Investment analysis - DERIVATIVES financial instrument designed to help businesses mitigate risks reported at market value on the balance sheet the gain

Investment analysis - DERIVATIVES financial instrument...

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EXAMPLEThe 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.
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HEDGING EXAMPLE Assume the current exchange rate is .70. Inventory 49,000 Accounts Payable 49,000 (70,000x.70=49,000)
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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)
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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
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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
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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
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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)
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MARKETABLE SECURITIES MS are investments in securities that are readily marketable and that the company intends to own only as a short-term investment.
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