Question

Jarvis Corporation transacts business with a number of foreign vendors and customers. These transactions are denominated in FC, and the company uses a number of hedging strategies to reduce the exposure to exchange rate risk. Several such transactions are as follows:

Transaction A: On November 30, the company purchased inventory from a vendor in the amount of 100,000 FC with payment due in 60 days. Also on November 30, the company purchased a forward contract to buy FC in 60 days. Assume a fair value hedge.

Relevant spot and forward rates are as shown below.

	Spot Rate	Forward Rate for 30 Days from November 1	Forward Rate for 60 Days from November 30
November 1	1 FC = $1.120	1 FC = $1.132
November 15	1 FC = $1.130
November 30	1 FC = $1.150		1 FC = $1.146
December 31	1 FC = $1.140		1 FC = $1.138

Required

Assuming that the company’s year-end is December 31, for each of the above transactions determine the current-year effect on earnings. All necessary discounting should be determined by using a 6% discount rate.

Answer 1

US/Foreign Company US/Broker

11/30  Inventory 115,000 11/30  FC Receivable     114,600

FC Payable           115,000 (100,000 x 1.150) $ Payable 114,600 (100,000 x 1.146)

12/31 FC Payable 1,000 12/31 FC Receivable 795

Ex Gain 1,000 (1.140?1.150) x 100,000 Ex Loss 795 ((1.138?1.146) x 100,000) ÷ 1.006

Impact on earnings:  Gain $1,000

Loss     (795)

Net impact $205