Question

Shandra Corporation (a U.S.-based company) expects to order goods from a foreign supplier at a price of 131,000 pounds, with delivery and payment to be made on April 20. On February 20, when the spot rate is $1.37 per pound, Shandra purchases a two-month call option on 131,000 pounds and designates this option as a cash flow hedge of a forecasted foreign currency transaction. The time value of the option is excluded in assessing hedge effectiveness; the change in time value is recognized in net income over the life of the option. The option has a strike price of $1.37 per pound and costs $1,310. The goods are received and paid for on April 20. Shandra sells the imported goods in the local market by May 31. The spot rate for pounds is $1.42 on April 20. What amount will Shandra Corporation report as foreign exchange gain or loss in net income for the quarter ended June 30

Answer 1

Answer:

Shandra Corporation

The amount which Shandra Corporation will report as foreign exchange gain in net income for the quarter ended June 30 is:

$5,240

Explanation:

Price of goods = 131,000 pounds

Delivery and payment date = April 20

On February 20, the spot rate for call option on 131,000 pounds = $1.37

Cost of the option = $1,310

The spot rate on April 20 = $1.42

The foreign exchange gain or loss to be reported in net income for the quarter ended June 30 = $0.05 ($1.42 - $1.37

Total gain = ($0.05 * 131,000) - $1,310

= $6,550 - $1,310

= $5,240

b) With this call option, which gives Shandra the right to buy the underlying asset, Shandra hedges his contract to purchase goods from a foreign supplier, and therefore, profits when the spot rate increases from $1.37 on February 20 to $1.42 on April 20.  The profit made is reduced by the cost of the call option.