Forward exchange contracts

Question 1

forward exchange contract

Answer 1

two parties agree today to exchange currencies at a future date at a specified exchange rate

Question 2

Why would businesses want to enter into a forward contract?

Answer 2

helps to mitigate (hedge) the impact of losses from foreign exchange translation by guaranteeing an exchange rate in the future

Question 3

T or F: A forward contract must be measured at fair value throughout its life

Answer 3

TRUE

Question 4

Under the net method, do you need a J.E when the FWD contract is signed

Answer 4

no J.E, but a memo is required

Question 5

Foreign exchange hedge

Answer 5

method used by companies to eliminate or hedge their foreign exchange risk resulting from transactions in foreign currencies

Question 6

hedged item

Answer 6

the item with the risk exposure that the entity has taken steps to mitigate (ex. payables or receivables)

Question 7

hedging instrument

Answer 7

the item used to offset the risk exposure (the FWD exchange contract)

Question 8

At settlement date, what transactions do you have to do (4):

Answer 8

• revalue payables and/or receivables (again)
• revalue FWD contract (again)
• settle FWD contract
• Settle payable or receivable

Question 9

At the financial reporting date (Y.E), what transactions do you have to do (2):

Answer 9

• revalue the transaction payable/receivable at the closing rate with the gain/loss recorded in income
• Revalue the FWD contract at the forward rate with the gain/loss recorded to to income

Question 10

If payables and receivables generate a loss when revalued, what will the forward contract generate

Answer 10

a gain

Question 11

income volatility

Answer 11

the gains and losses can fluctuate

Question 12

Hedge accounting method

Answer 12

net exchange gains or losses are moved to OCI and recognized in net income as a “hedge expense” over the life of the FWD contract. Effectively eliminates the income volatility

Question 13

T or F: In hedge accounting, Exchange gains and losses are recognized in the same period, when they would otherwise be recognized in different periods.

Answer 13

TRUE

Question 14

Fair value hedge

Answer 14

protects against the change in fair value of an asset, a liability or a firm commitment:
Fair value could go up or down, and the hedge seeks to minimize the impact of this on the F.S