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Accounting Practice Problems and Solutions

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Practice problems for Module 4​​ 

  • ABC Corporation negotiated a forward contract to sell C$100,000 in one year at a forward rate of C$1=$0.80. ​​ On the delivery date, the spot rate was C$1=$0.83.  ​​​​ 

How much is the revenue ABC Corporation can get from the forward hedge?​​ 

Answer:​​ 

Revenue from the forward hedge= C$100,000*C$0.80/$

= $80,000

ABC​​ Corporation​​ earns almost $80,000​​ in revenue through the forward hedge.​​ 

​​ What is the real cost of hedging receivables for this U.S. firm?

Answer:

Hedging of Real cost = Revenue without hedging less revenue with hedging

= $(100,000*)-$80,000 = $3000

For this U.S. company, the actual cost of hedging receivables is $3000, which is the contract's cost.

  • Given the following additional information​​ 

Future Spot rate​​ 

 

 

RCHr​​ 

 

Prob.​​  

0.78​​  

 

 

-2000​​ 

 

0.20​​  

0.81​​  

 

 

​​ 1000​​ 

 

0.50​​  

0.83​​  

 

 

​​ 3000​​ 

 

0.30​​ 

What is the probability that the forward hedge will result in higher revenue than no border?

How much is E(RCHr)? Overall, is forward hedge preferred?​​ 

Answer:

E(RCHr) = (-2000*0.20) + (1000*0.50) + (3000*0.30) =1000

In higher revenue than no hedge Profibility that forward hedge will result = Expected future spot rates is less than the forward rate (Nil)

With hedge revenue = E(RCHr) * 0.83

= 1000*0.83=$830

Without hedge revenue= (-2000*0.20*0.78)​​ +​​ (1000*0.50*0.81) + (3000*0.30*0.83)​​ 

= $840

Revenue with hedge is less than expected revenue without hedge that’s why overall hedge is not preferred.

  • Lora Corp. needs NZ$100,000 in 180 days. ​​ The 180-day forward rate is NZ$1=$.52.​​ 

Spot rate​​ 

Prob.​​  

$0.40​​ 

 

5%​​  

0.45​​ 

 

10%​​  

0.48​​ 

 

30%​​  

0.50​​ 

 

30%​​  

0.53​​ 

 

20%​​  

0.55​​ 

 

5%​​  

What is the probability that the forward hedge will result in higher cost than no border?

How much is E(RCHp)? Overall, is forward hedge preferred?​​ 

NZ$1 is the forward obtainable = $0.52.​​ 

Hedge rate more significant than the forward rates therefore add all the probabilities of the 180 day.

​​ In this case forward hedge will cost higher than no border there is a 75% probability.

NZ $ Probable spot rate

Probability

100000 NZ $ hedging nominal cost

100000 NZ $ price of unhedged

100000$ * Spot rate

Hedging real cost subtract unhedged cost - nominal

0.4

5%

52000

40000

12000

0.45

10%

52000

45000

7000

0.48

30%

52000

48000

4000

0.5

30%

52000

50000

2000

0.53

20%

52000

53000

-1000

0.55

5%

52000

55000

-3000

We can calculate E(RCHp) depend on the above calculations:

5%*($12,000) + 10%*($7000) +30%*($4,000) + 30%*($2000) + 20%*(-$1000) + 5%*(-$3000) = $600 + $700 + $ 1200 +$600- $200- $150 = $2,750

Companies like to know their future cash outflows because of this forward hedge are preferred.

  • Please use the following information to answer the next three questions about money market hedge:​​ 

90-day U.S. interest rate​​  

4%​​ 

90-day Malaysian interest rate ​​ 

3%​​ 

90-day MYR forward rate​​  

$.40​​ 

MYR spot rate ​​ 

$.404​​ 

Santa Barbara Co. will need 300,000​​ ringgits​​ in 90 days.​​ 

How much MYR do you need after currency conversion today?​​ 

Requirement = 3,00,000 ringgit after 90 days.

If forward rate is used USD needed = 3,00,000 * 0.4

= $1,20,000

How many U.S. dollars do you need to borrow today to get the amount of MYR you need?

Today USD needed =​​ ($300000/1.03)​​ *0.404 = $ 1,17,670

For 90 days, Malaysia's interest rate is 3%, Malaysian ringit today we will have to invest value. The said amount should then be sold spot.

How many U.S. dollars do you need to pay off after 90 days?​​ 

After 90 days US dollars needed to be paid off =​​ $ 1,17,670*1.04 = $1,22,377

For 90​​ days interest rate in US is 4%, at the said rate for the 90 days we will borrow the dollars.​​ 

  • Please use the following information to answer the next three questions about money market hedge:​​ 

180-day U.S. interest rate​​ 

 

8%​​ 

180-day British interest rate​​ 

 

9%​​ 

180-day pound forward rate​​ 

 

$1.50​​ 

U.K. pound spot rate​​  

 

$1.48​​ 

Riverside Co. will receive 400,000 pounds in 180 days. ​​ 

How much foreign currency do you need today in a money market hedge?​​ 

Requirements = 4,00,000 pounds in 180 days

Foreign currency= 400000 * 0.8

= 320000​​ foreign​​ currencies​​ required​​ today in money Market hedge.

How many U.S. dollars do you receive from the currency conversion today?​​ 

Today USD needed =​​ ($400000/1.09)​​ *​​ 0.015 = $ 5504.58

For 90 days the interest rate in British is 9%

How much will be available to Riverside Co. after 180​​ days?​​ 

5504.5871* 1.09= $6000​​ U.S. dollar will be available after​​ 180 days.

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