On January 2, 2023, Jackson Corporation purchased a call option for $500 on Walter Inc.’s common shares. The call option gives Jackson the option to buy 1,000 shares of Walter at a strike price of $30 per share any time during the next six months. The market price of a Walter share was $30 on January 2, 2023 (the intrinsic value was therefore $0). On March 31, 2023, the market price for Walter stock was $42 per share, and the fair value of the option was $17,500.

Instructions

a. Prepare the journal entry to record the purchase of the call option on January 2, 2023.

b. Prepare the journal entry(ies) to recognize the change in the call option’s fair value as at March 31, 2023.

c. What was the effect on net income of entering into the derivative transaction for the period from January 2 to March 31, 2023?

d. Based on the available facts, explain whether Jackson is using the option as a hedge or for speculative purposes.

e. Explain what financial risks the transaction exposes the entity to.