DM–13 Derivatives Module—Problems
PROBLEM M-2
(1) Corn Futures September 1 September 30 October 31 November 5
Number of bushels. …………………… 1,000,000 1,000,000 1,000,000 1,000,000
Spot price per bushel …………………. $2.5000 $2.5380 $2.5680 $2.5685
Futures price per bushel …………….. $2.5100 $2.5420 $2.5700 $2.5710
Fair value of contract ………………. $— $ 32,000 $ 60,000 $ 61,000
Futures price per bushel …………….. $3.5210 $3.5520 $3.5710 $3.5705
Fair value of contract ………………. $— $ 62,000 $ 100,000 $ 99,000
(a) Change in above fair value …. $ 62,000 $ 38,000 $ (1,000)
(b) Change in spot rates:
At beginning of period ……. $7,030,000 $7,096,000 $7,140,000
At end of period ……………. 7,096,000 7,140,000 7,140,000
Change ……………………………. $ 66,000 $ 44,000 $ —
Problem M-2, Concluded
Oct. 31 Futures Contract—Corn ………………………………………………. 28,000
Futures Contract—Wheat …………………………………………….. 38,000
Unrealized Hedging Loss …………………………………………….. 8,000
Other Comprehensive Income ………………………………….. 74,000
Nov. 5 Futures Contract—Corn ………………………………………………. 1,000
Unrealized Hedging Loss …………………………………………….. 500
Futures Contract—Wheat ………………………………………… 1,000
Other Comprehensive Income ………………………………….. 500
To record change in value of contract and
include in earnings change in time value
excluded from hedge effectiveness.
Cash ……………………………………………………………………. 230,000
Futures Contract—Corn …………………………………………… 61,000
(2) Factors that might cause the futures contracts to not be highly effective include the following:
a. Changes in the price of wheat and corn may not correlate as highly with the change in
the price of flour due to costs associated with producing flour.
DM–15 Derivatives Module—Problems
PROBLEM M-3
Futures Contract To Sell
Key Variables January February March
Number of units per contract ……………. 10,000 10,000
Spot price per unit ………………………….. $3.45 $3.40
Futures price per unit ……………………… $3.50 $3.44
Problem M-3, Continued
Forward Contract To Buy
Key Variables January February March
Number of units per contract ……………………. 5,000 5,000 5,000
Spot price per unit ………………………………….. $90.20 $90.50 $90.60
Forward rate per unit ………………………………. $91.50 $91.20 $90.60
Original forward rate per unit …………………… $92.00 $92.00 $92.00
Fair value of forward in future $s:
Discount rate …………………………………………. 6% 6%
Present value of the above fair value:
FV = –$2,500, n = 1.5, I = 0.25% ………… (2,491)
FV = –$4,000, n = 0.5, I = 0.25% ………… (3,995)
FV = –$7,000, n = 0.0, I = 0.25% ………… (7,000)
Current present value …………………………….. (2,491) (3,995) (7,000)
Problem M-3, Concluded
Call Option
Key Variables January February March
Number of units per option ………………. 100,000 100,000 100,000
Spot price per unit ………………………….. $8.05 $8.02 $7.95
Effect on Earnings—Gain (Loss)
Change in time value—gain (loss):
Original value of $1,000 vs. $400 . $ (600)
$400 vs. $0………………………………. $ (400)
Change in intrinsic value—gain (loss):
Original value of $5,000 vs. $2,000 In OCI
$2,000 vs. $0……………………………. In OCI
Sales revenue (100,000 × $12)………… $1,200,000
PROBLEM M-4
(1) Interest
Date Payment Quarterly Rate Amount Principal Balance
December 31, 2017 ……. $12,590,619
March 31, 2018 ………….. $1,136,408 1.25% $157,383 $ 979,025 11,611,594
June 30, 2018 ……………. 1,136,408 1.25 145,145 991,263 10,620,331
(2) Interest
Date Payment Quarterly Rate Amount Principal Balance
(3) Balance at
Beginning Pay Receive Net Swap Stated Interest Net Interest
(4) Balance at
Beginning Pay Receive Net Swap Stated Interest Net Interest
Date of Quarter Floating Rate Fixed Rate Interest on Note* Income
September 30, 2018 …… $10,000,000 1.1500% 1.1250% $(2,500) $122,500 $120,000
Problem M-4, Concluded
(5) Pay floating rate interest per quarter ($10,000,000 × 1.0875%) ………….. $108,750
Receive fixed rate interest per quarter ($10,000,000 × 1.1250%) ……….. 112,500
(6) In addition to the risk that the interest income on the note would decline due to falling varia-
ble interest rates, there is now a concern due to changing currency exchange rates. If the
PROBLEM M-5
July 10 July 31 August 31 September 10
Notional amount in troy ounces. ………. 100,000 100,000 100,000 100,000
Strike price ……………………………………. $5.00 $5.00 $5.00 $5.00
July 10 Investment in Call Option ………………………………………….. 20,000
Cash …………………………………………………………………. 20,000
To record payment of option premium
(100,000 × $0.20).
31 Investment in Call Option ………………………………………….. 3,000
Unrealized Loss on Hedge ($10,000 – $9,000) …………….. 1,000
Other Comprehensive Income ($10,000 – $14,000) … 4,000
Aug. 31 Investment in Call Option ………………………………………….. 14,000
Unrealized Loss on Hedge ………………………………………… 7,000
Sept. 10 Unrealized Loss on Hedge ………………………………………… 1,000
Other Comprehensive Income …………………………………… 3,000
Investment in Call Option …………………………………….. 4,000
To record change in value of the option.
Sept. Accounts Receivable ………………………………………………… 225,000
Plating Revenues ……………………………………………….. 225,000
To record sales.
Problem M-5, Concluded
Sept. Other Comprehensive Income …………………………………… 3,300
Cost of Sales ……………………………………………………… 3,300
To adjust cost of sales [(15,000 divided by
100,000) × $22,000 of OCI].
PROBLEM M-6
July
August September Total
a. Call Option A
Unrealized gain (loss) on commitment:
10,000 × ($45 – $46) …………………………………………. $(10,000) $(10,000)
10,000 × ($45 – $44) …………………………………………. $ 10,000 10,000
10,000 × ($45 – $46.50) …………………………………….. $(15,000) (15,000)
Less previously recognized gain (loss) ………………… 10,000 (10,000)
b. Call Option B (hedge not effective—does not qualify for special hedge accounting)
Unrealized gain (loss) on option:
Problem M-6, Concluded
July
August September Total
c. Put Option C
Sales revenue ……………………………………………………… $ 287,500 $ 287,500
Cost of sales ……………………………………………………….. (200,000) (200,000)
Adjustment to cost of sales—Intrinsic value at July 1 of
$0 versus intrinsic value at 9/10 of $12,500
[10,000 × ($30 – $28.75)] …………………………………… 12,500 12,500
e. Interest Rate Swap
Variable interest income:
(6.8% × $10,000,000 × 1/12 year) ………………………. $ 56,667 $ 56,667
(6.7% × $10,000,000 × 1/12 year) ………………………. $ 55,833 55,833
Settlement of fixed variable difference:
DM–23 Derivatives Module—Problems
PROBLEM M-7
(1) 2016
Dec. 31 Interest Expense ………………………………………………………… 800,000
Cash ……………………………………………………………………… 800,000
To record interest expense
[(7% + 1%) × $20,000,000 × ½ year].
Interest Rate Swap Asset ………………………………………… 47,001
To record settlement of the swap [(7.1% – 7.0%) ×
$20,000,000 × ½ year] and the change in the value
of the swap.
Other Comprehensive Income………………………………………. 10,000
To record settlement of the swap [(6.9% – 7.0%) ×
$20,000,000 × ½ year] and the change in value
of the swap.
Interest Expense ………………………………………………………… 10,000
Other Comprehensive Income ………………………………….. 10,000
Problem M-7, Concluded
2018
June 30 Interest Expense ………………………………………………………… 780,000
Cash ……………………………………………………………………… 780,000
To record interest expense [(6.8% + 1%) ×
$20,000,000 × ½ year].
(2) Impact on Earnings of the Interest Rate Swap
6-Month Period Ending
Dec. 31, June 30, Dec. 31, June 30,
2016
2017 2017 2018 Total
Effective interest rate:
Without a hedge ……….. 8.0% 8.1% 7.9% 7.8%
Unfortunately, in retrospect, the company would have been better off not to have engaged
in an interest rate swap. The swap resulted in an additional decrease in earnings of
$20,000.
(3) The LIBOR rate on December 31, 2017, would have had to be 7%. This would have re-