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Basic Derivatives - Student

The document describes 5 problems involving companies entering into various derivative contracts such as interest rate swaps, forward contracts, futures contracts, and call options. Each problem provides market rates, contract details, and asks to calculate the derivative asset or liability on specified dates.

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97 views4 pages

Basic Derivatives - Student

The document describes 5 problems involving companies entering into various derivative contracts such as interest rate swaps, forward contracts, futures contracts, and call options. Each problem provides market rates, contract details, and asks to calculate the derivative asset or liability on specified dates.

Uploaded by

dgdeguzman
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Problem 1

On January 1, 2018, Army Company borrowed Ᵽ5,000,000 from a bank at a variable rate of interest for 4
years. Interest will be paid annually to the bank on December 31 and the principal is due on December
31, 2021.
Under the agreement, the market rate of interest every January 1 resets the variable rate for that period
and the amount of interest to be paid on December 31.
In conjunction with the loan, Army Company entered into a “receive variable, pay fixed” interest rate swap
agreement with another bank speculator. The interest rate swap agreement was designated as a cash
flow hedge. The market rates of interest rate:

January 1, 2018 10%


January 1, 2019 14%
January 1, 2020 12%
January 1, 2021 11%

The PV of an ordinary annuity of 1 is 2.32 at 14% for three periods, 1.69 at 12% for two periods and 0.90
at 11% for one period.

1. What is the derivative asset or liability on December 31, 2018?


2. What is the derivative asset or liability on December 31, 2019?
3. What is the derivative asset or liability on December 31, 2020?
Problem 2
Dynamite Company operates a five-star hotel. The entity makes very detailed long-term planning. On
October 1, 2018, the entity determined that it would need to purchase 8,000 kilos of Korean lobster on
January 1, 2020.
Because of the fluctuation in the price of Korean lobster, on October 1, 2018, the entity negotiated a
forward contract with a bank to purchase 8,000 kilos of Korean lobster on January 1, 2020 at a price of
Ᵽ9,600,000.
The price of Korean lobster was Ᵽ1,200 per kilo on October 1, 2018. This forward contract was
designated as a cash flow hedge.
The entity is predicting a drop in worldwide lobster prices between October 1, 2018 and January 1, 2019.
On December 31, 2018, the price of a kilo of Korean lobster is Ᵽ1,500. On October 31, 2019 and January
1, 2020, the price of a kilo of Korean lobster is Ᵽ1,000.
The appropriate discount rate throughout this period is 10%. The present value of 1 at 10% for one period
is .91.

1. What is the notional value of the forward contract?


2. What is the derivative asset or liability on December 31, 2018?
3. What is the derivative asset or liability on December 31, 2019?
Problem 3
PAPASA AKO Company requires 40,000 kilos of soya beans each month in its operations.
To eliminate the price risk associated with the purchase of soya beans, on December 1, 2018, the entity
entered into a futures contract as a cash flow hedge to buy 40,000 kilos of soya beans at Ᵽ150 per kilo on
March 1, 2019.
The market price on December 31, 2018 and March 1, 2019 is Ᵽ160 per kilo. The market rate of interest
is 9% and the present value of 1 at 9% is .917 for one period.

What amount should be recognized on December 31, 2018 as derivative asset or liability?

Problem 4
Legaspi Company produces colorful 100% cotton shirts and the entity needs 50,000 kilos of raw materials
in the production process.
On December 1, 2018, the entity purchased a call option as a cash flow hedge to buy 50,000 kilos on July
1, 2019.
The option strike price is Ᵽ100 per kilo. The entity paid Ᵽ50,000 for the call option.
This derivative option contract means that if the market price is higher than Ᵽ100, the entity can exercise
the option and buy the asset at the strike option price of Ᵽ100.
If the market price is lower than Ᵽ100, the entity can throw away the option and buy the asset at the
cheaper price.
The market price per kilo is Ᵽ100 on December 31, 2018 and Ᵽ115 on July 1, 2019.

1. What is the derivative asset on December 31, 2018?


2. What is the cash settlement from the speculator on July 1, 2019?
3. What is the cost of perchases on July 1, 2019?
Problem 5
Janina Company regularly hedges purchase requirements and the sale of finished products in the futures
market.
On December 1, 2018, the entity entered into the following three contracts designated as cash flow
hedge:
Futures price Market price
Type of contract Quantity 12/1/2018 12/31/2018
Purchase sugar 20,000 60 75
Purchase milk 50,000 100 91
Sell ice cream 30,000 220 195

All three contracts are to be settled on January 1, 2019.

What is the derivative asset or liability on December 31, 2018?

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