What was the net increase or decrease in cash flow from having purchased the foreign currency option to hedge this exposure to foreign exchange risk?
a. $0.
b. A $1,000 increase in cash flow.
c. A $1,700 decrease in cash flow.
d. A $2,300 increase in cash flow.
On September 1, Year 1, Keefer Company received an order to sell a machine to a customer in Canada at a price of 100,000 Canadian dollars. The machine was shipped and payment was received on March 1, Year 2. On September 1, Year 1, Keefer Company purchased a put option giving it the right to sell 100,000 Canadian dollars on March 1, Year 2, at a price of $75,000. Keefer Company properly designates the option as a fair value hedge of the Canadian-dollar firm commitment. The option cost $1,700 and had a fair value of $2,800 on December 31, Year 1. The fair value of the firm commitment is measured through reference to changes in the spot rate. The following spot exchange rates apply:
Date U.S. Dollar per Canadian Dollar
September 1, Year 1 ……………………………… $0.75
December 31, Year 1 …………………………….. 0.73
March 1, Year 2 ………………………………….. 0.71
Keefer Company's incremental borrowing rate is 12 percent. The present value factor for two months at an annual interest rate of 12 percent (1 percent per month) is 0.9803.
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