Foreign Currency Transactions Continued Summer I 2009

Foreign Currency - Advanced Accounting Foreign Currency Transactions Continued A Hedging an Existing Foreign Currency Transaction with a Forward

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Advanced Accounting Foreign Currency Transactions Continued A. Hedging an Existing Foreign Currency Transaction with a Forward Contract 1. The objective of such a hedge is to offset the change in fair value of the asset or liability denominated in the foreign currency with the change in value of the hedging instrument. 2. For example, suppose a U.S. corporation acquires inventory from a British vendor with payment due in British pounds. Concurrently, the U.S. company enters into a forward contract to purchase British pounds. 3. If prior to settlement, the U.S. dollar weakens relative to the British pound, accounts payable will increase in value and an exchange loss will result. However, at the same time, the forward contract to buy British pounds, which is an asset, will increase in value if the dollar weakens. 4. The fair market value of a forward purchase contract is the difference between the contracted forward rate and the current forward rate for delivery on the contracted date. 5. For example, on April 1, 20X6, a U.S. corporation enters into a forward contract to purchase 100,000 Canadian dollars for $.70 per Canadian dollar on June 1, 20X6. The contract has no value on April 1 because the contracted rate equals the forward rate for delivery on June 1. Suppose that on May 1, the forward rate for delivery of Canadian dollars is $.72. Therefore, the fair value of the forward contract on May 1 is calculated as follows: ($.72 - .70) X 100,000 Canadian dollars = $2,000. Thus, the value of the forward contract changes as the forward rate for the contracted delivery date changes. 6. To be completely accurate, since the forward contract involves cash flows that will occur in the future, the difference between the current forward rate and the contracted rate should be discounted to its present value. We will assume that the effect of discounting is immaterial....
View Full Document

This note was uploaded on 03/08/2012 for the course ACCT 401 taught by Professor Staff during the Summer '08 term at Texas A&M.

Page1 / 5

Foreign Currency - Advanced Accounting Foreign Currency Transactions Continued A Hedging an Existing Foreign Currency Transaction with a Forward

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online