On December 1,20X8,Hedge Company entered into a 60-day speculative forward contract to sell 200,000 British pounds (£)at a forward rate of £1 = $1.78.On the same day it purchased a 60-day speculative forward contract to buy 100,000 euros (€)at a forward rate of €1 = $1.42.
The rates are as follows:
Hedge had no other speculation transactions in 20X8 and 20X9.Ignore taxes.
-Based on the preceding information,what is the overall effect of speculation on 20X8 net income?
A)$4,000 gain
B)$6,000 gain
C)$8,000 loss
D)$8,000 gain

Question

On December 1,20X8,Hedge Company entered into a 60-day speculative forward contract to sell 200,000 British pounds (£)at a forward rate of £1 = $1.78.On the same day it purchased a 60-day speculative forward contract to buy 100,000 euros (€)at a forward rate of €1 = $1.42.
The rates are as follows:
  Hedge had no other speculation transactions in 20X8 and 20X9.Ignore taxes.
-Based on the preceding information,what is the overall effect of speculation on 20X8 net income?
A)$4,000 gain 
B)$6,000 gain 
C)$8,000 loss 
D)$8,000 gain

Quizplus · Accepted Answer

To determine the effect of speculation on net income, we need to assess the potential gain or loss from each transaction. 
- For the sale of £200,000, using the forward rate of £1=$1.78, the company will receive $356,000. If the spot rate on the settlement date is higher than the forward rate, the company will have a gain. 
- For the purchase of €100,000, using the forward rate of €1=$1.42, the company will pay $142,000. If the spot rate on the settlement date is lower than the forward rate, the company will have a gain.

Since the company entered into both contracts on the same day and for the same duration, we can assume that the settlement dates are the same. Thus, the overall effect of speculation on net income is the combined gain or loss from both transactions.

If the spot rate on the settlement date is £1=$1.80 and €1=$1.40, the gain/loss calculation will be as follows: 
- Gain from selling £200,000 = ($1.80 - $1.78) x £200,000 = $4,000 
- Gain from buying €100,000 = ($1.42 - $1.40) x €100,000 = $2,000

Overall gain = $4,000 + $2,000 = $6,000

Therefore, the answer is B) $6,000 gain.

On December 1,20X8,Hedge Company Entered into a 60-Day Speculative Forward