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Chapter 07
1. According to the World Trade Organization, what was the size of international trade in 2011?
2. In the years between 1990 and 2001 when global gross domestic product rose 27%, what was
the growth in global exports?
A. 25%
B. 75%
C. 35%
D. 50%
7-1
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
4. Which of the following statements is true about the Euro?
A. On the difference between the spot rate and the foreign rate
B. A bank is forbidden, by law, to charge a premium in foreign currency exchange
C. On the present value of the forward rate discounted to the date an option is purchased
D. On the difference between the buying and selling rates
6. King's Bank, a British company, purchases market research services from Harris Interactive, a
U.S. company. As per the terms of the contract, payment is to be made three months later in
U.S. dollars when the report is delivered. How would King's Bank like to see the exchange
rate move, assuming it isn't hedging the transaction?
A. It hopes that the U.S. dollar appreciates in value against the British pound.
B. It hopes that the British pound appreciates in value against the U.S. dollar.
C. It makes no difference, since they are the customer and the sale takes place in the U.K.
D. It hopes that there is no change between the spot rate and the forward rate.
7. Why was there very little fluctuation in the foreign exchange rate in the period 1945-1973?
A. This was a period when the world economy was very stable.
B. There was very little growth in the world economy between 1945 and 1973.
C. Countries linked their currency to the U.S. dollar, which was backed by gold reserves.
D. Most currencies were pegged to the British pound, which could be converted to sterling
silver.
7-2
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McGraw-Hill Education.
8. The central bank of Country X buys and sells its own currency to ensure that the currency is
always exchanged in a ratio of 2:1 with the currency of Country Y. What can we conclude
about these two currencies?
9. When a currency is allowed to increase or decrease freely according to market forces, the
currency is said to:
10. For an upcoming trip, Pat wants to buy Euros at the local bank when the current exchange
rate quoted on OANDA.com was $1.563 per €1. What should Pat plan to pay for €1,000?
A. exactly $1,563
B. more than $1,563
C. about $640
D. less than $640
11. The number of Japanese yen (¥) required today to buy one U.S. dollar ($) today is called:
7-3
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McGraw-Hill Education.
12. The number of U.S. dollars ($) today to buy one U.K. pound (£) six months from now is
called:
A. The possibility that an asset denominated in domestic currency will decline in value
because of changes in the foreign exchange rate
B. The possibility that an asset denominated in a foreign currency will change in value
because of a change in the foreign exchange rate
C. The loss resulting from an import purchase when a foreign currency appreciates
D. The loss resulting from an import purchase when a foreign currency depreciates
7-4
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
16. Under U.S. GAAP, what method is required to account for foreign currency transactions?
17. Under International Accounting Standards Board rules, what method is required to account
for foreign currency transactions?
18. Why must the two-transaction perspective be used for recording foreign currency
transactions under U.S. GAAP?
19. Under U.S. GAAP, foreign exchange losses should be recorded by:
7-5
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McGraw-Hill Education.
20. Under U.S. GAAP, what is the proper treatment of unrealized foreign exchange losses?
A. They should be deferred on the Balance Sheet until the cash is paid.
B. They should not be recognized until cash is received to complete the transaction.
C. They should be recorded on the Income Statement in the period the exchange rate
changes.
D. They should be deferred on the Balance Sheet until an offsetting foreign exchange gain is
realized.
21. Under U.S. GAAP, what is the proper treatment of unrealized foreign exchange gains?
22. Why is the accrual method of accounting for unrealized foreign exchange gains sometimes
criticized?
A. Foreign exchange gains almost never occur, so there is no reason to have an accounting
standard for it.
B. It violates the principle of conservatism.
C. It is not objective.
D. There is no reliable method for measuring unrealized foreign exchange gains.
7-6
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McGraw-Hill Education.
23. How should U.S. companies record receivables and payables from international trade that are
denominated in foreign currencies?
A. All assets and liabilities of U.S. companies must be recorded in U.S. dollars.
B. Conservatism would dictate that liabilities should be recorded in the currency in which
they are payable, but assets should be recorded in U.S. dollars, regardless of what
currency will be received.
C. There should be separate receivable and payable accounts for each currency that is used
by the company.
D. The company should choose any one currency to use for recording receivable and
payables so that there is consistency in the accounts.
24. Northland Corporation recorded £1,000,000 in Accounts Receivable for sales to customers in
the United Kingdom and recorded Accounts Payable of 2,000,000 Yuan for product purchased
from China. If Northland recorded a foreign currency exchange loss on its receivables and a
foreign currency gain on its payables, what must have happened to each currency?
25. A noncancelable sales order that specifies foreign currency price and date of delivery is
known as a:
A. hedge.
B. foreign currency firm commitment.
C. forward contract.
D. put option.
7-7
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McGraw-Hill Education.
Amazing Corporation, a U.S. enterprise, sold product to a customer in Wales on October 1,
20x1 for £100,000 with payment required on April 1, 20x2. Relevant exchange rates are:
The discount factor corresponding to the company's incremental borrowing rate for 6 months
is 0.95.
26. Assuming that Amazing Corporation does not hedge this transaction, what is the amount of
exchange gain or loss that it should show on its December 31, 20x1 income statement?
A. Loss $1,000
B. Loss $2,000
C. Gain $1,000
D. Gain $1,900
27. Assume that Amazing Corporation enters a forward contract on October 1, 20x1 to sell
£100,000 six months hence, on April 1, 20x2. How should Amazing Corporation report the
forward contract on its December 31, 20x1 financial statements?
A. Asset $1,950
B. Liability $1,950
C. Asset $1,000
D. Asset $950
28. What term is used to describe the circumstances under which Amazing Corporation is
entering the forward contract?
7-8
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McGraw-Hill Education.
On November 1, 20x1 Zamfir Company, a U.S. corporation, purchased minerals from a
Russian company for 2,000,000 rubles, payable in 3 months. The relevant exchange rates
between the U.S. and Russian currencies are given:
The company's incremental borrowing rate provides a discount rate of 0.975 for three
months.
29. If Zamfir does not attempt to hedge this transaction, what is the gain or loss that should be
shown on the company's December 31, 20x1 financial statements?
A. $22,000 loss
B. $21,450 loss
C. $8,000 gain
D. $7,800 gain
30. Assume that on November 1, 20x1 Zamfir Company enters a forward contract to buy
2,000,000 rubles on February 1, 20x2. What is the fair value of the forward contract on
December 31, 20x1?
A. $8,000
B. $7,800
C. $22,000
D. $8,200
On December 1, 20x1 Pimlico made sales to a customer in India and recorded Accounts
Receivable of 10,000,000 rupees. The customer has until March 1, 20x2 to pay. On December
1, 20x1, Pimlico paid $500 for a put option to sell rupees at a strike price of $2.30 per 100
rupees on March 1, 20x2, which was the spot rate on December 1, 20x1. On December 31,
20x1, the spot rate was $2.80 per 100 rupees and the option premium was $0.004 per 100
rupees.
7-9
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McGraw-Hill Education.
31. What is the fair value of the option on December 1, 20x1?
A. $0
B. $500
C. $400
D. $10,000
32. What is the fair value of the option on December 31, 20x1?
A. $0
B. $500
C. $400
D. $10,000
33. What is the foreign currency exchange gain or loss on December 31, 20x1?
A. $50,000 loss
B. $50,000 gain
C. $10,000 gain
D. $10,000 loss
34. If the spot rate on March 1, 20x2 was $2.45 per 100 rupees, what is the foreign currency
exchange gain or loss that should be recorded that day?
A. $15,000 gain
B. $15,000 loss
C. $35,000 gain
D. $35,000 loss
7-10
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McGraw-Hill Education.
35. When two parties from different countries enter into a transaction:
A. the currency to be used for settling the transaction is set by the government.
B. a third country's currency must be used to denominate the transaction.
C. the two parties are free to decide the currency that should be used to settle the
transaction.
D. the domestic currency of the buyer must be used to settle the transaction.
36. What has occurred when one company arranges to buy a foreign currency sometime in the
future, at an exchange rate quoted today?
37. What has occurred when one company purchases the right to buy a foreign currency
sometime in the future at an exchange rate quoted today?
7-11
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McGraw-Hill Education.
39. What term is used for an option with a positive intrinsic value?
A. Put option
B. Over the counter
C. In the money
D. Call option
A. The difference between the spot rate and the strike price
B. The gain that could be realized if the option was exercised immediately
C. The chance that a currency will rise over time to make the option in the money
D. The difference between a call option and a put option
41. On 1 January, 2015, Hikers Inc., a U.S.-based company, borrowed £200,000 on a two-year
note at a per annum interest of 4.5%. The spot rate on this day was $1.65 per pound. The
spot rate on 31 December, 2015, was $1.64 per pound. The journal entries to account for this
foreign currency borrowing will include:
42. What is the primary difference between a cash flow hedge and a fair value hedge?
A. The fair value hedge must completely offset the variability in the cash flow from the
foreign currency receivable or payable.
B. The cash flow hedge can only be used to offset potential foreign currency losses on
accounts receivable.
C. The cash flow hedge must completely offset the variability in cash flow from the foreign
currency receivable or payable.
D. The fair value hedge can only be used to offset the variability in cash flow from long-term
fixed assets related to foreign currency fluctuations.
7-12
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McGraw-Hill Education.
43. Which of the following statements is true about hedge accounting under U.S. GAAP?
A. Companies may choose whether to account for derivatives as cash flow hedges or fair
value hedges.
B. If a derivative qualifies as a cash flow hedge, the hedging instrument is adjusted to fair
value on each balance sheet date.
C. If a derivative is elected by the company not to be designated as a cash flow hedge, it
must be accounted for as such.
D. Hedge accounting is only advantageous when a foreign currency depreciates between the
transaction date and the payment date.
44. Under U.S. GAAP, which of the following conditions must be met to qualify for hedge
accounting?
46. What kind of exposure exists for recognized foreign currency assets and liabilities?
7-13
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McGraw-Hill Education.
47. What kind of exposure exists for foreign currency firm commitments?
48. What is the requirement for reporting derivatives under international accounting standards
and U.S. GAAP?
A. They may be shown on the balance sheet or they may be treated as off-balance sheet
investments.
B. They must be shown on the balance sheet at fair value.
C. They must be shown on the balance sheet at historical cost.
D. They may be shown on the balance sheet at historical cost or at net realizable value.
49. What information is needed to determine the fair value of a foreign currency forward
contract?
7-14
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McGraw-Hill Education.
51. Under U.S. GAAP, where are changes in the fair value of derivatives reported?
52. Which of the following is done when accounting for a cash flow hedge, but is not done when
accounting for a fair value hedge?
53. How should discounts or premiums on forward contracts be treated if the derivative is
hedging a foreign-currency-denominated asset?
54. Under U.S. GAAP, what method of amortizing discounts or premiums on forward contracts
must be used?
7-15
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McGraw-Hill Education.
55. On May 1, 20x1, Ustar purchased a put option to sell £50,000 on April 30, 20x2 at a strike
price equal to $2, which was the spot rate on May 1, 20x1. Ustar paid a premium of $0.01 per
pound. How should the option be recorded on May 1, 20x1?
56. In hedge accounting, which of the following exposure should be hedged by foreign currency
derivative?
A. Temporal exposure
B. Fair value exposure
C. Derivative exposure
D. Forward contract exposure
57. When accounting for forward contracts, what is meant by the term "executory contract"?
58. Excel Sources Inc. is a U.S. incorporated company. Due to change in exchange rate, it
receives $150,000 as payment against a sale of $165,000. Under the two-transaction
perspective:
7-16
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McGraw-Hill Education.
59. Which of the following statements is true of the relationship between foreign currency
transactions, exchange rate changes, and foreign exchange gains and losses?
A. In an export sales, depreciation of the foreign currency causes a foreign exchange gain.
B. In an import purchase, appreciation of the foreign currency causes a foreign exchange
gain.
C. In an import purchase, depreciation of the foreign currency causes a foreign exchange
loss.
D. In an export sales, appreciation of the foreign currency causes a foreign exchange gain.
A. When the option strike price is more than the spot rate, the intrinsic value is zero.
B. When the option strike price is equal to the spot rate, the intrinsic value is positive.
C. When the option strike price is less than the spot rate, the intrinsic value is zero.
D. When the option strike price is more than the spot rate, the intrinsic value is negative.
7-17
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McGraw-Hill Education.
Chapter 07 Foreign Currency Transactions and Hedging Foreign
Exchange Risk Answer Key
1. According to the World Trade Organization, what was the size of international trade in
2011?
2. In the years between 1990 and 2001 when global gross domestic product rose 27%, what
was the growth in global exports?
A. 25%
B. 75%
C. 35%
D. 50%
7-18
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
3. What is a "foreign exchange rate?"
A. On the difference between the spot rate and the foreign rate
B. A bank is forbidden, by law, to charge a premium in foreign currency exchange
C. On the present value of the forward rate discounted to the date an option is purchased
D. On the difference between the buying and selling rates
7-19
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
6. King's Bank, a British company, purchases market research services from Harris
Interactive, a U.S. company. As per the terms of the contract, payment is to be made three
months later in U.S. dollars when the report is delivered. How would King's Bank like to
see the exchange rate move, assuming it isn't hedging the transaction?
A. It hopes that the U.S. dollar appreciates in value against the British pound.
B. It hopes that the British pound appreciates in value against the U.S. dollar.
C. It makes no difference, since they are the customer and the sale takes place in the
U.K.
D. It hopes that there is no change between the spot rate and the forward rate.
7. Why was there very little fluctuation in the foreign exchange rate in the period 1945-1973?
A. This was a period when the world economy was very stable.
B. There was very little growth in the world economy between 1945 and 1973.
C. Countries linked their currency to the U.S. dollar, which was backed by gold reserves.
D. Most currencies were pegged to the British pound, which could be converted to sterling
silver.
Learning Objective: 07-02 Explain how fluctuations in exchange rates give rise to foreign exchange risk.
Level of Difficulty: 2 Medium
8. The central bank of Country X buys and sells its own currency to ensure that the currency
is always exchanged in a ratio of 2:1 with the currency of Country Y. What can we
conclude about these two currencies?
Learning Objective: 07-02 Explain how fluctuations in exchange rates give rise to foreign exchange risk.
Level of Difficulty: 2 Medium
7-20
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McGraw-Hill Education.
9. When a currency is allowed to increase or decrease freely according to market forces, the
currency is said to:
Learning Objective: 07-02 Explain how fluctuations in exchange rates give rise to foreign exchange risk.
Level of Difficulty: 1 Easy
10. For an upcoming trip, Pat wants to buy Euros at the local bank when the current exchange
rate quoted on OANDA.com was $1.563 per €1. What should Pat plan to pay for €1,000?
A. exactly $1,563
B. more than $1,563
C. about $640
D. less than $640
Learning Objective: 07-02 Explain how fluctuations in exchange rates give rise to foreign exchange risk.
Level of Difficulty: 2 Medium
11. The number of Japanese yen (¥) required today to buy one U.S. dollar ($) today is called:
Learning Objective: 07-02 Explain how fluctuations in exchange rates give rise to foreign exchange risk.
Level of Difficulty: 1 Easy
7-21
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
12. The number of U.S. dollars ($) today to buy one U.K. pound (£) six months from now is
called:
Learning Objective: 07-02 Explain how fluctuations in exchange rates give rise to foreign exchange risk.
Level of Difficulty: 2 Medium
Learning Objective: 07-02 Explain how fluctuations in exchange rates give rise to foreign exchange risk.
Level of Difficulty: 3 Hard
A. The possibility that an asset denominated in domestic currency will decline in value
because of changes in the foreign exchange rate
B. The possibility that an asset denominated in a foreign currency will change in value
because of a change in the foreign exchange rate
C. The loss resulting from an import purchase when a foreign currency appreciates
D. The loss resulting from an import purchase when a foreign currency depreciates
Learning Objective: 07-02 Explain how fluctuations in exchange rates give rise to foreign exchange risk.
Level of Difficulty: 3 Hard
7-22
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
15. What is a foreign currency transaction?
Learning Objective: 07-03 Demonstrate the accounting for foreign currency transactions.
Level of Difficulty: 3 Hard
16. Under U.S. GAAP, what method is required to account for foreign currency transactions?
Learning Objective: 07-03 Demonstrate the accounting for foreign currency transactions.
Level of Difficulty: 2 Medium
17. Under International Accounting Standards Board rules, what method is required to
account for foreign currency transactions?
Learning Objective: 07-03 Demonstrate the accounting for foreign currency transactions.
Level of Difficulty: 2 Medium
7-23
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McGraw-Hill Education.
18. Why must the two-transaction perspective be used for recording foreign currency
transactions under U.S. GAAP?
Learning Objective: 07-03 Demonstrate the accounting for foreign currency transactions.
Level of Difficulty: 2 Medium
19. Under U.S. GAAP, foreign exchange losses should be recorded by:
Learning Objective: 07-03 Demonstrate the accounting for foreign currency transactions.
Level of Difficulty: 2 Medium
20. Under U.S. GAAP, what is the proper treatment of unrealized foreign exchange losses?
A. They should be deferred on the Balance Sheet until the cash is paid.
B. They should not be recognized until cash is received to complete the transaction.
C. They should be recorded on the Income Statement in the period the exchange rate
changes.
D. They should be deferred on the Balance Sheet until an offsetting foreign exchange gain
is realized.
Learning Objective: 07-03 Demonstrate the accounting for foreign currency transactions.
Level of Difficulty: 2 Medium
7-24
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
21. Under U.S. GAAP, what is the proper treatment of unrealized foreign exchange gains?
Learning Objective: 07-03 Demonstrate the accounting for foreign currency transactions.
Level of Difficulty: 2 Medium
22. Why is the accrual method of accounting for unrealized foreign exchange gains sometimes
criticized?
Learning Objective: 07-03 Demonstrate the accounting for foreign currency transactions.
Level of Difficulty: 2 Medium
23. How should U.S. companies record receivables and payables from international trade that
are denominated in foreign currencies?
A. All assets and liabilities of U.S. companies must be recorded in U.S. dollars.
B. Conservatism would dictate that liabilities should be recorded in the currency in which
they are payable, but assets should be recorded in U.S. dollars, regardless of what
currency will be received.
C. There should be separate receivable and payable accounts for each currency that is
used by the company.
D. The company should choose any one currency to use for recording receivable and
payables so that there is consistency in the accounts.
Learning Objective: 07-03 Demonstrate the accounting for foreign currency transactions.
Level of Difficulty: 2 Medium
7-25
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
24. Northland Corporation recorded £1,000,000 in Accounts Receivable for sales to customers
in the United Kingdom and recorded Accounts Payable of 2,000,000 Yuan for product
purchased from China. If Northland recorded a foreign currency exchange loss on its
receivables and a foreign currency gain on its payables, what must have happened to each
currency?
Learning Objective: 07-03 Demonstrate the accounting for foreign currency transactions.
Level of Difficulty: 2 Medium
25. A noncancelable sales order that specifies foreign currency price and date of delivery is
known as a:
A. hedge.
B. foreign currency firm commitment.
C. forward contract.
D. put option.
Learning Objective: 07-03 Demonstrate the accounting for foreign currency transactions.
Level of Difficulty: 2 Medium
The discount factor corresponding to the company's incremental borrowing rate for 6
months is 0.95.
7-26
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
26. Assuming that Amazing Corporation does not hedge this transaction, what is the amount
of exchange gain or loss that it should show on its December 31, 20x1 income statement?
A. Loss $1,000
B. Loss $2,000
C. Gain $1,000
D. Gain $1,900
Learning Objective: 07-03 Demonstrate the accounting for foreign currency transactions.
Level of Difficulty: 2 Medium
27. Assume that Amazing Corporation enters a forward contract on October 1, 20x1 to sell
£100,000 six months hence, on April 1, 20x2. How should Amazing Corporation report the
forward contract on its December 31, 20x1 financial statements?
A. Asset $1,950
B. Liability $1,950
C. Asset $1,000
D. Asset $950
Learning Objective: 07-03 Demonstrate the accounting for foreign currency transactions.
Level of Difficulty: 2 Medium
28. What term is used to describe the circumstances under which Amazing Corporation is
entering the forward contract?
Learning Objective: 07-03 Demonstrate the accounting for foreign currency transactions.
Level of Difficulty: 2 Medium
7-27
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
On November 1, 20x1 Zamfir Company, a U.S. corporation, purchased minerals from a
Russian company for 2,000,000 rubles, payable in 3 months. The relevant exchange rates
between the U.S. and Russian currencies are given:
The company's incremental borrowing rate provides a discount rate of 0.975 for three
months.
29. If Zamfir does not attempt to hedge this transaction, what is the gain or loss that should
be shown on the company's December 31, 20x1 financial statements?
A. $22,000 loss
B. $21,450 loss
C. $8,000 gain
D. $7,800 gain
Learning Objective: 07-03 Demonstrate the accounting for foreign currency transactions.
Level of Difficulty: 2 Medium
30. Assume that on November 1, 20x1 Zamfir Company enters a forward contract to buy
2,000,000 rubles on February 1, 20x2. What is the fair value of the forward contract on
December 31, 20x1?
A. $8,000
B. $7,800
C. $22,000
D. $8,200
Learning Objective: 07-03 Demonstrate the accounting for foreign currency transactions.
Level of Difficulty: 2 Medium
7-28
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
On December 1, 20x1 Pimlico made sales to a customer in India and recorded Accounts
Receivable of 10,000,000 rupees. The customer has until March 1, 20x2 to pay. On
December 1, 20x1, Pimlico paid $500 for a put option to sell rupees at a strike price of
$2.30 per 100 rupees on March 1, 20x2, which was the spot rate on December 1, 20x1. On
December 31, 20x1, the spot rate was $2.80 per 100 rupees and the option premium was
$0.004 per 100 rupees.
A. $0
B. $500
C. $400
D. $10,000
Learning Objective: 07-03 Demonstrate the accounting for foreign currency transactions.
Level of Difficulty: 2 Medium
32. What is the fair value of the option on December 31, 20x1?
A. $0
B. $500
C. $400
D. $10,000
Learning Objective: 07-03 Demonstrate the accounting for foreign currency transactions.
Level of Difficulty: 2 Medium
33. What is the foreign currency exchange gain or loss on December 31, 20x1?
A. $50,000 loss
B. $50,000 gain
C. $10,000 gain
D. $10,000 loss
Learning Objective: 07-03 Demonstrate the accounting for foreign currency transactions.
Level of Difficulty: 2 Medium
7-29
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McGraw-Hill Education.
34. If the spot rate on March 1, 20x2 was $2.45 per 100 rupees, what is the foreign currency
exchange gain or loss that should be recorded that day?
A. $15,000 gain
B. $15,000 loss
C. $35,000 gain
D. $35,000 loss
Learning Objective: 07-03 Demonstrate the accounting for foreign currency transactions.
Level of Difficulty: 2 Medium
35. When two parties from different countries enter into a transaction:
A. the currency to be used for settling the transaction is set by the government.
B. a third country's currency must be used to denominate the transaction.
C. the two parties are free to decide the currency that should be used to settle the
transaction.
D. the domestic currency of the buyer must be used to settle the transaction.
Learning Objective: 07-04 Describe how foreign currency forward contracts and foreign currency options can be used to
hedge foreign exchange risk.
Level of Difficulty: 1 Easy
36. What has occurred when one company arranges to buy a foreign currency sometime in the
future, at an exchange rate quoted today?
Learning Objective: 07-04 Describe how foreign currency forward contracts and foreign currency options can be used to
hedge foreign exchange risk.
Level of Difficulty: 2 Medium
7-30
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
37. What has occurred when one company purchases the right to buy a foreign currency
sometime in the future at an exchange rate quoted today?
Learning Objective: 07-04 Describe how foreign currency forward contracts and foreign currency options can be used to
hedge foreign exchange risk.
Level of Difficulty: 2 Medium
Learning Objective: 07-04 Describe how foreign currency forward contracts and foreign currency options can be used to
hedge foreign exchange risk.
Level of Difficulty: 2 Medium
39. What term is used for an option with a positive intrinsic value?
A. Put option
B. Over the counter
C. In the money
D. Call option
Learning Objective: 07-04 Describe how foreign currency forward contracts and foreign currency options can be used to
hedge foreign exchange risk.
Level of Difficulty: 2 Medium
7-31
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
40. What is the intrinsic value of a foreign currency option?
A. The difference between the spot rate and the strike price
B. The gain that could be realized if the option was exercised immediately
C. The chance that a currency will rise over time to make the option in the money
D. The difference between a call option and a put option
Learning Objective: 07-04 Describe how foreign currency forward contracts and foreign currency options can be used to
hedge foreign exchange risk.
Level of Difficulty: 3 Hard
41. On 1 January, 2015, Hikers Inc., a U.S.-based company, borrowed £200,000 on a two-year
note at a per annum interest of 4.5%. The spot rate on this day was $1.65 per pound. The
spot rate on 31 December, 2015, was $1.64 per pound. The journal entries to account for
this foreign currency borrowing will include:
Learning Objective: 07-04 Describe how foreign currency forward contracts and foreign currency options can be used to
hedge foreign exchange risk.
Level of Difficulty: 3 Hard
42. What is the primary difference between a cash flow hedge and a fair value hedge?
A. The fair value hedge must completely offset the variability in the cash flow from the
foreign currency receivable or payable.
B. The cash flow hedge can only be used to offset potential foreign currency losses on
accounts receivable.
C. The cash flow hedge must completely offset the variability in cash flow from the
foreign currency receivable or payable.
D. The fair value hedge can only be used to offset the variability in cash flow from long-
term fixed assets related to foreign currency fluctuations.
Learning Objective: 07-05 Describe the concepts of cash flow hedges; fair value hedges; and hedge accounting.
7-32
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
Level of Difficulty: 3 Hard
43. Which of the following statements is true about hedge accounting under U.S. GAAP?
A. Companies may choose whether to account for derivatives as cash flow hedges or fair
value hedges.
B. If a derivative qualifies as a cash flow hedge, the hedging instrument is adjusted to fair
value on each balance sheet date.
C. If a derivative is elected by the company not to be designated as a cash flow hedge, it
must be accounted for as such.
D. Hedge accounting is only advantageous when a foreign currency depreciates between
the transaction date and the payment date.
Learning Objective: 07-05 Describe the concepts of cash flow hedges; fair value hedges; and hedge accounting.
Level of Difficulty: 3 Hard
44. Under U.S. GAAP, which of the following conditions must be met to qualify for hedge
accounting?
Learning Objective: 07-05 Describe the concepts of cash flow hedges; fair value hedges; and hedge accounting.
Level of Difficulty: 2 Medium
Learning Objective: 07-05 Describe the concepts of cash flow hedges; fair value hedges; and hedge accounting.
Level of Difficulty: 2 Medium
7-33
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
46. What kind of exposure exists for recognized foreign currency assets and liabilities?
Learning Objective: 07-05 Describe the concepts of cash flow hedges; fair value hedges; and hedge accounting.
Level of Difficulty: 3 Hard
47. What kind of exposure exists for foreign currency firm commitments?
Learning Objective: 07-05 Describe the concepts of cash flow hedges; fair value hedges; and hedge accounting.
Level of Difficulty: 3 Hard
48. What is the requirement for reporting derivatives under international accounting standards
and U.S. GAAP?
A. They may be shown on the balance sheet or they may be treated as off-balance sheet
investments.
B. They must be shown on the balance sheet at fair value.
C. They must be shown on the balance sheet at historical cost.
D. They may be shown on the balance sheet at historical cost or at net realizable value.
Learning Objective: 07-06 Demonstrate the accounting for forward contracts and options used as cash flow hedges and
fair value hedges to hedge foreign currency assets and liabilities; foreign currency firm commitments; and forecasted
foreign currency transactions.
Level of Difficulty: 2 Medium
7-34
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
49. What information is needed to determine the fair value of a foreign currency forward
contract?
Learning Objective: 07-06 Demonstrate the accounting for forward contracts and options used as cash flow hedges and
fair value hedges to hedge foreign currency assets and liabilities; foreign currency firm commitments; and forecasted
foreign currency transactions.
Level of Difficulty: 2 Medium
Learning Objective: 07-06 Demonstrate the accounting for forward contracts and options used as cash flow hedges and
fair value hedges to hedge foreign currency assets and liabilities; foreign currency firm commitments; and forecasted
foreign currency transactions.
Level of Difficulty: 2 Medium
51. Under U.S. GAAP, where are changes in the fair value of derivatives reported?
Learning Objective: 07-06 Demonstrate the accounting for forward contracts and options used as cash flow hedges and
fair value hedges to hedge foreign currency assets and liabilities; foreign currency firm commitments; and forecasted
foreign currency transactions.
Level of Difficulty: 2 Medium
7-35
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
52. Which of the following is done when accounting for a cash flow hedge, but is not done
when accounting for a fair value hedge?
Learning Objective: 07-06 Demonstrate the accounting for forward contracts and options used as cash flow hedges and
fair value hedges to hedge foreign currency assets and liabilities; foreign currency firm commitments; and forecasted
foreign currency transactions.
Level of Difficulty: 2 Medium
53. How should discounts or premiums on forward contracts be treated if the derivative is
hedging a foreign-currency-denominated asset?
Learning Objective: 07-06 Demonstrate the accounting for forward contracts and options used as cash flow hedges and
fair value hedges to hedge foreign currency assets and liabilities; foreign currency firm commitments; and forecasted
foreign currency transactions.
Level of Difficulty: 2 Medium
7-36
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
54. Under U.S. GAAP, what method of amortizing discounts or premiums on forward contracts
must be used?
Learning Objective: 07-06 Demonstrate the accounting for forward contracts and options used as cash flow hedges and
fair value hedges to hedge foreign currency assets and liabilities; foreign currency firm commitments; and forecasted
foreign currency transactions.
Level of Difficulty: 2 Medium
55. On May 1, 20x1, Ustar purchased a put option to sell £50,000 on April 30, 20x2 at a strike
price equal to $2, which was the spot rate on May 1, 20x1. Ustar paid a premium of $0.01
per pound. How should the option be recorded on May 1, 20x1?
Learning Objective: 07-06 Demonstrate the accounting for forward contracts and options used as cash flow hedges and
fair value hedges to hedge foreign currency assets and liabilities; foreign currency firm commitments; and forecasted
foreign currency transactions.
Level of Difficulty: 2 Medium
56. In hedge accounting, which of the following exposure should be hedged by foreign
currency derivative?
A. Temporal exposure
B. Fair value exposure
C. Derivative exposure
D. Forward contract exposure
Learning Objective: 07-06 Demonstrate the accounting for forward contracts and options used as cash flow hedges and
fair value hedges to hedge foreign currency assets and liabilities; foreign currency firm commitments; and forecasted
foreign currency transactions.
7-37
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
Level of Difficulty: 2 Medium
57. When accounting for forward contracts, what is meant by the term "executory contract"?
Learning Objective: 07-06 Demonstrate the accounting for forward contracts and options used as cash flow hedges and
fair value hedges to hedge foreign currency assets and liabilities; foreign currency firm commitments; and forecasted
foreign currency transactions.
Level of Difficulty: 2 Medium
58. Excel Sources Inc. is a U.S. incorporated company. Due to change in exchange rate, it
receives $150,000 as payment against a sale of $165,000. Under the two-transaction
perspective:
59. Which of the following statements is true of the relationship between foreign currency
transactions, exchange rate changes, and foreign exchange gains and losses?
A. In an export sales, depreciation of the foreign currency causes a foreign exchange gain.
B. In an import purchase, appreciation of the foreign currency causes a foreign exchange
gain.
C. In an import purchase, depreciation of the foreign currency causes a foreign exchange
loss.
D. In an export sales, appreciation of the foreign currency causes a foreign exchange gain.
Learning Objective: 07-02 Explain how fluctuations in exchange rates give rise to foreign exchange risk.
Level of Difficulty: 2 Medium
7-38
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
60. Which of the following statements is true of intrinsic value of options?
A. When the option strike price is more than the spot rate, the intrinsic value is zero.
B. When the option strike price is equal to the spot rate, the intrinsic value is positive.
C. When the option strike price is less than the spot rate, the intrinsic value is zero.
D. When the option strike price is more than the spot rate, the intrinsic value is negative.
Learning Objective: 07-04 Describe how foreign currency forward contracts and foreign currency options can be used to
hedge foreign exchange risk.
Level of Difficulty: 2 Medium
7-39
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
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