Investment analysis - DERIVATIVES financial instrument...

EXAMPLE
The Limited buys jeans from a French apparel manufacturer. The purchase
is denominated in euros. The Limited is to pay 70,000 euros in 3
months.
The Limited is assuming the risk of exchange rate changes. The Limited
has to pay 70,000 euros regardless of the dollar equivalent.

HEDGING EXAMPLE
Assume the current exchange rate is .70.
Inventory 49,000
Accounts Payable 49,000
(70,000x.70=49,000)

BALANCE SHEET DATE
The Limited closes its books and prepares financial statements before the
payable to the French company is paid. The exchange rate is .90 at the
balance sheet date.
Foreign currency loss 14,000
Accounts Payable 14,000
(70,000x.90=63,000-49,000=14,000)

HEDGING EXAMPLE
The Limited could buy a forward contract
for 70,000 euros to be delivered in 3
months. The forward contract is a
derivative instrument.
At time of purchase:
Inventory 49,000
Accounts Payable 49,000
Derivative 49,000
Due to Broker 49,000

HEDGING EXAMPLE
At Dec 31: The exchange rate is .9
Foreign Currency Loss 14,000
Accounts Payable 14,000
Derivative 14,000
Hedging Gain 14,000

HEDGING EXAMPLE
At time of payment:
Due to Broker 49,000
Cash 49,000
Cash 63,000
Derivative 63,000
Accounts Payable 63,000
Cash 63,000

TYPES OF DERIVATIVES

Fair Value Hedge

a hedge of an exposure to changes in the fair
value of a recognized asset or liability or
unrecognized firm commitment

Receivables/payables in foreign denominations

gain or loss reported on the income statement

Cash Flow Hedge

a hedge of an exposure to the variability in the
cash flows of an existing asset or liability or
forecasted transaction.

variable rate loan

gain or loss reported in owner’s equity (other
comprehensive income)

MARKETABLE SECURITIES
MS are investments in securities that are readily marketable and that the
company intends to own only as a short-term investment.