Professional Documents
Culture Documents
Chapter 10
Chapter 10
Chapter 10
Denominated Currency
3 Denominated Currency - #1
4 Denominated Currency - #2
5 Denominated Currency - #2
6 Denominated Currency - #3
E.g, if US$:
US buyer pays same US$s as promised
Doesnt matter to US buyer
7 Denominated Currency - #4
1 = US$ 1.05303
US$ 1= 0.949639
Forward rate
Price for FC you pay/get if:
You make binding contract today
Delivery of FC occurs at future time
E.g., delivery in 30 to 180 days
Forward Contract
You enter contract binding today to buy/sell
FC for delivery of FC at future time
Can be any time period not just 30-day intervals
This is a Hedge
If FCs price goes up, US Buyer has locked in
lower price. Avoids loss
BUT, if FCs price goes down, US Buyer has
locked in higher price . Avoids gain
With a Hedge
No risk
2.20/2.20 = 1.02/2.2
Direct Quote: 1 FC = $ .4636
Spot
Rate
U.S.
Interest
Rate
Foreign
Interest
Rate
.4636
= .50
(1.02
/ 1.10)
1 year
.4810
= .50
(1.01
/ 1.05)
6 months
If Denominated Currency is FC
Doesnt matter with whom US Co is dealing
US company exposed to foreign currency risk
Requires special accounting treatment
A/R
C.
$1.00
Sales Revenue
$1.00
Cash
C.
A/R
Exchange Gain
$1.25
$1.00
.25
A/R
C.
$1.00
Sales Revenue
$1.00
Cash
Exchange Loss
C.
A/R
$.833
.167
$1.00
Two Rules:
Rule #1 WHO GETS GAIN/LOSS: Whoever
views Denominated Currency as foreign gets
gain/loss on exchange rate changes
Rule #2 IS THERE GAIN/LOSS: Change in
Buyers domestic currency determines
whether there is gain or loss
If buyers currency went up, then gain
If buyers currency went down, then loss
E.g., Assume
US Buyer buys inv from Foreign Supplier
A/P is for FC 1,000
Rate at time of time of purchase 1FC = 50
Rate at end of Year 1 FC = 52
Rate when US Buyer pays A/P 1 FC = 55
Inventory
Cr.
$500
Accounts Payable
$500
$20
Accounts Payable
$20
Accounts Payable
Exchange Loss [(.55 - .52) x 1,000]
Cr.
Cash
$520
30
$550
37
No risk
Hedge
US Seller
Under Trans
$
FC pay Broker
Product FC rec
Foreign Buyer
Hedge
US Buyer
$
FC rec Broker
E.g., Assume:
US Co buying inventory for FC 100,000 when
1FC = 50
US Co afraid that FC will go up & US Co will
have to pay more than orig expected
US Co gets Forward Contract when forward
rate is 1FC = 50.6
Assume:
US Co buying inventory for FC 100,000
Current spot rate is 1FC = 50
US Co gets Forward Contract when forward
rate is 1FC = 50.6
At Settlement:
Spot rate is 1FC = 55
We know:
A/P will lose 5 x FC100,000 = $5,000
Hedge Receivable will gain 4.4 x FC100,000 =
$4,400
$55,000 - $50,400 = $4,600
US Co buys inventory
Value A/P using current exchange rate
(1FC = US$ .50)
D. Inventory
C. Accounts Payable (FC100,000)
$50,000
$50,000
Hedge
US Buyer
$
FC rec Broker
At Time of Settlement
Spot price = US$ .55
$4,400
$55,000
Forward Contract
$4,400
Cash
50,600
D.
Accounts Payable
Exchange Loss [(.55 - .50) x 1,000]
C.
Foreign Currency
$50,000
5,000
$55,000
49
Assume:
US Co buying inventory for FC 100,000
Current spot rate is 1FC = 50
US Co gets Forward Contract when forward
rate is 1FC = 50.6
At end of year:
Spot rate is 1FC = 52
Forward rate 1FC = 53
At Settlement:
Spot rate is 1FC = 55
US Co buys inventory
Value A/P using current exchange rate
(1FC = US$ .50)
D.
Inventory
C. Accounts Payable
(Obligation to Pay FC100K)
$50,000
$50,000
D.
Exchange Loss
[(.52 - .50) x 100,000]
C.
Accounts Payable
$2,000
$2,000
$2,388
$2,388
At Time of Settlement
Spot price = US$ .55
What did US Co make on Forward Contract?
Forward Contract worth $4,400 ($55,000 - $50,600)
US Co locked in cheap price to buy FC (US$ .506)
That is the total gain on Forward Contract
US Co already took gain at end of last year
Only report gain for 2nd year
At end of last year, Forward Contract had gain of $2,388.
So, This years gain on Forward Contract is $2,012
$4,400 (Total) - $2,388(1st Year) = $2,012 (2nd Year)
D. Forward Contract
C. Gain on Forward Contract
$2,012
$2,012
$55,000
Forward Contract
$4,400
Cash
50,600
D.
Accounts Payable
Exchange Loss [(.55 - .52) x 100K]
C.
Foreign Currency
$52,000
3,000
$55,000
This year
Foreign Currency Loss: -$3,000
Hedge Gain: +$2,012
Net loss is -$988
E.g., Assume:
US Seller sells goods to foreign buyer
Denominated Currency FC
Price is 100,000 FC
Delivery & payment will be in 90 days
US Seller afraid that FC will drop & hedges
Exchange Rates:
At time of signing Contract:
Current spot rate: 1FC = 85
Forward rate: 1 FC = 84.5
At end of year:
Spot rate: 1 FC = 82
Forward rate: 1FC = 81.4
At settlement:
Spot rate: 1 FC = 80
D.
Forward Contract
C. Gain on Forward Contract
$3,085
$3,085
$3,085
$3,085
At Settlement date.
How much did US Co make on Forward Contract?
Future rate changed from US$ .845 to US$ .80
(.845 - .80) x 100,000 = $4,500 total gain
D. Forward Contract
C.
$1,415
$1,415
$1,415
$1,415
$80,000
Firm Commitment
4,500
C.
Sales Revenue
$84,500
Inventory
$55,000
$55,000
D.
Cash
C.
$84,500
Foreign Currency
$80,000
Forward Contract
4,500
Types of Hedges
You can also hedge your position in a nonbinding business arrangement (e.g.,
forecasted or planned transaction)
E.g., I have plans that involve FC
If I decide to do them, I dont want to be in a
worse position than I am now due to a change
in FC
77
78
Lets Review:
We dont have Exchange Gains/Losses with
equal and offsetting Hedge Gains/Losses
Terms of projected transaction are not fixed
Hedge will create Other Comprehensive Income
(OCI)
80
82
BUT
US Co doesnt pay to enter into Forward Contract
Options cost money up front
Cost of Option depends on how much protection US Co
wants
Cost may be too much for complete protection against loss
Time-Value of Option
You pay more than Intrinsic Value of Option
Why? Because Option can make more $ in future
E.g., Assume:
US Co thinks it will buy inventory 3 months from now
US Co thinks that the inventory will cost 100,000 FC
US Co is afraid that FC will go up & inventory will cost
more 3 months from now
US Co buys option to buy 100,000 FC at 55 each
Now:
Current spot rate is 53
Option Price = $900
At end of year:
Spot rate is 57
Option Price = $2,400
Sell Option :
Spot rate is 57.5
Option Price = $2,600
$900
$900
At purchase of Option:
Option has no intrinsic value
Option is not in the money
Spot rate is 53
Exercise Price is 55
At end of year:
Spot Rate goes up to US$ .57
Option now sells for $2,400
D.
$1,500
$500
$2000
Sell Option
Spot Rate goes up to US$ .575
Option now sells for $2,600
D.
$200
300
$500
Cash
C.
$2,600
$2,600
D.
$2,500
$2,500