Hedging

Question 1

Hedge on an investment in Foreign Currency:

Answer 1

When you have an investment in a f.c you risk on a decrease in the exchange rate
Inorder to offset that risk,(Hedge), the idea would be to borrow in the same f.c

To reason is because:
Investment = Asset
Borrow=Liab
Therefore they offset each other, hence, hedging the investment

Question 2

Hedging a purchase of Equipment from a Foreign Manufacturer.

What can you hedge?

The Plan or the contract of the purchase?

Answer 2

Both.

The plan would be = Hedge of the forecasted transaction
The contract would be = hedge of a firm Committment

Question 3

On October 1 of the current year, a U.S. company sold merchandise on account to a British company for 2,000 pounds (exchange rate, 1 pound = $1.43). At the company’s December 31 fiscal year end, the exchange rate was 1 pound = $1.45. The exchange rate was $1.50 on collection in January of the subsequent year. What amount would the company recognize as a gain (loss) from foreign currency translation when the receivable is collected?

Answer 3

$100
A foreign currency exchange gain will be recognized for the change in exchange rate between December 31 and the January collection date. That gain is computed as $1.45 -> $1.50 = $0.05 x 2,000 pounds = $100 gain.

Question 4

Garr Co. received a $60,000, 6-month, 10% interest-bearing note from a customer. After holding the note for two months, Garr was in need of cash and discounted the note at the United Local Bank at 12%.
The amount of cash Garr received from the bank was

Answer 4

$60,480
The calculation leading to the correct answer is:
Maturity value of the note: $60,000 + $60,000(.10)(6/12) = $63,000
Less discount to bank: $63,000(.12)(4/12) =
2,520
Equals proceeds to Garr
$60,480
The bank charges its discount on the maturity value of the note, for the period of time it will hold the note.