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
Want to see more full solutions like this?
Chapter 9 Solutions
Advanced Accounting
- 1. Assume a futures price of Php5000 at the start of the transaction, with Php250 initial margin requirement and a Ph150 maintenance margin requirement. The trader takes in a long position of 10 contracts. Marking-to-market process occurs over the period of seven trading days. A. Complete the table above for the holder of the long position. B. When could there be a margin call? C. How much are the total gains or losses by the end of day 7? Futures Beginning Balance Ending Balance Funds Settlement Day Price Gain/Loss Deposited Price Change 5000 4960 2 4800 5050 4 5175 5200 5250.50 5310.75 7 D. Complete the table above for the holder of the short position. Futures Beginning Balance Funds Day Settlement Price Ending Balance Price Gain/Loss Deposited Change 5000 1 4960 4800 5050 4 5175 5200 5250.50 7 5310.75 E. How much are the total gains or losses by the end of day 7?arrow_forward1. Assume a futures price of Php5000 at the start of the transaction, with Php250 initial margin requirement and a Ph150 maintenance margin requirement. The trader takes in a long position of 10 contracts. Marking-to-market process occurs over the period of seven trading days. A. Complete the table above for the holder of the long position. B. When could there be a margin call? C. How much are the total gains or losses by the end of day 7? Futures Beginning Balance Funds Settlement Ending Balance Day Price Gain/Loss Deposited Price Change 5000 1 4960 2 4800 5050 4 5175 5 5200 6. 5250.50 7 5310.75 D. Complete the table above for the holder of the short position. Futures Beginning Balance Funds Settlement Ending Balance Day Price Gain/Loss Deposited Price Change 5000 4960 1 2 4800 3 5050 4 5175 5200 5250.50 7 5310.75 E. How much are the total gains or losses by the end of day 7?arrow_forward13. Explain what is meant by basis risk in the situation where a company knows it will be purchasing a certain asset in two months and uses a three-month futures contract to hedge its risk.arrow_forward
- (a) The transferring of risk onto the clearing house is not something unique to futures trading. In fact, most of financial intermediaries such as insurance companies, finance companies and bank take on risk transferred to them and manage these risks. Based on the above statement, discuss the TWO (2) types of margins in derivatives markets. (b) You as a farmer have gone short 15 March Cocoa futures contracts. The 5-day period using hypothetical futures settlement prices. On the day 0 which both parties enter the contract. Given the following information, determine the daily marking-to-market adjustment to both you and the counterparty account. (Assuming same total value) Contract size = 10 tons per contract Initial margin = 10 percent of total value Maintenance margin = 70 percent of initial marginarrow_forwardOn the 1st of March, a commodity’s spot price is $60 and its futures contract price with maturity in August is $59. On the 1st of July, the commodity spot price is $64 and its futures contract price with maturity in August is $63.50. A company entered into the futures contracts on 1st of March to hedge its purchase of the commodity on July 1. It closed out its position on July 1. What is the effective price (after taking account of hedging) paid by the company? $60.50 $61.50 $63.50 $59.50arrow_forwardAssume a futures price of Php5000 at the start of the transaction, with Php250 initial margin requirement and a Ph150 maintenance margin requirement. The trader takes in a short position of 10 contracts. Marking-to-market process occurs over the period of seven trading days. A. Complete the table above for the holder of the long position. B. When could there be a margin call? C. How much are the total gains or losses by the end of day 7?arrow_forward
- (i) A forward contract with 12 months to maturity is written on an underlying stock. The stock price is $45, and it is expected to pay dividends of $2 after 6 months and $3 immediately prior to maturity. The relevant riskless rate of interest is 4%. Calculate the theoretical forward price and initial value of the forward contract and explain the forward pricing relationship. (ii) Provide a numerical example of an arbitrage strategy for situations where the forward is trading above, and below the theoretical forward price.arrow_forwardAn investor has a short position in 10 futures contracts for which the price increases from $85 to $92 per contract during a trading day. Explain how "marketing to market" will affect the investor's margin account as a resultarrow_forwardA trader has decided to roll a short hedge forward until December to hedge a long position in corn inventory. The schedule below shows the dates on which trades are made and the prices. a. Determine the effective price at which the corn was sold on December 10. e b. Explain whether the trader would have made more (or less) profit if it had not hedged its inventory position.“ Date Action Sell March Futures Buy March Futurese Sell May Futures Buy May Futuresa Sell July Futuresa Buy July Futuresa Sell September Futurese Buy September Futures Sell December Futures Buy December Futures Sell Cash Inventory Price February 6 March 15e $5.73e $6.20 $5.90 $5.10 $5.30 $5.70 March 15e May 16e May 16 July 22 $6.20 $6.90 $6.95e $6.50 $6.45 July 22e September 17 September 17 December 12e December 12arrow_forward
- As a Treasurer of SemCo Ltd you would like to use currency futures contracts to hedge US$40million that you owe to the supplier in June. A futures quote of £0.74/$ for June delivery is available on International Money Market. The contract size is US$125,000. You decide to take a position in the futures to hedge exposure to the US$. In June the relevant futures contract is trading £0.76/$. Ignoring margin, was it good that you hedged using futures if the spot exchange rate in June is £75/$? How much is the profit or loss on the futures position?arrow_forwardGive typing answer with explanation and conclusion On January 1, the listed spot and futures prices of a Treasury bond were 93.8 and 93.13. You purchased $100,000 par value Treasury bonds and sold one Treasury bond futures contract, also $100,000 face value. One month later, the listed spot price and futures prices were 94 and 94.09, respectively. Determine the change in the value of your combined position.arrow_forwardAn investor enters a long position in a Bitcoin April 2023 futures contract at $23,450. Each contract controls 5 bitcoins. The initial margin for each contract is $30,800, the maintenance margin is $28,000. The futures price changes to $23,020 at the end of the first day and $22,752 on the end of the second day. Compute the amount in the margin account at the end of each day for the long position and any variation margin needed. (Please provide a step-by-step solution on how to solve this problem with a calculator, thank you!)arrow_forward
- AccountingAccountingISBN:9781337272094Author:WARREN, Carl S., Reeve, James M., Duchac, Jonathan E.Publisher:Cengage Learning,Accounting Information SystemsAccountingISBN:9781337619202Author:Hall, James A.Publisher:Cengage Learning,
- Horngren's Cost Accounting: A Managerial Emphasis...AccountingISBN:9780134475585Author:Srikant M. Datar, Madhav V. RajanPublisher:PEARSONIntermediate AccountingAccountingISBN:9781259722660Author:J. David Spiceland, Mark W. Nelson, Wayne M ThomasPublisher:McGraw-Hill EducationFinancial and Managerial AccountingAccountingISBN:9781259726705Author:John J Wild, Ken W. Shaw, Barbara Chiappetta Fundamental Accounting PrinciplesPublisher:McGraw-Hill Education