Question 1

What kind of exposure exists for recognized foreign currency assets and liabilities?
A) Fair value exposure
B) Cash flow exposure
C) Both fair value exposure and cash flow exposure
D) Neither fair value exposure nor cash flow exposure

Accepted Answer

The answer of What kind of exposure exists for recognized...

Question 2

Under U.S. GAAP, what method of amortizing discounts or premiums on forward contracts must be used?
A) Weighted average method or accelerated method
B) Sum of digit method only
C) Effective interest rate method or straight line method
D) Straight line method only

Accepted Answer

Under U.S. GAAP, the effective interest rate method or straight line method must be used to amortize discounts or premiums on forward contracts. The choice of method depends on the circumstances of the contract and the financial reporting objectives of the entity. The weighted average method and accelerated method are not appropriate for amortizing discounts or premiums on forward contracts. The sum of digit method is also not commonly used in this context.

Question 3

What kind of exposure exists for foreign currency firm commitments?
A) Fair value exposure
B) Cash flow exposure
C) Both fair value exposure and cash flow exposure
D) Neither fair value exposure nor cash flow exposure

Accepted Answer

Foreign currency firm commitments are assets and liabilities that are denominated in a foreign currency and represent an obligation to pay or receive a certain amount in the future. As a result, they are exposed to both fair value and cash flow risks. Fair value exposure arises from changes in the foreign exchange rates between the time the firm commitment was made and the time it is settled. Cash flow exposure arises from changes in the foreign exchange rates between the functional currency of the entity and the currency of the firm commitment, which can affect the amount of cash flows required to settle the obligation.

Question 4

What is "hedge accounting?"
A) Any record keeping related to purchase, sale, or valuation of derivatives.
B) Recording options and other derivatives on the Balance Sheet.
C) Matching gains or losses from hedging with losses or gains from the risk being hedged.
D) Using multiple accounting methods to offset the effect of foreign currency exchange.

Accepted Answer

Hedge accounting is the practice of matching gains or losses from hedging with losses or gains from the risk being hedged. This allows for a more accurate reflection of the economic realities of the hedging transaction in financial statements.

Question 5

What is the primary difference between a cash flow hedge and a fair value hedge?
A) The fair value hedge must completely offset the variability in the cash flow from the foreign currency receivable or payable.
B) The cash flow hedge can only be used to offset potential foreign currency losses on accounts receivable.
C) The cash flow hedge must completely offset the variability in cash flow from the foreign currency receivable or payable.
D) The fair value hedge can only be used to offset the variability in cash flow from long-term fixed assets related to foreign currency fluctuations.

Accepted Answer

The primary difference between cash flow hedge and fair value hedge is that a cash flow hedge must completely offset the variability in cash flow from the foreign currency receivable or payable, while a fair value hedge can only be used to offset the variability in cash flow from long-term fixed assets related to foreign currency fluctuations. Option A is incorrect as it refers to the requirements of a fair value hedge. Option B is incorrect as it limits the use of cash flow hedge only to accounts receivable. Option D is incorrect as it wrongly describes the requirements for fair value hedge.

Question 6

Which of the following is done when accounting for a cash flow hedge, but is not done when accounting for a fair value hedge?
A) The hedged asset or liability is adjusted to fair value.
B) Foreign exchange gains or losses on the hedged asset or liability are recorded in net income.
C) Increases or decreases in a derivative's fair value are recorded in accumulated other comprehensive income.
D) Gains or losses resulting from adjusting the fair value of a derivative are recorded in net income.

Accepted Answer

When accounting for a cash flow hedge, increases or decreases in a derivative's fair value are recorded in accumulated other comprehensive income. This is done so that the gains or losses can be recognized in the income statement at the same time as the cash flows from the hedged item. In contrast, when accounting for a fair value hedge, gains or losses resulting from adjusting the fair value of a derivative are recorded in net income.

Question 7

On May 1, 2001, Ustar purchased a put option to sell £50,000 on April 30, 2002 at a strike price equal to $2, which was the spot rate on May 1, 2001. Ustar paid a premium of $0.01 per pound. How should the option be recorded on May 1, 2001?
A) Debit Foreign Currency Option for $100,500.
B) Credit Foreign Currency Option for $100,500.
C) Debit Foreign Currency Option for $500.
D) Debit Hedge Expense for $500.

Accepted Answer

The option should be recorded as a debit (an asset) for the cost of the premium paid. The premium is $0.01 per pound for £50,000, which equals $500.

Question 8

How should discounts or premiums on forward contracts be treated if the derivative is hedging a foreign-currency-denominated asset?
A) Carried on the balance sheet until the contract is completed
B) Included in income in the period the derivative is acquired
C) Amortized over the life of the forward contract
D) None of the above

Accepted Answer

Discounts or premiums on forward contracts that are used to hedge foreign-currency-denominated assets should be amortized over the life of the contract. This is because the discount or premium represents an adjustment to the cost of the asset being hedged, and therefore affects the overall cost basis over the life of the contract. The other options are not correct as simply carrying the discount or premium on the balance sheet or including it in income in the period of acquisition would not properly reflect the effect on the cost basis of the hedged asset.

Question 9

What is the requirement for reporting derivatives under international accounting standards and U.S. GAAP?
A) They may be shown on the balance sheet or they may be treated as off-balance sheet investments.
B) They must be shown on the balance sheet at fair value.
C) They must be shown on the balance sheet at historical cost.
D) They may be shown on the balance sheet at historical cost or at net realizable value.

Accepted Answer

Both international accounting standards and U.S. GAAP require derivatives to be shown on the balance sheet at fair value.

Question 10

How is the fair value of a foreign currency option calculated?
A) By using the Box-Jenkins technique
B) Using the modified Black-Scholes pricing model
C) Through an arms-length transaction
D) Using quotes given daily in the Wall Street Journal

Accepted Answer

The fair value of a foreign currency option is typically calculated using the modified Black-Scholes pricing model, which takes into account factors such as the underlying exchange rate, strike price, time to expiration, interest rates, and volatility. This model is widely used in the financial industry for pricing and valuing various types of options.

Question 11

Under U.S. GAAP, which of the following conditions must be met to qualify for hedge accounting?
A) There must be formal documentation of the hedging relationship.
B) A derivative must be used specifically to hedge fair value exposure or cash flow exposure.
C) The hedge must be effective.
D) All of the above must be met in order to qualify for hedge accounting.

Accepted Answer

All three conditions must be met to qualify for hedge accounting under U.S. GAAP. There must be formal documentation of the hedging relationship, a derivative must be used specifically to hedge fair value exposure or cash flow exposure, and the hedge must be effective.

Question 12

What information is needed to determine the fair value of a foreign currency forward contract?
A) The forward rate at the date the contract was entered
B) The current forward rate for a contract that matures on the same dates as the forward contract that was entered into
C) A discount rate to determine the present value of the contract
D) All of the above information is needed

Accepted Answer

To determine the fair value of a foreign currency forward contract, all of the above information is needed. The forward rate at the date the contract was entered is needed to calculate the difference between the contracted rate and the current rate. The current forward rate for a contract that matures on the same dates as the forward contract that was entered into is needed as a benchmark to determine if the forward contract rate is above or below market rates. A discount rate is needed to determine the present value of the contract, as future cash flows must be discounted to their present value to determine their fair value.

Question 13

Which of the following statements is true of intrinsic value of options?
A) When the option strike price is more than the spot rate, the intrinsic value is zero.
B) When the option strike price is equal to the spot rate, the intrinsic value is positive.
C) When the option strike price is less than the spot rate, the intrinsic value is zero.
D) When the option strike price is more than the spot rate, the intrinsic value is negative.

Accepted Answer

The answer of Which of the following statements is true...

Question 14

When accounting for forward contracts, what is meant by the term "executory contract"?
A) No cash changes hands
B) The CEO of the company is the only one authorized to engage in the contract
C) There must be a price paid for the option
D) The contract is valid if one of the parties sign it

Accepted Answer

An executory contract is a contract in which both parties have made promises but neither has yet performed. In the case of forward contracts, no cash changes hands initially and both parties have made promises to execute the contract at a later date.

Question 15

Which of the following statements is true about hedge accounting under U.S. GAAP?
A) Companies may choose whether to account for derivatives as cash flow hedges or fair value hedges.
B) If a derivative qualifies as a cash flow hedge, the hedging instrument is adjusted to fair value on each balance sheet date.
C) If a derivative is elected by the company not to be designated as a cash flow hedge, it must be accounted for as such.
D) Hedge accounting is only advantageous when a foreign currency depreciates between the transaction date and the payment date.

Accepted Answer

The answer of Which of the following statements is true...

Question 16

Excel Sources Inc. is a U.S. incorporated company. Due to change in exchange rate, it receives $150,000 as payment against a sale of $165,000. Under the two-transaction perspective:
A) no journal entry will be prepared on the date of sale.
B) the sale will be recorded at $150,000 on the date of sale.
C) foreign exchange loss will be recorded for $15,000.
D) Accounts Receivable will be debited for $15,000 on the date of payment.

Accepted Answer

Under the two-transaction perspective, foreign exchange gain or loss is recognized when payment is received or made, and not on the date of sale. In this case, since Excel Sources Inc. received $150,000 instead of $165,000 due to the change in exchange rate, a foreign exchange loss of $15,000 will be recorded. Therefore, option C is the best choice.

Question 17

In hedge accounting, which of the following exposure should be hedged by foreign currency derivative?
A) Temporal exposure
B) Fair value exposure
C) Derivative exposure
D) Forward contract exposure

Accepted Answer

In hedge accounting, fair value exposure should be hedged by foreign currency derivative. Temporal exposure is the difference in the exchange rate between the transaction date and the settlement date, and it can be managed through operational or balance sheet measures. Derivative exposure and forward contract exposure are not types of currency exposure that need to be hedged, but rather instruments used to hedge exposures.

Question 18

Under U.S. GAAP, where are changes in the fair value of derivatives reported?
A) As part of "Accumulated Other Comprehensive Income" on the Balance Sheet
B) They are not recognized until the options are exercised
C) Retained Earnings
D) None of the above

Accepted Answer

Changes in the fair value of derivatives are reported as part of "Accumulated Other Comprehensive Income" on the Balance Sheet under U.S. GAAP.

Question 19

Which of the following statements is true of the relationship between foreign currency transactions, exchange rate changes, and foreign exchange gains and losses?
A) In an export sales, depreciation of the foreign currency causes a foreign exchange gain.
B) In an import purchase, appreciation of the foreign currency causes a foreign exchange gain.
C) In an import purchase, depreciation of the foreign currency causes a foreign exchange loss.
D) In an export sales, appreciation of the foreign currency causes a foreign exchange gain.

Accepted Answer

In an export sale, if the foreign currency appreciates, the exporter receives more in their home currency, resulting in a foreign exchange gain.

Question 20

On 1 January, 2015, Hikers Inc., a U.S.-based company, borrowed £200,000 on a two-year note at a per annum interest of 4.5%. The spot rate on this day was $1.65 per pound. The spot rate on 31 December, 2015, was $1.64 per pound. The journal entries to account for this foreign currency borrowing will include:
A) a debit to Cash for $200,000 on January 1, 2015.
B) a credit to Notes Payable for $330,000 on December 31, 2015.
C) a debit to Foreign Exchange Loss for $90 on December 31, 2015.
D) a debit to Interest Expense for $14,760 on December 31, 2015.

Accepted Answer

- A is incorrect because the borrowing was in pounds, not dollars, and the exchange rate is only relevant for calculating the dollar equivalent of the borrowing amount (which was £200,000 x $1.65 = $330,000).
- B is correct because it records the repayment of the note at its dollar equivalent on December 31, 2015, which includes both the principal and interest.
- C is incorrect because there is no indication that the company incurred a foreign exchange loss on this transaction.
- D is correct because it records the interest expense at 4.5% per annum on the borrowed amount for one year, converted to dollars using the spot rate on the date the interest accrued (which was £200,000 x 4.5% x 365/365 x $1.64/$1 = $14,760).

Quiz 6: Foreign Currency Transactions and Hedging Foreign Exchange Risk

What kind of exposure exists for recognized foreign currency assets and liabilities?

Under U.S. GAAP, what method of amortizing discounts or premiums on forward contracts must be used?

What kind of exposure exists for foreign currency firm commitments?

What is "hedge accounting?"

What is the primary difference between a cash flow hedge and a fair value hedge?

Which of the following is done when accounting for a cash flow hedge, but is not done when accounting for a fair value hedge?

On May 1, 2001, Ustar purchased a put option to sell £50,000 on April 30, 2002 at a strike price equal to $2, which was the spot rate on May 1, 2001. Ustar paid a premium of $0.01 per pound. How should the option be recorded on May 1, 2001?

How should discounts or premiums on forward contracts be treated if the derivative is hedging a foreign-currency-denominated asset?

What is the requirement for reporting derivatives under international accounting standards and U.S. GAAP?

How is the fair value of a foreign currency option calculated?

Under U.S. GAAP, which of the following conditions must be met to qualify for hedge accounting?

What information is needed to determine the fair value of a foreign currency forward contract?

Which of the following statements is true of intrinsic value of options?

When accounting for forward contracts, what is meant by the term "executory contract"?

Which of the following statements is true about hedge accounting under U.S. GAAP?

Excel Sources Inc. is a U.S. incorporated company. Due to change in exchange rate, it receives $150,000 as payment against a sale of $165,000. Under the two-transaction perspective:

In hedge accounting, which of the following exposure should be hedged by foreign currency derivative?

Under U.S. GAAP, where are changes in the fair value of derivatives reported?

Which of the following statements is true of the relationship between foreign currency transactions, exchange rate changes, and foreign exchange gains and losses?