EXERCISES

Exercise 10.1 (b)

Exercise 10.2 (d).
Exercise 10.3 (a).
Exercise 10.4 (c).
Exercise 10.5 (b)..
Exercise 10.6 (c) .
Exercise 10.7 (c).
Exercise 10.8 (d).
Exercise 10.9 (a).
Exercise 10.10 (b).
Exercise 10.11 (c).
PROBLEMS
Problem 10.1
(1) = 0.95
The hedge is effective as the delta ratio is within the 0.8 and 1.25 range.
(2) Journal entries 1 November 20x5
Dr Margin deposit 330,000 Cr Cash 330,000
31 December 20x5
Dr Futures contract 110,000
Cr Gain on futures contract 110,000

Dr Loss on inventory 100,000

Cr Inventory 100,000

31 January 20x6
Dr Loss on futures contract 190,000
Cr Futures contract 190,000

Dr Inventory 200,000 Cr Gain on inventory 200,000

[To record gain in fair value of inventory
Dr Cash 250,000
Dr Futures contract 80,000
Cr Margin deposit 330,000
Problem 10.2
(1) 31 Mar 30 April 31 May Notional amount 100,000 100,000 100,000 Spot price of oil $42 $45 $44
Strike price $40 $40 $40 Premium/unit $3 $6 $4 Fair value of option $300,000 $600,000 $400,000
Intrinsic value $200,000 $500,000 $400,000 Time value $100,000 $100,000 $0
(2) 1 March 20x3
Dr Call option 200,000 /Cr Cash 200,000
31 March 20x3
Dr Call option 200,000 / Cr Hedging reserves – equity 200,000
Dr Loss on time value 100,000 / Cr Call option 100,000
3 April 20x3
Dr Call option 300,000 /Cr Hedging reserves – equity 300,000
31 May 20x3
Dr Hedging reserves – equity 100,000 / Cr Call option 100,000
Dr Loss on time value 100,000 / Cr Call option 100,000
Dr Purchase of jet fuel oil/inventory 4,400,000 / Cr Cash 4,400,000
Dr Hedging reserves – equity 400,000 / Cr Purchase of jet fuel oil/inventory 400,000 (Adjust effective
portion of the hedge against cost of inventory) Dr Cash 400,000 Cr Call option 400,000 ( Close position
on call option)
Problem 10.3
Journal entries for hedged item Journal entries for hedging instrument
30.11.20x1
No journal entry is required to record the
firm commitment
30.11.20x1
Dr Put option 500
Cr Cash
500
[Purchase of put option]
30.6.20x2
Dr Loss on firm
Commitment (P/L) 500
Cr Firm commitment
500
[To record loss in fair value of firm
commitment]
30.6.20x2
Dr Put Option 500
Cr Gain on put option (P/L) 500
Dr Loss on put option (P/L) 300 / Cr Put Option 300
31.7.20x2
Dr Loss on firm Commitment (P/L) 500 / Cr Firm commitment 500
Dr. Investment 5,000/ Cr Cash 5,000
Dr. Firm commitment 1,000/ Cr. Investment 1,000
Dr Cash 4,000/ Cr Investment 4,000

31.7.20x2
Dr Put option 500/ Cr Gain on put option 500
Dr Loss on put option 200/ Cr Put option 200
Dr Cash 1,000/ Cr Put option 1,000

Problem 10.4
(1) The premium on the put option on 28 February 20x4 is $0.07 per FC. The fair value of put
option, intrinsic value and time value are as follows:
01/03/20x3 500,000 0.045 22,500 22,500 -
01/06/20x3 500,000 0.055 27,500 17,500 10,000
31/12/20x3 500,000 0.06 30,000 5,000 25,000
28/02/20x4 500,000 0.07 35,000 - 35,000
(2) Journal entries
1 March 20x3
Dr Put option 22,500 / Cr Cash/bank 22,500
1 June 20x3
Dr Put option 5,000
Dr Loss in time value 5,000
Cr Hedging reserve – equity 10,000
31 December 20x3
Dr Put option 2,500 / Cr Gain on put option 2,500
Dr Loss on firm commitment 15,000 / Cr Firm commitment 15,000
Dr Accounts receivable 850,000 / Cr Sales 850,000
Dr Hedging reserve – equity 10,000
Dr Firm commitment 15,000
Cr Sales 25,000
28 February 20x4
Dr Put option 5,000 / Cr Gain on put option 5,000
Dr Loss on account receivable 10,000 / Cr Accounts receivable 10,000
Dr Cash 840,000 Cr Accounts receivable 840,000 (Record settlement of accounts receivable)
Dr Cash 35,000 / Cr Put option 35,000
The journal entries on 31 December 20x3 would be as follows:
Dr Put option 2,500
Dr Loss in time value 12,500
Cr Hedging reserve – equity 15,000

Dr Hedging reserve – equity 25,000 / Cr Sales 25,000

Problem 10.5
(1) Journal entries 1 October 20x4 (optional)
Dr Investment (AFS) 358,400 / Cr Cash 358,400
1 November 20x4
Dr Fair value reserves – equity 2,150 / Cr Investment (AFS) 2,150
31 December 20x4
Dr Investment (AFS) 6,750
Dr Forward contract 11,400
Dr Exchange loss on investment 12,000
Cr Fair value reserves – equity 18,750
Cr Gain on forward contract 11,400
Change in fair value of forward contract: 285,000 x (1.23 – 1.19) = $12,000

Dr Put option 3,630 / Cr Cash 3,630

31 March 20x5
Dr Fair value reserves – equity 8,470 * reversed out to I/S see last entry
Dr Exchange loss on investment 2,930
Dr Loss on forward contract 2,850
Cr Investment (AFS) 11,400
Cr Forward contract 2,850
Dr Cash 8,550 / Cr Forward contract 8,550

Dr Put option 6,570 / Cr Gain on put option 6,570

30 June 20x5
Dr Put option 7,950 / Cr Gain on put option 7,950
Dr Loss on investment (AFS)/ 9,600 Cr Investment (AFS) 9,600
Dr Investment (AFS) 2,850 / Cr Fair value reserves – equity 2,850
Dr Cash 18,150 / Cr Put option 18,150
Dr Cash 344,850 / Cr Investment 344,850
Dr Fair value reserves (equity) 19,450 / Cr Gain on hedging 19,450

Problem 10.6
1 December 20x1 The forward contract is nil.
31 December 20x2
Dr Forward contract 300,000
Dr Loss in time value 100,000
Cr Hedging reserve – equity 400,000
1 February 20x2
Dr Forward contract 400,000
Dr Loss in time value 100,000
Cr Hedging reserve – equity 500,000
30 March 20x2
Dr Loss on forward contract 600,000
Cr Forward contract 600,000
Dr Firm commitment 400,000 / Cr Gain on firm commitment 400,000
Dr Cash 16,900,000 / Cr Sales 16,900,000
 Dr Hedging reserve 900,000
Cr Firm commitment 400,000
Cr Sales 500,000
Dr Cash 100,000 / Cr Forward contract 100,000

Problem 10.7 from 1 December 20x1 to 1 February 20x2 are the same as in P 9.6. 30 March 20x2
Dr Hedging reserve 400,000
Dr Time value (Interest component) (I/S) 200,000
Cr Forward contract 600,000 (Record:

Dr Cash 16,900,000 / Cr Sales 16,900,000

Dr Hedging reserve 500,000 / Cr Sales 500,000
Dr Cash 100,000 / Cr Forward contract 100,000

Problem 10.8
30 September 20x5 No journal entry required.
31 December 20x5
Dr Interest element (I/S) 3,251/ Cr Hedging reserve – equity 2,167 ; Cr Forward contract 1,084
31 January 20x6
Dr Interest element (I/S) 2,502
Dr Hedging reserve – equity 1,672
Cr Forward contract 4,174

Dr Inventory 292,000
Dr Hedging reserve 495
Cr Inventory 495
Cr Accounts payable 292,000
31 March 20x6
Dr Accounts payable 292,000
Dr Exchange loss on payable 1,100
Cr Cash 293,100
Dr Forward contract 357 / Cr Gain on forward contract 357
Dr Forward contract 4,900 / Cr Cash 4,900
31 December 20x5
Dr Hedging reserve -Equity 1,084 / Cr Forward contract 1,084
31 January 20x5
Dr Hedging reserve -Equity 4,174 / Cr Forward contract 4,174
Dr Inventory 292,000 Dr Inventory 5,258* Cr Hedging reserve 5,258 Cr Accounts payable 292,000
31 March 20x6
Dr Accounts payable 292,000 Dr Exchange loss on payable 1,100 /Cr Cash 293,100
Dr Forward contract 357 / Cr Gain on forward contract 357
Dr Forward contract 4,900 / Cr Cash 4,900

Problem 10.9
1 December 20x1 No journal entry is necessary.
31 December 20x1
Dr Forward contract 1,000,000 / Cr Gain on forward contract 1,00,000
Dr Loss on firm commitment 1,100,000 / Cr Firm commitment 1,100,000
1 March 20x2
Dr Forward contract 200,000 / Cr Gain on forward contract 200,000
Dr Loss on firm commitment 300,000 / Cr Firm commitment 300,000
Dr Accounts receivable 17,000,000 / Cr Sales 17,000,000
Dr Firm commitment 1,400,000 / Cr Sales 1,400,000
1 April 20x2
Dr Bank 17,600,000 / Cr Exchange gain 600,000 Cr Accounts receivable 17,000,000
Dr Loss on forward contract 800,000 / Cr Forward contract 800,000
Dr Cash 400,000 / Cr Forward contract 400,000

Problem 10.10
(1) Journal entries: 30/6/20x1
nil entry
 31/12/20x1
Dr Forward contract 485 / Cr Hedging reserve (equity) 485
31/3/20x2
Dr Forward contract 254 / Cr Hedging reserve 254
Dr Inventory 108,300 / Cr Payable 108,300
Dr Hedging reserves 739 / Cr Inventory 739
30/6/20x2
Dr Exchange loss 400 Dr Payable 108,300 / Cr Cash 108,700
Dr Forward contract 261 / Cr Gain on forward contract 261
Dr Cash 1,000 / Cr Forward contract 1,000
(2) 31/12/20x1
Dr Loss (interest element) 291 Dr Forward contract 485 Cr Equity (spot element) 776
31/3/20x2
Dr Loss (interest element) 54 Dr Forward contract 254 / Cr Equity (spot element) 308

Dr Inventory 108,300 Dr Equity 1,084 / Cr Inventory (hedging gain) 1,084 Cr Payable 108,300

30/6/20x2
Dr Exchange loss 400 Dr Payable 108,300 / Cr Cash 108,700
Dr Forward contract 261 / Cr Gain on forward contract 261
Dr Cash 1,000 /Cr Forward contract 1,000
(2) B/S: Carrying value of inventory $107,561 $107,216 Income Statement 0 (345)

Problem 10.11
(1) Journal entries 31/12/20x1
Dr Loss on firm commitment 776 / Cr Firm commitment 776
Dr Forward contract 776 / Cr Gain on forward contract 776
Dr Interest portion 291 / Cr Forward contract 291
31/3/20x2
Dr Loss on firm commitment 308 / Cr Firm commitment 308
Dr Forward contract 308 / Cr Gain on forward contract 308
Dr Interest portion 54 / Cr Forward contract 54
Dr Inventory 108,300 / Cr Payable 108,300
Dr Firm commitment 1,084 / Cr Inventory 1,084
30/6/20x2
Dr Exchange loss 400 Dr Payable 108,300 / Cr Cash 108,700
Dr Forward contract 261 / Cr Gain on forward contract 261
Dr Cash 1,000/ Cr Forward contract 1,000
(2) There is no difference if there is no discounting of the future cash flows.

Problem 10.12
30 June 20x3
Dr Interest expense 1,375,000 / Cr Bank 1,375,000
Dr Interest rate swap 576,573 / Cr Fair value adjustment (equity) 576,573
31 December 20x3
Dr Interest expense 1,500,000 / Cr Bank 1,500,000
Dr Bank 125,000 / Cr Interest receipt 125,000
Dr Interest rate swap 352,702 / Cr Fair value adjustment (equity) 352,702
30 June 20x4
Dr Interest expense 1,625,000 / Cr Bank 1,625,000
Dr Bank 250,000 / Cr Interest receipt 250,000
Dr Fair value adjustment (equity) 436,637 / Cr Interest rate swap 436,637
31 December 20x4
Dr Interest expense 1,550,000 / Cr Bank 1,550,000
Dr Bank 175,000 / Cr Interest receipt 175,000
Dr Fair value adjustment (equity) 253,800 / Cr Interest rate swap 253,800
30 June 20x5
Dr Interest expense 1,500,000 / Cr Bank 1,500,000
Dr Bank 125,000 / Cr Interest receipt 125,000
Dr Fair value adjustment (equity) 166,022 / Cr Interest rate swap 166,022
31 December 20x5
Dr Interest expense 1,450,000 / Cr Bank 1,450,000
Dr Bank 75,000 / Cr Interest receipt 75,000
Dr Fair value adjustment (equity) 72,816 / Cr Interest rate swap 72,816

Problem 10.13
(1) The hedged item was the forecasted cash flow of the anticipated transaction.
(2) October 20x1
Dr Margin deposit 150,000 / Cr Cash 150,000
31 December 20x1
Dr Futures contract 200,000 [(3.21 – 3.17) x 5,000,000] / Cr Hedging reserve 175,000 Cr Profit
or loss 25,000
28 February 20x2
Dr Futures contract 600,000 [(3.17 – 3.05) x 5,000,000] / Cr Hedging reserve 575,000 Cr Profit
or loss 25,000
 31 March 20x2
Dr Futures contract 250,000 / Cr Hedging reserve 250,000
Dr Cash 15,500,000 / Cr Sales 15,500,000
Dr Cost of sales 15,000,000 / Cr Inventory 15,000,000
Dr Hedging reserve 1,000,000 / Cr Sales 1,000,000
Dr Cash 1,200,000 Cr Margin deposit 150,000 Cr Futures contract 1,050,000
(3) Without hedging With hedging Sales 15,500,000 16,500,000 COGS (15,000,000) (15,000,000)
Gross profit 500,000 1,500,000 Gain on futures contract 50,000 Net profit $500,000 $1,550,000

Problem 10.14 (1)

/10/x1
Dr Option contract 600,000 / Cr Cash 600,000
31/12/x1
Dr Loss in fair value of inventory 175,000 / Cr Inventory 175,000
Dr Loss in time value of option 125,000 / Cr Options contract 125,000
Dr Options contract 175,000 / Cr Gain in intrinsic value 175,000
28/2/x2
Dr Loss in fair value of inventory 575,000 / Cr Inventory 575,000
Dr Loss in time value of option 350,000 / Cr Options contract 350,000
Dr Options contract 575,000 / Cr Gain in intrinsic value 575,000
31/3/x2
Dr Loss in fair value of inventory 250,000 / Cr Inventory 250,000
Dr Loss in time value of option 125,000 / Cr Options contract 125,000
Dr Options contract 250,000 / Cr Gain in intrinsic value 250,000
Dr Cash 1,000,000 / Cr Option contract 1,000,000
Dr Cash 15,500,000 / Cr Sales 15,500,000
Dr Cost of sales 14,000,000/ Cr Inventory 14,000,000
(3) Without hedging With hedging Sales 15,500,000 15,500,000 COGS (15,000,000)
(14,000,000) Gross profit 500,000 1,500,000 Net gain on option contract 400,000 Loss on
inventory (1,000,000) Profit $500,000 $900,000

Problem 10.15
Transaction 1: Fair value hedge
Journal entries: 31 July 20x5
Dr Investment (AFS) 250,000 / Cr Cash 250,000 (Investment in AFS)
Dr Put option 3,000 / Cr Cash 3,000
30 September 20x5
Dr Loss on fair value (AFS) 30,000 / Cr Investment (AFS) 30,000
Dr Put option 25,000 / Cr Gain on put option 25,000
Dr Cash 28,000 / Cr Put option 28,000 (Close option position)
Transaction 2: (Cash flow hedge)
31 March 20x5
Dr Interest expense 900,000 / Cr Cash/bank 900,000
31 March
Dr Swap asset 666,273 / Cr FV adjustment (equity) 666,273
30 June 20x5
Dr Interest expense 1,000,000 / Cr Cash/bank 1,000,000
31 March
Dr Cash/bank 100,000 / Cr Interest expense 100,000
Dr Swap asset 477,931 / Cr FV adjustment (equity) 477,931
30 September 20x5
Dr Interest expense 1,100,000 / Cr Cash/bank 1,100,000
Dr Cash/bank 200,000 / Cr Interest expense 200,000
Dr FV adjustment (equity) 470,697 / Cr Swap asset 470,697

Transaction 3: Hedge of net investment

1 January 20x5 No entry required.
31 March 20x5
Dr Forward contract 22,400 Dr Interest component (P/L) 11,200 Cr FCTR (Equity) 33,600
30 June 20x5
Dr Forward contract 33,600 Dr Interest component (P/L) 11,200 Cr FCTR (Equity) 44,800
30 September 20x5
Dr Forward contract 29,120 Dr Interest component (P/L) 4,480 Cr FCTR (Equity) 33,600

30 September 20x5
Income statement Change in FV of AFS (30,000) Gain on put option 25 ,000 Interest expense
(2,700,000) Interest component of forward contract (26,880)
Balance sheet
Equity FV Adjustment (swap) 673,507
Assets Available-for-sale 220,000 Forward contract 85,120 Swap asset 673,507
Equity FCTR 112,000*

Problem 10.16
Convert to SGD/USD rates
Dr Loss on time value (P/L) (0.0156-0.0107)*S$1.4m 6,860
Dr Forward contract (0.7353 – 0.7299)*S$1.4m 7,560
Cr Deferred gain (OCI) (0.7246 – 0.7143)*S$1.4m 14,420
31 Dec 2010 FX loss on firm commitment
Dr Loss on firm commitment (0.7576-0.7246)*S$1.4m 46,200 / Cr Firm commitment (payable) 46,200
Dr Forward contract (0.7752-0.7353)*S$1.4m 55,860 / Cr Gain on forward contract (P/L) 55,860
Dr Equipment (0.7576*S$1.4m) 1,060,640 / Cr Equipment payable 1,060,640
Dr Deferred gain (OCI) 14,420 Dr Firm commitment (payable) 46,200 Cr Equipment 60,620
June 2011
Dr FX loss on equipment payable 89,740 / Cr Equipment payable (0.8333-0.7692)*S$1.4m 89,740
Dr Equipment payable 1,166,620 / Cr Cash (US$1.4m x 0.8333) 1,166,620
Dr Forward contract (0.8333-0.7752)*S$1.4m 81,340 / Cr Gain on forward contract (P/L) 81,340
Dr Cash (0.8333-0.7299)*S$1.4m 144,714 / Cr Forward contract 144,714
31 Dec 2011
Dr Depreciation expense (1,076,880-76,860)/10 100,002 / Cr Accumulated depreciation – Equipment
100,002

Problem 10.17 Swap interest settlement table

30 June 2010
Dr Swap Asset/Liability 50,420 / Cr Swap fair value P/L (36,536*1.38) 50,420
31 Dec 2010
Dr Cash (7,500*1.32) 9,900 / Cr Swap interest income (7,500*1.32) or (7,500*1.34) 9,900
Dr Swap fair value P/L (41,250*1.32) 54,450 / Cr Swap Asset/Liability 54,450
31 Dec 2010 30 Jun 2011
Dr Swap interest income (1200*1.2) (or 1200*1.25) 1,440 / Cr Cash 1,440
Dr Swap fair value P/L (4,162*1.2) 4,994 / Cr Swap Asset/Liability 4,994