Question

In December 12, 20X8, Imp Co. entered into a forward exchange contract to hedge a firm commitment to purchase equipment being manufactured to Imp's specifications. The forward contract was to purchase 100,000 Euros in 90 days as a fair value hedge of the equipment. The relevant direct exchange rates were as follows:SR = Spot rateFR = Forward rateSR FR (for Mar 12, Year 2)December 12, Year 1 $.88 $.90December 31, Year 1 .98 .93Imp entered into the third forward contract for speculation. At December 31, Year 1, what amount of foreign currency gain should Imp include in income from this forward contract?a) $0b) $3,000c) $5,000d) $10,000

Answer 1

Answer:

B) $3,000

Explanation:

Since this is defined as a derivative operation, its result must be reported either as a gain or loss as part of normal income. Imp entered a contract to buy 100,000 euros at $0.90. If the exchange rate remained at $0.90 in 90 days, no gain or loss should be recognized.

But the currency exchange increased to $0.93 per euro, so the contract now results in a $0.03 gain per euro (= $0.93 - $0.90), so a gain of $0.03 x 100,000 = $3,000 must be reported.