Possible discussion points for instructors: Note that all transactions had a $
Chapter 09 – Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e
Excel Case (continued)
On the other hand, the relatively small appreciation in the value of the CLP
over the same time period resulted in a foreign exchange loss on a foreign
currency payable.
A depreciation in the Euro from 1/10/15 to 4/10/15 coupled with the Euro asset
exposure resulting from the export sale on 1/10/15 generated a large foreign
Analysis Case—Cash Flow Hedge
1. Given the $6,000 total Premium Expense, the forward rate on 2/1/15 must
2. Given that the forward contract is reported as a liability of $1,980 ($2,000 x
3. Given that the cost of goods sold is $103,000, the spot rate on 5/1/15 must
have been $1.03. Linber must pay $1.06 per euro under the forward
4. The Premium Expense of $6,000 reflects the increase in cost for the parts
from the date the transaction was forecasted until the date of purchase. If
Chapter 09 – Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e
9-59
Education.
Internet Case—Historical Exchange Rates
Note to Instructors: At the time this case is assigned to students, please verify
that www.x-rates.com still reports the exchange rates used in the solution
below. These exchange rates were obtained from www.x-rates.com in
January 2016. For unexplained reasons, in the past, www.x-rates.com has
made changes over time to the historical exchange rates that it reports.
1. Spreadsheets for the calculation of the foreign exchange gains (losses)
related to Pier Ten Company’s foreign currency account receivables.
Currency
Code
Foreign
Currency
Account
Receivable
Exchange
Rate on
9/15/15
U.S. Dollar
Value on
9/15/15
Indian rupee
INR
3,319,000
0.015066
$ 50,004.05
Philippine peso
PHP
2,337,000
0.021404
50,021.15
Japanese yen
JPY
6,017,000
0.008311
50,007.29
Malaysian ringgit
MYR
214,800
0.232814
50,008.45
$ 200,040.94
Currency
Code
Foreign
Currency
Account
Receivable
Exchange
Rate on
9/30/15
U.S. Dollar
Value on
9/30/15
Foreign
Exchange
Gain (Loss)
on 9/30/15
Indian rupee
INR
3,319,000
0.015264
$ 50,661.22
$ 657.16
Philippine peso
PHP
2,337,000
0.021398
50,007.13
(14.02)
Japanese yen
JPY
6,017,000
0.008349
50,235.93
228.65
Malaysian ringgit
MYR
214,800
0.22748
48,862.70
(1,145.74)
$ 199,766.98
$ (273.96)
Chapter 09 – Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e
9-60
Education.
Internet Case (continued)
Currency
Code
Foreign
Currency
Account
Receivable
Exchange
Rate on
10/15/15
U.S. Dollar
Value on
10/15/15
Foreign
Exchange
Gain (Loss)
on 10/15/15
Indian rupee
INR
3,319,000
0.015441
$ 51,248.68
$ 587.46
Philippine peso
PHP
2,337,000
0.021822
$ 50,998.01
$ 990.89
Japanese yen
JPY
6,017,000
0.008455
$ 50,873.74
$ 637.80
Malaysian ringgit
MYR
214,800
0.24175
$ 51,927.90
$ 3,065.20
$ 205,048.33
$ 5,281.35
Currency
Code
Foreign
Currency
Account
Receivable
U.S. Dollar
Value on
9/15/15
U.S. Dollar
Value on
10/15/15
Net Foreign
Exchange
Gain (Loss)
Indian rupee
INR
3,319,000
$ 50,004.05
$ 51,248.68
$ 1,244.63
Philippine peso
PHP
2,337,000
50,021.15
50,998.01
$ 976.87
Japanese yen
JPY
6,017,000
50,007.29
50,873.74
$ 866.45
Malaysian ringgit
MYR
214,800
50,008.45
51,927.90
$ 1,919.45
$200,040.94
$ 205,048.33
$ 5,007.39
Source of exchange rates: www.x-rates.com, Historical Lookup
2. Pier Ten would have reported a net foreign exchange loss of $273.96 in the
fiscal year ended September 30, 2015 and a net foreign exchange gain of
3. Assuming a strike price equal to the September 30, 2015 spot rate, the
purchase of a put option would not have been beneficial for any of the
Chapter 09 – Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e
Communication Case—Forward Contracts and Options
To: Mr. Dewey Nukem, CEO, Palmetto Bug Extermination Company (PBEC)
The primary advantage of using forward contracts to hedge foreign exchange
risk is that there is no cost to enter into them. 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
Exporters sometimes use forward contracts to hedge export sales (import
foreign currency at the spot rate to settle the forward contract. This is
essentially the same as speculation; a gain or loss could arise. In this case,
the exporter might be better off by purchasing a foreign currency put option.
The exporter can simply allow the option to exercise if it has not received
foreign currency from the customer by the expiration date.
PBEC with foreign currency for which it has no current use.
The bottom line is that there is no right or wrong answer to the question
which hedging instrument should be used to hedge the Swiss franc exposure
to foreign exchange risk. Both forward contracts and option have the
advantages and disadvantages.