Hedging:
Hedging against an investment risk is termed for strategically implementing the instruments and tools in the market to minimize the risk and effects of any adverse price movements. It can be said that investors are benefitted through hedging as they hedge one investment by making another investment. The financial instruments like exchange traded funds, stocks, forward contracts, options, insurance, swaps, etc may construct hedge.
To calculate:
The effect on earnings for 3 months from January to March for various hedging instruments.
Answer to Problem M.3P
Fair value of Contract in March is $
Explanation of Solution
Working notes:
Calculation of Fair value of Contract:
Note:
The difference between change in fair value and change in intrinsic value is considered as change in time value.
Forward Contract to buy:
Particulars | January(Amount in $) | February(Amount in $) | March(Amount in $) |
Number of units per contractSpot Price per unitForward rate per unitOriginal forward rate per unit | | | |
Fair Value of Forward in Futures:Original Forward value | | | |
Change in forward value-Gain(Loss) | | | |
Discount Rate | | ||
Present Value of the fair value: | | | |
Change in Present Value | | | |
Effect on earnings − Gain(Loss)Gain(Loss) on firm commitmentGain(Loss) on forward contractSales revenueCost of sales | | | |
Net Impact on earnings | | | |
Working Notes:
Calculation of Sales Revenue:
Call Option:
Particulars | January(Amount in $) | February(Amount in $) | March(Amount in $) |
Number of Units Per OptionSpot Price Per unitFutures Price Per unit | | | |
Fair value of option Value of Option: Intrinsic Value | | - | - |
Total Value | | - | |
Effect on earnings-Gain(Loss): Change in time value- Gain(Loss)Original value of$ | | | |
Net Impact on Earnings | | | |
Working Notes:
Calculation of Sales Revenue:
Calculation of cost of sales processing:
Calculation of Cost of sales- Commodity A:
Conclusion:
Fair value of Contract in March is
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Chapter 9 Solutions
Advanced Accounting
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