Question 1

When a share of a company's stock is selling for $55.00, a put option on the stock with a strike price of $56.00 is said to be:

Accepted Answer

A put option is "in the money" when the strike price is above the current market price of the stock, allowing the holder to sell the stock at a price higher than the current market price.

Question 2

A company uses options to hedge its forecasted purchase of merchandise. If the options qualify as a cash flow hedge of the forecasted purchase, and analysis of hedge effectiveness excludes option time value, which statement is true concerning reporting for changes in the value of the options?

Accepted Answer

Changes in intrinsic value adjust cost of goods sold when the merchandise is sold.

Question 3

A company uses options to hedge its merchandise inventory. If the options qualify as a fair value hedge of the inventory, and analysis of hedge effectiveness excludes option time value, which statement is true concerning reporting for changes in the value of the options?

Accepted Answer

The answer of A company uses options to hedge its...

Question 4

Use the following information to answer bellow Questions.
On January 1, 2020, Teller Corporation borrows $1 million for three years at the prime rate plus 1.5%, with the rate adjusted annually. The interest is due December 31 of each year. The prime rate is currently 0.5%. To hedge against rising interest rates, Teller buys a three-year, 2% interest rate cap for $5,000, paid in full immediately. Teller's loan was renewed December 31, 2020, when the prime rate was 0.7%, and the fair value of the cap declines by $800. By the end of 2021, the cap's value increases by $300. The cap qualifies as a hedge of the future variable interest payment, and all income effects of the loan and the cap are reported in interest expense.
-Total interest expense for 2020 is

Accepted Answer

((.015 + .005) x $1,000,000) + $800 = $20,800

Question 5

Use the following information to answer bellow Questions.
On January 1, 2020, Teller Corporation borrows $1 million for three years at the prime rate plus 1.5%, with the rate adjusted annually. The interest is due December 31 of each year. The prime rate is currently 0.5%. To hedge against rising interest rates, Teller buys a three-year, 2% interest rate cap for $5,000, paid in full immediately. Teller's loan was renewed December 31, 2020, when the prime rate was 0.7%, and the fair value of the cap declines by $800. By the end of 2021, the cap's value increases by $300. The cap qualifies as a hedge of the future variable interest payment, and all income effects of the loan and the cap are reported in interest expense.
-Total interest expense for 2021 is

Accepted Answer

((.015 + .007) x $1,000,000) - $300 = $21,700

Question 6

Use the following information to answer bellow Questions.
On January 1, 2020, Teller Corporation borrows $1 million for three years at the prime rate plus 1.5%, with the rate adjusted annually. The interest is due December 31 of each year. The prime rate is currently 0.5%. To hedge against rising interest rates, Teller buys a three-year, 2% interest rate cap for $5,000, paid in full immediately. Teller's loan was renewed December 31, 2020, when the prime rate was 0.7%, and the fair value of the cap declines by $800. By the end of 2021, the cap's value increases by $300. The cap qualifies as a hedge of the future variable interest payment, and all income effects of the loan and the cap are reported in interest expense.
-What is the change in the time value of the cap in 2020?

Accepted Answer

The option's value declines by $800 and the option is out of the money, with no intrinsic value. Therefore, the value change is all time value.

Question 7

Use the following information to answer bellow Questions.
On January 1, 2020, Teller Corporation borrows $1 million for three years at the prime rate plus 1.5%, with the rate adjusted annually. The interest is due December 31 of each year. The prime rate is currently 0.5%. To hedge against rising interest rates, Teller buys a three-year, 2% interest rate cap for $5,000, paid in full immediately. Teller's loan was renewed December 31, 2020, when the prime rate was 0.7%, and the fair value of the cap declines by $800. By the end of 2021, the cap's value increases by $300. The cap qualifies as a hedge of the future variable interest payment, and all income effects of the loan and the cap are reported in interest expense.
-What is the change in the intrinsic value of the cap in 2021?

Accepted Answer

The 2021 rate on the loan is 1.5% + 0.7% = 2.2%, so the cap is in the money by 2.2% - 2% = 0.2% x $1,000,000 = $2,000. The cap had no intrinsic value in 2020, so the increase in intrinsic value is $2,000.

Question 8

Use the following information to answer bellow Questions.
On January 1, 2020, Teller Corporation borrows $1 million for three years at the prime rate plus 1.5%, with the rate adjusted annually. The interest is due December 31 of each year. The prime rate is currently 0.5%. To hedge against rising interest rates, Teller buys a three-year, 2% interest rate cap for $5,000, paid in full immediately. Teller's loan was renewed December 31, 2020, when the prime rate was 0.7%, and the fair value of the cap declines by $800. By the end of 2021, the cap's value increases by $300. The cap qualifies as a hedge of the future variable interest payment, and all income effects of the loan and the cap are reported in interest expense.
-When Teller is reimbursed in 2021 by the cap writer, what account is credited?

Accepted Answer

The answer of Use the following information to answer bellow...

Question 9

Use the following information to answer bellow questions 
A U.S. company expects to sell £100,000 in merchandise to a customer in the U.K. in 3 months. To protect against a strengthening U.S. dollar, on November 1 the company pays $3,000 for January put options on £100,000, with a strike price of $1.40/£. The current spot rate is $1.38/£. The intrinsic value of the options is designated as a cash flow hedge of the forecasted sale, and changes in time value are reported in income. Income effects of the sale and the options are reported in sales revenue. On December 31, the company's year-end, the spot rate is $1.375/£ and the options have a market value of $3,200. On January 31, the spot rate is $1.35/£, and the company sells the options for their intrinsic value. The company delivers the merchandise, receives payment in pounds sterling, and converts the currency to U.S. dollars at the spot rate. The company's year-end is December 31.
-When the options are adjusted to their December 31 market value, what is the effect on sales revenue?

Accepted Answer

The intrinsic value of the options increases from $2,000 (= ($1.40 - $1.38) x £100,000) to $2,500 (= ($1.40 - $1.375) x £100,000. The options increase in value by $200, so time value must decline by $300, adjusting sales revenue.

Question 10

Use the following information to answer bellow questions 
A U.S. company expects to sell £100,000 in merchandise to a customer in the U.K. in 3 months. To protect against a strengthening U.S. dollar, on November 1 the company pays $3,000 for January put options on £100,000, with a strike price of $1.40/£. The current spot rate is $1.38/£. The intrinsic value of the options is designated as a cash flow hedge of the forecasted sale, and changes in time value are reported in income. Income effects of the sale and the options are reported in sales revenue. On December 31, the company's year-end, the spot rate is $1.375/£ and the options have a market value of $3,200. On January 31, the spot rate is $1.35/£, and the company sells the options for their intrinsic value. The company delivers the merchandise, receives payment in pounds sterling, and converts the currency to U.S. dollars at the spot rate. The company's year-end is December 31.
-When the options are adjusted to their December 31 market value, what is the effect on other comprehensive income?

Accepted Answer

The increase in intrinsic value is $500.

Question 11

Use the following information to answer bellow questions 
A U.S. company expects to sell £100,000 in merchandise to a customer in the U.K. in 3 months. To protect against a strengthening U.S. dollar, on November 1 the company pays $3,000 for January put options on £100,000, with a strike price of $1.40/£. The current spot rate is $1.38/£. The intrinsic value of the options is designated as a cash flow hedge of the forecasted sale, and changes in time value are reported in income. Income effects of the sale and the options are reported in sales revenue. On December 31, the company's year-end, the spot rate is $1.375/£ and the options have a market value of $3,200. On January 31, the spot rate is $1.35/£, and the company sells the options for their intrinsic value. The company delivers the merchandise, receives payment in pounds sterling, and converts the currency to U.S. dollars at the spot rate. The company's year-end is December 31.
-What amount is reported as sales revenue on January 31?

Accepted Answer

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Question 12

Use the following information to answer bellow questions
On January 1, a company holds an inventory of a commodity carried at a cost of $100,000. The commodity's current market value is $110,000. To guard against a potential decline in the value of that inventory, the company purchases put options with a total strike price of $110,000 exercisable in 3 months, paying a total of $500 for the options. The puts qualify as a fair value hedge of the inventory. All income effects of the inventory and the hedge are reported in cost of goods sold. On March 25, the commodity's market price is $108,000 and the company closes the hedge by selling the put options for $2,200. The company sells its inventory later in the year. The company has a December 31 year-end.
-How is cost of goods sold affected by the sale of the options on March 25?

Accepted Answer

The options are sold for a gain of $1,700 (= $2,200 - $500). The gain reduces cost of goods sold.

Question 13

Use the following information to answer bellow questions
On January 1, a company holds an inventory of a commodity carried at a cost of $100,000. The commodity's current market value is $110,000. To guard against a potential decline in the value of that inventory, the company purchases put options with a total strike price of $110,000 exercisable in 3 months, paying a total of $500 for the options. The puts qualify as a fair value hedge of the inventory. All income effects of the inventory and the hedge are reported in cost of goods sold. On March 25, the commodity's market price is $108,000 and the company closes the hedge by selling the put options for $2,200. The company sells its inventory later in the year. The company has a December 31 year-end.
-What is the carrying value of the inventory as of March 25?

Accepted Answer

$100,000 - ($110,000 - $108,000) = $98,000

Question 14

Use the following information to answer bellow questions
On January 1, a company holds an inventory of a commodity carried at a cost of $100,000. The commodity's current market value is $110,000. To guard against a potential decline in the value of that inventory, the company purchases put options with a total strike price of $110,000 exercisable in 3 months, paying a total of $500 for the options. The puts qualify as a fair value hedge of the inventory. All income effects of the inventory and the hedge are reported in cost of goods sold. On March 25, the commodity's market price is $108,000 and the company closes the hedge by selling the put options for $2,200. The company sells its inventory later in the year. The company has a December 31 year-end.
-What is total cost of goods sold for the year?

Accepted Answer

-$1,700 + $2,000 + $98,000 = $98,300

Question 15

Option value changes are classified as intrinsic value changes and time value changes. Assume a company designates changes in intrinsic value as the hedge, with changes in time value reported in income. For options used to hedge a forecasted sale of merchandise, when does the change in option intrinsic value impact income?

Accepted Answer

The change in option intrinsic value impacts income when the merchandise sale is recorded. This is because the intrinsic value change is designated as the hedge, and its effectiveness is recognized in earnings in the same period the hedged forecasted transaction affects earnings.

Question 16

Which of the following is a fair value hedge?

Accepted Answer

A receive fixed/pay variable interest rate swap is a fair value hedge because it is used to hedge against changes in the fair value of an asset or liability or a firm commitment, such as fluctuations in interest rates affecting the value of a fixed-rate loan.

Question 17

A company has a receive fixed/pay variable interest rate swap that qualifies as an effective hedge of its fixed rate debt. If interest rates rise:

Accepted Answer

The answer of A company has a receive fixed/pay variable...

Question 18

A company has a receive variable/pay fixed interest rate swap that qualifies as an effective hedge of its variable rate debt. When it enters the swap agreement, it records the swap investment at what amount?

Accepted Answer

Under accounting standards, when a company enters into a swap agreement that qualifies as an effective hedge, it records the swap on its balance sheet at its fair value, which is the present value of expected future cash flows from the swap, including both receipts and payments. This approach reflects the economic reality of the swap's value to the company at the inception of the agreement.

Question 19

A company enters a receive variable/pay fixed interest rate swap, and the market interest rate increases. Which of the following statements is true from the company's perspective?

Accepted Answer

When a company enters a receive variable/pay fixed interest rate swap and the market interest rate increases, the market value of the swap increases from the company's perspective. This is because the company benefits from receiving higher interest payments on the variable side of the swap while continuing to pay a fixed rate.

Question 20

A company has variable rate debt. It swaps the variable payments for fixed payments. If interest rates increase during the year:

Accepted Answer

The answer of A company has variable rate debt. It...

Quiz 9: Futures, Options and Interest Rate Swaps