On May 1, 2011, Mosby Company received an order to sell a machine to a customer
ID: 2485238 • Letter: O
Question
On May 1, 2011, Mosby Company received an order to sell a machine to a customer in Canada at a price of 2,000,000 Mexican pesos. The machine was shipped and payment was received on March 1, 2012. On May 1, 2011, Mosby purchased a put option giving it the right to sell 2,000,000 pesos on March 1, 2012 at a price of $190,000. Mosby properly designates the option as a fair value hedge of the peso firm commitment. The option cost $3,000 and had a fair value of $3,200 on December 31, 2011. The following spot exchange rates apply:
Mosby's incremental borrowing rate is 12 percent, and the present value factor for two months at a 12 percent annual rate is .9803.
What was the impact on Mosby's 2012 net income as a result of this fair value hedge of a firm commitment? Please provide detailed calculation.
A.
$1,800.00 decrease.
B.
$2,500.00 increase.
C.
$2,500.00 decrease.
D.
$188,760.60 increase.
E.
$188,760.60 decrease.
A.
$1,800.00 decrease.
Explanation / Answer
The impact on Mosby's 2012 net income as a result of this fair value hedge of a firm commitment = Net Income will Increase by $9,940
..
Profit on Fair Value Hedge = Fair Value of Hedge on March-1,2012 - Fair Value of Hedge on Dec-31,2011
=[3200+(190,000-20,00,000*0.089)]- [3200 +(190,000-20,00,000*0.094)]
= $15,200 - $5,200
= $10,000
..
Interest on Option Premium for two months = $3000*12%*(2/12)
= $60
..
Net gain = $10,000-$60
= $9,940
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