Question 1

On October 1, 2011, Eagle Company forecasts the purchase of inventory from a British supplier on February 1, 2012, at a price of 100,000 British pounds. On October 1, 2011, Eagle pays $1,800 for a three-month call option on 100,000 pounds with a strike price of $2.00 per pound. The option is considered to be a cash flow hedge of a forecasted foreign currency transaction. On December 31, 2011, the option has a fair value of $1,600. The following spot exchange rates apply:$\begin{array} { | l | c | } 
\hline \text { Date } & \text { Spot Rate } \
\hline \text { October 1, 2011 } & \$ 2.00 \
\hline \text { December 31, 2011 } & \$ 1.97 \
\hline \text { February 1, 2012 } & \$ 2.01 \
\hline
\end{array}$
-What journal entry should Eagle prepare on October 1,2011?$\begin{array} { | l | l | r | r | } 
\hline \text { A) } & \text { Cash } & 1,800 & \
\hline & \text { Foreign Currency Option } & & 1,800 \
\hline \text { B) } & \text { Forward Contract } & 1,800 & \
\hline & \text { Cash } & & 1,800 \
\hline \text { C) } & \text { Foreign Currency Option } & 1,800 & \
\hline & \text { Gain on Foreign Currency } & & 1,800 \
\hline \text { D) } & \text { Loss on Foreign Currency } & 1,800 & \
\hline & \text { Cash } & & 1,800 \
\hline \text { E) } & \text { Foreign Currency Option } & 1,800 & \
\hline & \text { Cash } & & 1,800 \
\hline
\end{array}$
A)A above.
B)B above.
C)C above.
D)D above.
E)E above.

Accepted Answer

Eagle Company should record the purchase of the foreign currency option as an asset by debiting "Foreign Currency Option" and crediting "Cash" for the amount paid, $1,800.

Question 2

What is the major assumption underlying the one-transaction perspective?

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Question 3

What is the purpose of a hedge of foreign exchange risk?

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Question 4

What happens when a U.S.company purchases goods denominated in a foreign currency and the foreign currency appreciates?

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Question 5

Old Colonial Corp.(a U.S.company)made a sale to a foreign customer on September 15,2011,for 100,000 stickles.Payment was received on October 15,2011.The following exchange rates applied: $\begin{array} { | l | c | } 
\hline & \text { Exchange } \
\hline  { \text { Date } } & \text { Rate } \
\hline \text { September } 15,2011 & \$ 1 = \$ .48 \
\hline \text { September } 30,2011 & \$ 1 = \$ .50 \
\hline \text { October } 15,2011 & \$ 1 = \$ .44 \
\hline
\end{array}$
Required:
Prepare all journal entries for Old Colonial Corp.in connection with this sale assuming that the company closes its books on September 30 to prepare interim financial statements.

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Question 6

What happens when a U.S.company sells goods denominated in a foreign currency and the foreign currency appreciates?

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Question 7

What happens when a U.S.company purchases goods denominated in a foreign currency and the foreign currency depreciates?

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Question 8

On October 1, 2011, Eagle Company forecasts the purchase of inventory from a British supplier on February 1, 2012, at a price of 100,000 British pounds. On October 1, 2011, Eagle pays $1,800 for a three-month call option on 100,000 pounds with a strike price of $2.00 per pound. The option is considered to be a cash flow hedge of a forecasted foreign currency transaction. On December 31, 2011, the option has a fair value of $1,600. The following spot exchange rates apply:$\begin{array} { | l | c | } 
\hline \text { Date } & \text { Spot Rate } \
\hline \text { October 1, 2011 } & \$ 2.00 \
\hline \text { December 31, 2011 } & \$ 1.97 \
\hline \text { February 1, 2012 } & \$ 2.01 \
\hline
\end{array}$
-What is the 2012 effect on net income as a result of these transactions?
A)$195,000
B)$201,600
C)$201,000
D)$202,600
E)$203,000

Accepted Answer

The answer of  On October 1, 2011, Eagle Company...

Question 9

What happens when a U.S.company sells goods denominated in a foreign currency and the foreign currency depreciates?

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Question 10

Gaw Produce Co.purchased inventory from a Japanese company on December 18,2011.Payment of 4,000,000 yen (¥)was due on January 18,2012.Exchange rates between the dollar and the yen were as follows: $\begin{array}{cc}
&  \text { Exchange  } &  \
\underline{ \text { Date }} & \underline{\text {  Rate}} \
 \text {  December 18, 2011} &¥1=\$ .0080  \
 \text { December 31, 2011 } &¥ 1=\$ .0082 \
 \text { January 18,2012 } &¥ 1=\$ .0083 \
 \text {  } &\
\end{array}$

Required:
Prepare all journal entries for Gaw Produce Co.in connection with the purchase and payment.

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Question 11

What is meant by the spot rate?

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Question 12

What factors create a foreign exchange gain?

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Question 13

On October 1, 2011, Eagle Company forecasts the purchase of inventory from a British supplier on February 1, 2012, at a price of 100,000 British pounds. On October 1, 2011, Eagle pays $1,800 for a three-month call option on 100,000 pounds with a strike price of $2.00 per pound. The option is considered to be a cash flow hedge of a forecasted foreign currency transaction. On December 31, 2011, the option has a fair value of $1,600. The following spot exchange rates apply:$\begin{array} { | l | c | } 
\hline \text { Date } & \text { Spot Rate } \
\hline \text { October 1, 2011 } & \$ 2.00 \
\hline \text { December 31, 2011 } & \$ 1.97 \
\hline \text { February 1, 2012 } & \$ 2.01 \
\hline
\end{array}$
-What is the amount of option expense for 2012 from these transactions?
A)$1,000.
B)$1,600.
C)$2,500.
D)$2,600.
E)$0.

Accepted Answer

The answer of  On October 1, 2011, Eagle Company...

Question 14

On October 1, 2011, Eagle Company forecasts the purchase of inventory from a British supplier on February 1, 2012, at a price of 100,000 British pounds. On October 1, 2011, Eagle pays $1,800 for a three-month call option on 100,000 pounds with a strike price of $2.00 per pound. The option is considered to be a cash flow hedge of a forecasted foreign currency transaction. On December 31, 2011, the option has a fair value of $1,600. The following spot exchange rates apply:$\begin{array} { | l | c | } 
\hline \text { Date } & \text { Spot Rate } \
\hline \text { October 1, 2011 } & \$ 2.00 \
\hline \text { December 31, 2011 } & \$ 1.97 \
\hline \text { February 1, 2012 } & \$ 2.01 \
\hline
\end{array}$
-What is the amount of Adjustment to Accumulated Other Comprehensive Income for 2012 from these transactions?
A)$1,000.
B)$1,600.
C)$1,800.
D)$2,000.
E)$2,600.

Accepted Answer

The answer of  On October 1, 2011, Eagle Company...

Question 15

Yelton Co.just sold inventory for 80,000 euros,which Yelton will collect in sixty days.Briefly describe a hedging transaction Yelton could engage in to reduce its risk of unfavorable exchange rates.

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Question 16

On October 1, 2011, Eagle Company forecasts the purchase of inventory from a British supplier on February 1, 2012, at a price of 100,000 British pounds. On October 1, 2011, Eagle pays $1,800 for a three-month call option on 100,000 pounds with a strike price of $2.00 per pound. The option is considered to be a cash flow hedge of a forecasted foreign currency transaction. On December 31, 2011, the option has a fair value of $1,600. The following spot exchange rates apply:$\begin{array} { | l | c | } 
\hline \text { Date } & \text { Spot Rate } \
\hline \text { October 1, 2011 } & \$ 2.00 \
\hline \text { December 31, 2011 } & \$ 1.97 \
\hline \text { February 1, 2012 } & \$ 2.01 \
\hline
\end{array}$
-What journal entry should Eagle prepare on December 31,2011?$\begin{array} { | l | l | r | r | } 
\hline \text { A. } & \text { Foreign Currency Option } & 200 & \
\hline & \text { Cash } & & 200 \
\hline \text { B. } & \text { Foreign Currency Option } & 200 & \
\hline & \text { Option Revenue } & & 200 \
\hline \text { C. } & \text { Foreign Currency Option } & 400 & \
\hline & \text { Option Revenue } & & 400 \
\hline \text { D. } & \text { Option Expense } & 200 & \
\hline & \text { Foreign Currency Option } & & 200 \
\hline \text { E) } & \text { Option Expense } & 400 & \
\hline & \text { Foreign Currency Option } & & 400 \
\hline
\end{array}$
A)A above.
B)B above.
C)C above.
D)D above.
E)E above.

Accepted Answer

The option's fair value decreased from $1,800 to $1,600, resulting in a loss of $200. This loss is recorded as an option expense.

Question 17

How does a foreign currency forward contract differ from a foreign currency option?

Accepted Answer

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Question 18

On October 1, 2011, Eagle Company forecasts the purchase of inventory from a British supplier on February 1, 2012, at a price of 100,000 British pounds. On October 1, 2011, Eagle pays $1,800 for a three-month call option on 100,000 pounds with a strike price of $2.00 per pound. The option is considered to be a cash flow hedge of a forecasted foreign currency transaction. On December 31, 2011, the option has a fair value of $1,600. The following spot exchange rates apply:$\begin{array} { | l | c | } 
\hline \text { Date } & \text { Spot Rate } \
\hline \text { October 1, 2011 } & \$ 2.00 \
\hline \text { December 31, 2011 } & \$ 1.97 \
\hline \text { February 1, 2012 } & \$ 2.01 \
\hline
\end{array}$
-What is the amount of Cost of Goods Sold for 2012 as a result of these transactions?
A)$200,000.
B)$195,000.
C)$201,000.
D)$202,600.
E)$203,000.

Accepted Answer

The answer of  On October 1, 2011, Eagle Company...

Question 19

How is the fair value of a Forward Contract determined by U.S.GAAP?

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The answer of How is the fair value of a...

Question 20

Where can you find exchange rates between the U.S.dollar and most foreign currencies?

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The answer of Where can you find exchange rates between...

Quiz 7: Foreign Currency Transactions and Hedging Foreign Exchange Risk

What is the major assumption underlying the one-transaction perspective?

What is the purpose of a hedge of foreign exchange risk?

What happens when a U.S.company purchases goods denominated in a foreign currency and the foreign currency appreciates?

What happens when a U.S.company sells goods denominated in a foreign currency and the foreign currency appreciates?

What happens when a U.S.company purchases goods denominated in a foreign currency and the foreign currency depreciates?

What happens when a U.S.company sells goods denominated in a foreign currency and the foreign currency depreciates?

What is meant by the spot rate?

What factors create a foreign exchange gain?

Yelton Co.just sold inventory for 80,000 euros,which Yelton will collect in sixty days.Briefly describe a hedging transaction Yelton could engage in to reduce its risk of unfavorable exchange rates.

How does a foreign currency forward contract differ from a foreign currency option?

How is the fair value of a Forward Contract determined by U.S.GAAP?

Where can you find exchange rates between the U.S.dollar and most foreign currencies?