Professional Documents
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DERIVATIVES
FORWARD CONTRACTS
1. Consider the following forward contract to buy 100 units of inventories:
2. Playlist Co. is a golf course developer that constructs approximately 5 courses each year. On January
1, 2016, Playlist Co. has agreed to buy 5,000 trees on January 31, 2017 to be planted in the courses
it intends to build. In recent years, the price of trees has fluctuated wildly. On January 1, 2016,
Playlist Co. entered into a forward contract with a reputable bank. The price is set at P 500 per
tree.
The forward contract provides that if the market price on January 31, 2017 is more than P 500, the
difference is paid by the bank to Playlist. On the other hand, if the market price is less than P 500,
Playlist will pay the difference to the bank. This derivative was designated as a cash flow hedge.
The market price on December 31, 2016 is P 800 and the market price on January 31, 2017 is P 700.
The appropriate discount rate is 8% and the PV of 1 at 8% for 1 period is 0.926.
DERIVATIVES Page 1 of 4
FA&R SMARTS CPA REVIEW
4. Bounce Co. operates a seafood restaurant. On October 1, 2016, Bounce Co. determined that it will
need to purchase 50,000 kilos of deluxe fish on March 1, 2017. Because of the volatile fluctuation in
the price of deluxe fish, on October 1, 2016, Bounce negotiated a forward contract with a reputable
bank for Bounce to purchase 50,000 kilos of deluxe fish on March 1, 2017 at a forward price of P
50/kilo or P 2,500,000 in total. This forward contract was designated as a cash flow hedge.
On December 31, 2016, the market price is P 60/kilo and March 1, 2017, the market price of deluxe
fish per kilo dramatically drops to P 48. The appropriate discount rate is 8% and the present value of
1 at 8% for one period is 0.93.
5. On July 1, 2013, Sarah Company sold some limited edition art prints to Plastic Company for ¥
47,850,000 to be paid on September 30 of that year. The current exchange rate on July 1, 2013, was
¥ 110=P 1, so the total payment at the current exchange rate would be equal to P 435,000. Sarah
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, if ¥47,850,000 is worth less than P 435,000, the
bank will pay Sarah the difference in cash. Likewise, if ¥47,850,000 is worth more than P4 35,000,
Sarah must pay the bank the difference in cash.
Assuming the exchange rate on September 30 is ¥ 115=P 1, what amount will Sarah pay to, or receive from, the
bank (rounded to the nearest peso)?
A. P 18,913 P B. P 18,913 R C. P 87,000 P D. P 87,000 R
Assuming the exchange rate on September 30 is ¥ 105=P 1, what amount will Sarah pay to, or receive from, the
bank (rounded to the nearest peso)?
A. P 87,000 P B. P 87,000 R C. P 20,714 P D. P 20,714 R
FUTURES CONTRACT
6. Villegas Co. produces bottled grape juice. Grape juice concentrate is typically bought and sold by the
pound. Villegas uses 50,000 pounds of grape juice concentrate each month.
On November 1, 2014, Villegas entered into a grape juice concentrate futures contract as a cash flow
hedge to buy 50,000 pounds of concentrate on February 1, 2015 at a price of P 50 per pound.
The market price on December 31, 2014 and February 1, 2015 of the grape juice concentrate is P 38
per pound. The appropriate discount rate is 11%. The periodic system is used.
All 3 contracts are to be settled on January 1, 2015. What is the derivative value (net) on December 31, 2014?
A. P 300,000 A B. P 600,000 A C. P 900,000 L D. P 1,050,000 L
8. In July of 2016, Sue enters into a forward agreement with Ann to lock in a sales price for wheat. Sue
anticipates selling 300,000 bushels of wheat at the market in March of 2017. Ann agrees to a forward
with Sue to buy 300,000 bushels at P 6.20. Sue’s cost for the wheat is P 5.90 per bushel. The
contract allows for net settlement.
What is the economic income (loss) for sales transactions at a market price of P 6.30 per bushel?
A. P 90,000 B. P 120,000 C. (P 30,000) D. P 60,000
Consider the same basic facts, but instead of a forward contract Sue purchases put options to sell
300,000 bushels at P 6.20 per bushel. The options cost P 0.05 a bushel.
OPTION
9. Harry Co. produces colorful 100% cotton T-shirts that are very popular among the youth. The entity
uses 150,000 kilos of cotton each month in its production process. In accordance with the entity’s
long-term planning, the entity normally procures one month supply of cotton to be used in its
production process.
On December 31, 2014, Harry purchased a call option as a cash flow hedge to buy 150,000 kilos of
cotton on July 1, 2015. The call option price is P 30/kilo. The entity paid P 50,000 for the call
option.
11. On June 18, Glory Corporation entered into a firm commitment to purchase specialized equipment
from the Hotty 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,
Glory pays P 12,000 for a call option contract. This contract gives Glory the option to purchase ¥
80,000,000 at an exchange rate of ¥ 100 = P 1 on August 20.
12. On January 1, 2016, Emily, Inc. paid P 20,000 for call option to purchase 100 units of shares
for P100/share on March 1, 2016. The following data are available:
January 1, 2016 February 1, 2016 March 1, 2016
Market value P 100 P 280 P 450
Fair value of the option 20,000 30,000 35,000
What is the loss on call option – time value element – on February 1, 2016?
A. P 20,000 B. P 12,000 C. P 8,000 D. P 18,000
What is the gain on call option – intrinsic value element – on February 1, 2016?
A. P 20,000 B. P 12,000 C. P 8,000 D. P 18,000
What is the loss on call option – time value element – on March 1, 2016?
A. P 35,000 B. P 12,000 C. P 17,000 D. P0
What is the gain on call option – intrinsic value element – on March 1, 2016?
A. P 35,000 B. P 12,000 C. P 17,000 D. P0
13. On January 1, 2017, Meme, Inc. paid P 10,000 to acquire put option for 100 units of unique furniture
for P 50,000 each, with an expiration date of December 31, 2017. On December 31, 2017, the selling
price of the furniture was P 46,000 each.
If the selling price on December 31, 2017 was P 50,500, how much would Meme lose?
A. Zero B. P 50,000 C. P 40,000 D. P 10,000
NOTHING FOLLOWS.