UNIVERSITY OF SAN JOSE-RECOLETOS

COLLEGE OF COMMERCE
Accountancy and Finance Department

DERIVATIVES SAMPLE PROBLEMS MS. SARAH M. BALISACAN, CPA

1. Which of the following is not a distinguishing characteristic of a derivative instrument?

a. Terms that require or permit net settlement investment
b. Must be highly effective throughout its life
c. No initial net investment
d. One or more underlying/s
Answer: B

2. Change in fair value of a derivative is recognized in other comprehensive income when derivative is
a. For speculation.
b. A hedging instrument in a fair value hedge.
c. A hedging instrument in an ineffective cash flow hedge.
d. A hedging instrument in an effective cash flow hedge.
Answer; D

3. Hedged item in a fair value hedge least likely include

a. A recognized asset
b. A recognized liability
c. An unrecognized firm commitment
d. A highly probable forecast transaction
Answer: D

4. A hedge of the foreign currency risk of a firm commitment is accounted for as a

a. Hedge of a net investment in a foreign operation
b. Fair value hedge
c. Cash flow hedge
d. Either b or c
Answer: D

5. An agreement between two parties to exchange a specified amount of a commodity, security, or

foreign currency at a specified date in the future with the price or exchange rate being set now is
referred to as a(n)
a. Interest rate swap.
b. Forward contract.
c. Futures contract.
d. Option.
Answer: B

6. Futures are contracts similar to forwards but with the following differences
a. Futures are generic exchange-traded, whereas forwards are individually tailored.
b. Futures are generally settled through an offsetting (reversing) trade, whereas forwards are
generally settled by delivery of the underlying item or cash settlement.

1
 c. Both a and b.
d. Neither a nor b.
Answer: C

7. Which type of contract is unique in that it protects the owner against unfavorable movements in the
prices or rates while allowing the owner to benefit from favorable movements?
a. Interest rate swap
b. Forward contract
c. Futures contract
d. Option
Answer: D

8. In exchange for the rights inherent in an option contract, the owner of the option will typically pay a
price
a. Only when a call option is exercised.
b. Only when a put option is exercised.
c. When either a call option or a put option is exercised.
d. At the time the option is received regardless of whether the option is exercised or not.
Answer: D

9. If the price of the underlying is greater than the strike or exercise price of the underlying, the call option
is
a. In the money.
b. At the money.
c. Out of the money.
d. On the money.
Answer: A

10. Allan Company operates a chain of seafood restaurants. On July 1, 2020, the entity determined that it
will need to purchase 50,000 kilos of deluxe fish on July 1, 2021. Because of the volatile fluctuation in
the price of deluxe fish, on July 1, 2020, the entity negotiated a forward contract as a cash flow hedge
with a reputable bank to purchase 50,000 kilos of deluxe fish on July 1, 2021 at a strike price of P50
per kilo or P2,500,000. This derivative forward contract provides that if the market price of deluxe fish
on July 1, 2021 is more than P50, the differences is paid by the bank to the entity. On the other hand,
if the market price on July 1, 2021 is less than P50, the entity will pay the difference to the bank. The
market price per kilo of the deluxe fish is P55 on December 31, 2020 and P52 on July 1, 2021. What is
the derivative asset or liability on December 31, 2020?
a. 100,000 asset
b. 100,000 liability
c. 250,000 asset
d. 250,000 liability

Answer: C 250,000 asset

Solution: 50,000 (55-50) = 250,000 asset

Journal Entries (Cash Flow Hedge)

7/1/2020 No entry

12/31/2020 Forward contract receivable 250,000

Unrealized gain - OCI 250,000

2
 7/1/2021 Unrealized gain – OCI 150,000
Forward contract receivable 150,000

Cash 100,000
Forward contract receivable 100,000

Purchases 2,600,000
Cash 2,600,000

Unrealized gain – OCI 100,000

Purchases 100,000

For numbers 11 to 13

On January 1, 2019, John Lester Company received a four-year P5,000,000 loan with interest payments
occurring at the end of each year and the principal to be repaid on December 31, 2022. The interest for
2014 is the prevailing market rate of 10% on January 1, 2019, and the market interest rate every January
1 resets the variable rate of interest for that year. The “underlying” fixed interest rate is 10%. In
conjunction with the loan, the entity entered into a “receive variable, pay fixed” interest rate swap
agreement as cash flow hedge. The interest swap payment will be made on December 31 of each year.
The market rate of interest is 6% on January 1, 2020 and 8% on January 1, 2016. The PV of an ordinary
annuity of 1 at 6% for three periods is 2.67 and the PV of an ordinary annuity of 1 at 8% for two periods is
1.78.

11. What is the derivative asset or liability on December 31, 2019?

a. 600,000 asset
b. 600,000 liability
c. 534,000 asset
d. 534,000 liability

Answer: D 534,000 liability

Solution: 5,000,000 (10% - 6%) = 200,000 x 2.67 = 534,000

12. What is the derivative asset or liability on December 31, 2020?

a. 178,000 asset
b. 178,000 liability
c. 334,000 asset
d. 334,000 liability

Answer: B 178,000 liability

Solution: 5,000,000 (10% - 8%) =100,000 x 1.78 = 178,000

13. What amount of interest expense should be reported for 2020?

a. 500,000
b. 300,000
c. 400,000
d. 156,000
Answer: A 500,000
Solution: 5,000,000 (10%) = 500,000

3
Journal Entries (Cash Flow Hedge):

1/1/2019 Cash 5,000,000

Note Payable – Bank 5,000,000

12/31/2019 Interest expense 500,000

Cash 500,000

Unrealized loss – OCI 534,000

Interest rate swap payable 534,000

12/31/2020 Interest expense 300,000

Cash 300,000

Interest rate swap payable 200,000

Cash 200,000

Interest expense 200,000

Unrealized loss - OCI 200,000

Interest rate swap payable 156,000

Unrealized loss - OCI 156,000

For numbers 14 to 17

On January 1, 2018, Elton Company borrowed P1,000,000 from a bank at an 8% fixed interest rate with
interest to be paid annually on December 31 and the principal to be repaid on December 31, 2020.

On January 1, 2018, the entity entered into a “receive fixed, pay variable” interest rate swap with a
speculator and has designated the swap as fair value hedge of the fixed interest rate loan.

The market rate of interest on January 1 of each year determines the interest swap settlement to be
made every December 31.

This means that the entity will make a swap payment if the market rate of interest on January 1 is higher
than the 8% fixed rate and will receive a swap payment of the market rate of interest on January 1 is
lower than the 8% fixed rate.

The market rates of interest are:

January 1, 2018 8%
January 1, 2019 10%
January 1, 2020 11%

The relevant present value factors are:

PV of 1 at 10% for two periods 0.8264

PV of an ordinary annuity of 1 at 10% for two periods 1.7355
PV of 1 at 11% for one period 0.9009

14. What is the derivative asset or liability on December 31, 2018?

a. 40,000 asset
b. 40,000 liability
c. 34,760 asset
d. 34,760 liability

4
Answer: D 34,760 liability

15. What is the carrying amount of note payable on December 31, 2018?
a. 1,160,000
b. 1,000,000
c. 972,972
d. 899,128
Answer: C 972,972

16. What amount of gain or loss on derivative asset or liability should be reported for 2019?
a. 7,733 gain
b. 7,733 loss
c. 12,267 gain
d. 12,267 loss
Answer: D 12,267 loss

17. What amount of interest expense should be reported for 2020?

a. 80,000
b. 96,524
c. 107,028
d. 110,000
Answer: C 107,028

Journal Entries (Fair Value Hedge):

1/1/2018 Cash 1,000,000

Note Payable – Bank 1,000,000

12/31/2018 Interest expense 80,000

Cash 80,000

Note payable 34,760

Gain on note payable 34,760

PV of principal (1,000,000 x .8264) 826,400

PV of interest (80,000 x 1.7355) 138,840
Fair value of note – 12/31/2018 965,240
Carrying value of note payable 1,000,000
Decrease in varying amount - gain 34,760

Loss on interest rate swap 34,760

Interest rate swap payable 34,760

Variable interest (1,000,000 x 10%) 100,000

Fixed interest (1,000,000 x 8%) 80,000
Net cash payment to speculator 20,000
PV of OA of 1 at 10% for two periods 1.7355
FV of interest swap payable – 12/312018 34,760

12/31/2019 Interest expense 96,524

Cash 80,000
Note payable 16,624

5
 Interest expense (965,240 x 10%) 96,524
Interest paid (1,000,000 x 8%) 80,000
Amort. of discount – increase in note payable 16,524

Note payable 8,792

Gain on note payable 8,792

PV of principal (1,000,000 x .9009) 900,900

PV of interest payment (80,000 x .9009) 72,072
Fair value of note payable – 12/31/2019 972,972
Carrying amt. of note pay. (965,240-16,524) 981,764
Decrease in carrying amount. – gain 8,792

Interest rate swap payable 200,000

Cash 200,000

Loss on interest rate swap 12,267

Interest rate swap payable 12,267

Variable interest (1,000,000 x 11%) 110,000

Fixed interest (1,000,000 x 8%) 80,000
Net cash payment to speculator 30,000
Multiply by PV of 1 at 11% for one period .9009
FV of interest rate swap payable - 12/31/2019 27,027
Carrying amt. of interest rate swap payable
(34,760 – 20,000) 14,760
Increase in interest rate swap payable 12,267

12/31/2020 Interest expense 107,028

Cash 80,000
Note payable 27,028

Interest expense (927,972 x 11%) 107,028

Interest paid 80,000
Amortization of discount 27,028

Loss on interest rate swap 2,973

Interest rate swap payable 2,973

Final cash payment to speculator 30,000

Carrying amt. of interest rate swap payable 27,027
Loss on interest rate swap 2,973

Interest rate swap payable 30,000

Cash 30,000

Note payable 1,000,000

Cash 1,000,000

6
For numbers 18 to 21

Daizy Company produces colorful 100% cotton shirts and the entity needs 50,000 kilos of raw materials in
the production process. On December 1, 2019, the entity purchased a call option as a cash flow hedge to
buy 50,000 kilos on July 1, 2020. The option strike is P100 per kilo. The entity paid P50,000 for the call
option. This derivative option contract means that if the market price is higher than P100, the entity can
exercise the option and buy the asset at the strike option price of P100. If the market price is lower than
P100, the entity can throw away the option and buy the asset at the cheaper price. The market price per
kilo is P110 on December 31, 2019 and P115 on July 1, 2020.

18. What is the derivative asset on December 31, 2019?

a. 500,000
b. 450,000
c. 750,000
d. 700,000
Answer: A 500,000
Solution: 50,000 (110 – 100) = 500,000

19. What is the cash settled from the speculator on July 1, 2020?
a. 750,000
b. 700,000
c. 500,000
d. 450,000
Answer: A 750,000
Solution: 50,000 (115 – 100) = 750,000

Journal Entries (Cash Flow Hedge):

12/1/2019 Call option 50,000

Cash 50,000

12/31/2019 Call option 500,000

Unrealized gain – OCI 500,000

7/1/2020 Call option 250,000

Unrealized gain - OCI 250,000

Unrealized loss – P/L 50,000

Call option 50,000

Cash 750,000
Call option 750,000

Purchases 5,750,000
Cash 5,750,000

Unrealized gain – OCI 750,000

Purchases 750,000

20. Assume the market price is P110 on December 31, 2019 and P90 on July 1, 2020. What amount
should be recognize as loss on call option in 2020?
a. 500,000
b. 450,000

7
 c. 50,000
d. 0
Answer: C 50,000
Explanation: Option is out-of-the-money (Strike price > Spot price); Loss = Call premium

7/1/2020 Loss on call option 50,000

Unrealized gain – OCI 500,000
Call option 550,000

Purchases 4,500,000
Call option 4,500,000

21. Assume the market price is P110 on December 31, 2014 and P90 on July 1, 2020. What is the
derivative liability on July 1, 2020?
a. 500,000
b. 250,000
c. 450,000
d. 0
Answer: D 0
Explanation: Option is a right not an obligation.

22. Sarah Agriculture sells approximately 300,000 bushels of corn each month. On January 1, 2020,
Sarah purchased option to sell 500,000 bushels of corn on June 30, 2020, at a price of P95 per
bushel. Sarah had to pay P400,000 to purchase this corn put option, which it designated as a hedge
against price decreases for its June 30, 2020 sale of corn. If the price of the corn on June 30, 2020 is
P100 per bushel, Sarah shall recognize a loss on put option in 2020 at
a. P1,500,000
b. P1,100,000
c. P400,000
d. P0

Answer: C P400,000

Explanation: Option is out-of-the-money (Strike price < Spot price); Loss = Put premium

Journal Entries:

1/1/2020 Put option 400,000

Cash 400,000

6/30/2020 Loss on put option 400,000

Put option 400,000

For numbers 23 to 24

On July 1 of the current year, Dexter Company sold goods to Brian for ¥47,850,000 to be paid on
September 30. The current exchange rate on July 1 was ¥110=P1, so the total payment at the current
exchange rate would be equal to P435,000. Dexter entered into a forward contract with a universal bank
to guarantee the number of pesos to be received. According to the terms of the contract, ¥47,850,00 is
worth less than P435,000, the bank will pay Dexter the difference in cash. Likewise, if ¥47,850,000 is
worth more than P435,000, Dexter must pay the bank the difference in cash.

8
23. Assuming the exchange rate on September 30 is ¥115=P1, what amount will Dexter pay to, or receive
from the bank (rounded to the nearest peso)?
a. P18,913 payment
b. P18,913 receipt
c. P87,000 payment
d. P87,000 receipt
Answer: B P18,913 receipt
Solution: (¥47,850,000/¥110:P1) - (¥47,850,000/¥115:P1) = P18,913 receipt

Journal Entries:

Undesignated Hedge (Net Accounting):

7/1 Accounts receivable 435,000

Sales 435,000

9/30 Loss on foreign exchange 18,913

Accounts receivable 18,913

Cash 416,087
Accounts receivable 416,087

Forward contract receivable 18,913

Gain on forward contract 18,913

Cash 18,913
Forward contract receivable 18,913

Undesignated Hedge (Gross Accounting):

7/1 Accounts receivable 435,000

Sales 435,000

Pesos receivable 435,000

Foreign currency payable 435,000

9/30 Loss on foreign exchange 18,913

Accounts receivable 18,913

Cash 416,087
Accounts receivable 416,087

Pesos receivable 18,913

Gain on forward contract 18,913

Cash 453,913
Pesos receivable 453,913

Foreign currency payable 435,000

Cash 435,000

24. Assuming the exchange rate on September 30 is ¥105=P1, what amount will Dexter pay to, or receive
from, the bank (rounded to the nearest peso)?
a. P87,000 payment
b. P87,000 receipt

9
 c. P20,714 payment
d. P20,714 receipt
Answer: C P20,714 payment
Solution: (¥47,850,000/¥110:P1) - (¥47,850,000/¥105:P1) = P20,714 payment
Journal Entries:

Undesignated Hedge (Net Accounting):

7/1 Accounts receivable 435,000

Sales 435,000

9/30 Accounts receivable 20,714

Gain on foreign exchange 20,714

Cash 455,714
Accounts receivable 455,714

Loss on forward contract 20,714

Forward contract payable 20,714

Forward contract payable 20,714

Cash 20,714

Undesignated Hedge (Gross Accounting):

7/1 Accounts receivable 435,000

Sales 435,000

Pesos receivable 435,000

Foreign currency payable 435,000

9/30 Accounts receivable 20,714

Gain on foreign exchange 20,714

Cash 455,714
Accounts receivable 455,714

Loss on forward contract 20,714

Pesos receivable 20,714

Cash 414,286
Pesos receivable 414,286

Foreign currency payable 435,000

Cash 435,000

25. On June 18, Cedric Corporation entered into a firm commitment to purchase specialized equipment
from the Kristine Trading Company for ¥80,000,000 on August 20. The exchange rate on June 18 is
¥100=P1. To reduce the exchange rate risk that could increase the cost of the equipment in pesos,
Cedric pays P12,000 for a call option contract. This contract gives Cedric the option to purchase
¥80,000,000 at an exchange rate of ¥100=P1 on August 20. On August 20, the exchange rate is
¥93=P1. How much did Cedric save by purchasing the call option?
a. P12,000
b. P48,215

10
 c. P60,215
d. Cedric would have been better off not to have purchased the call option.

Answer: B P48,215

Solution: (¥80,000,000/¥93:P1) - (¥80,000,000/¥100:P1) = P60,215 – P12,000 = P48,215

Journal Entries:

Cash Flow Hedge (Net Accounting):

6/18 Call Option 12,000

Cash 12,000

8/20 Call Option 60,215

Unrealized gain – OCI 60,215

Unrealized gain – P/L 12,000

Call Option 12,000

Cash 60,215
Call Option 60,215

Equipment 860,215
Cash 860,215

Unrealized gain – OCI 60,215

Equipment 60,215

Fair Value Hedge (Net Accounting):

6/18 Call Option 12,000

Cash 12,000

8/20 Call Option 60,215

Unrealized gain – P/L 60,215

Unrealized gain – P/L 12,000

Call Option 12,000

Cash 60,215
Call Option 60,215

Loss on foreign exchange – P/L 60,215

Firm Commitment 60,215

Equipment 860,215
Cash 860,215

Firm Commitment 60,215

Equipment 60,215

11
26. Peter Company has the Philippine peso as its functional currency. The entity expects to purchase
equipment from USA for $20,000 on March 31, 2021. Accordingly, the entity is exposed to a foreign
currency exchange risk. If the dollar increases before the purchase takes place, the entity will have to
pay more pesos to obtain the $20,000 that it will have to pay for the equipment.

To offset the risk of any increase in the dollar rate, the entity enters into a forward currency contract on
October 1, 2020 to purchase $20,000 in six months for a fixed amount of P1,000,000 or P50 to $1.
The entity designates the forward currency contract as the hedging instrument in a cash flow hedge of
its exposure to increases in the dollar exchange rate.

On December 31, 2020, the exchange rate is P52 to $1 and on March 31, 2021, the exchange rate is
P53 to $1. What is the fair value of the derivative asset (forward contract receivable) on December 31,
2020?
a. P40,000
b. P20,000
c. P60,000
d. P0
Answer: B P40,000
Solution: $20,000 (P52:$1 – P50:$1) = P40,000
Journal Entries:

Cash Flow Hedge (Net Accounting):

10/1/2020 No journal entry

12/31/2020 Forward contract receivable 40,000

Unrealized gain – OCI 40,000

3/31/2021 Forward contract receivable 20,000

Unrealized gain - OCI 20,000

Cash 60,000
Forward contract receivable 60,000

Equipment 1,060,000
Cash 1,060,000

Unrealized gain – OCI 60,000

Equipment 60,000

Cash Flow Hedge (Gross Accounting):

10/1 Foreign currency receivable 1,000,000

Pesos payable 1,000,000

12/31 Foreign currency receivable 40,000

Unrealized gain – OCI 40,000

3/31/2021 Foreign currency receivable 20,000

Unrealized gain - OCI 20,000

Cash 1,060,000
Foreign currency receivable 1,060,000

12
Pesos payable 1,000,000
Cash 1,000,000

Equipment 1,060,000
Cash 1,060,000

Unrealized gain – OCI 60,000

Equipment 60,000

13