Question

On December 1, 2018, Lane Corp., a US-based company, entered into a three-month forward contract to purchase 1 million Jordanian Dinar (JOD) on March 1, 2019. Lane had a contract to buy I million JOD of clothing made especially for Lane.

The following USD-JOD exchange rates apply:

Date	Spot rate	Forward rate (to March 1, 2016)
12/1/18	0.7075	.7060
12/31/18	0.7064	.7055
3/1/2019	0.7050

Lane has a 12% incremental borrowing rate.

0.         Is Lane an importer or exporter? why?

3a.       Describe what needs to go into the hedge documentation on 12/1/18.

3b.       Prepare a table like the ones in the notes to support the journal entries you need to prepare.

3c.       Prepare all the journal entries needed on each date if this FCFC were treated as a cash flow hedge.

3d.       Show the impact on the IS and BS from this set of facts on 12/31 and 3/1.

3e.       Prepare a table like the ones in the notes if Lane had treated this as a fair value hedge instead?

3f.        What would have been the effect on net income on 12/31 and 3/1 if Lane had not hedged this at all? What would be the net USD Lane pays at 12/31?

Answer 1

0. Lane is an exporter of materials, since they have got a firm order for purchase of their goods.

3a. In the hedge documentation, the following is to be stated clearly
Why the hedge is required

What is the risk mitigation involved
What is the hedge instrument and hedging item
How effective will the hedge be

3d. In the balance sheet of 12/31, the forward contract must be reported as a liability.
The forward contract must be reported at it is fair value as on 12/31 [ (.7060-.7055)x1 million x PV of 12% for 1 month]
= 5000 *.9803 = $4901.5.

In case of 3/1, the loss will be at its fair value discounted for two months at 12% [($.07060 - $.07050) x 1,000,000 = $10,000 x .9803 = $9,803.00].