On November 1 of the current year, Patriot Inc. purchased a container of electri

Question

On November 1 of the current year, Patriot Inc. purchased a container of electrical components from its supplier in Japan. Patriot agreed to pay 15,000,000 ¥ in 90 days. The exchange rate on November 1 was $1 = 120 ¥. Patriot decided to hedge the transaction and entered into a 90 day forward contract to purchase yen at a cost of $1 = 125 ¥. The 60 day forward rate that would take Patriot to the December 31 fiscal year end was $1 = 127.50 ¥. On December 31, the spot rate was $1 = 118 ¥, and the 30-day forward rate was $1 = 122 ¥. What is the balance in the forward contract account on December 31 of the current year? (For purposes of this exercise, use a present value factor of 1.)
A) $7,119 debit
B) $7,119 credit
C) $2,951 debit
D) $2,951 credit
E) $120,000 debit

Explanation / Answer

C) $2,951 Credit
Compare the forward contract rate to the currently available rate that will take us to the due date.
a. Cost of a current 30 Day forward Contract (15,000,000/122) $122,951
b. Cost of Yen at the contracted rate (15,000,000/125) $120,000
Value of the forward contract a-b= $2,951

This is a debit balance because we are better off having hedged the transaction on November 1 of the current year than we would be if we had waited until December 31 to hedge the transaction.

Related Questions

Navigate

• Browse (All)
• Browse O
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.