Companies seeking to hedge future purchases or revenue flows can often choose between futures contracts and option contracts. Sami Corp. projects purchasing 100 tons of a commodity in three months; its current spot price per ton is $500 and the six-month futures price per ton is $525. Ninety-one day call options on the commodity at the money sell for $40. Assume that Sami subsequently signs purchase orders for 100 tons to be delivered in three months at the then-current spot price, and hedges those firm commitments with six-month futures contracts requiring a $10,000 margin deposit. At the end of the three-month period, when the futures price per ton is $510. Sami closes its futures position and takes delivery of the 100 tons at the spot price per ton of $505. Sami records all income effects of commodities transactions and related hedges in cost of goods sold.

a. What factors should Sami consider when deciding between hedging with futures versus options?

Select which statement is false with regards to a futures contract or an option contract.

Hedging with futures and options provides the same loss-neutralization capability, as long as similar contracts are available for the needed commodity

Futures contracts are two-sided and, by requiring performance whether prices increase or decrease, negate both the chance of loss and the chance of gain.

The user pays a premium for a futures contract in addition to making a margin deposit with the clearinghouse.

The option contract contains a speculative component, the options time value, whereas the futures contract is a pure hedge.

Futures contracts remove the risk at very low (transaction) cost whereas with options a firm pays a premium for a chance at a gain.

Mark 1.00 out of 1.00

b. Prepare summary journal entries to record all the events surrounding the firm commitment, the futures hedge and the eventual purchase of the 100 tons at the spot price per ton of $505.

General Journal
Description	Debit	Credit
Investment in optionsCashCost of goods soldInvestment in futuresFirm commitmentInventory
Investment in optionsCashCost of goods soldInvestment in futuresFirm commitmentInventory
To record payment of margin deposit.
Investment in optionsCashCost of goods soldInvestment in futuresFirm commitmentInventory
Investment in optionsCashCost of goods soldInvestment in futuresFirm commitmentInventory
To record loss from decline in value of futures contracts.
Investment in optionsCashCost of goods soldInvestment in futuresFirm commitmentInventory
Investment in optionsCashCost of goods soldInvestment in futuresFirm commitmentInventory
To record gain from reduced cost to fullfil firm commitment and related commitment asset.
Investment in optionsCashCost of goods soldInvestment in futuresFirm commitmentInventory
Investment in optionsCashCost of goods soldInvestment in futuresFirm commitmentInventory
To record receipt of the margin deposit when the futures contract is closed.
Investment in optionsCashCost of goods soldInvestment in futuresFirm commitmentInventory
Investment in optionsCashCost of goods soldInvestment in futuresFirm commitmentInventory
To record purchase of the commodity.
Investment in optionsCashCost of goods soldInvestment in futuresFirm commitmentInventory
Investment in optionsCashCost of goods soldInvestment in futuresFirm commitmentInventory
To close the firm commitment asset to the purchase transaction.

c. Suppose that Sami does not sign purchase orders and instead uses option contracts to hedge its anticipated purchases, designating the options' intrinsic values as the hedge instrument. The option contracts remain out of the money and expire when Sami makes the spot market purchase at $505 per ton. Prepare summary journal entries to record these events.

General Journal
Description	Debit	Credit
Investment in optionsCashCost of goods soldInvestment in futuresFirm commitmentInventory
Investment in optionsCashCost of goods soldInvestment in futuresFirm commitmentInventory
To record purchase of call options.
Investment in optionsCashCost of goods soldInvestment in futuresFirm commitmentInventory
Investment in optionsCashCost of goods soldInvestment in futuresFirm commitmentInventory
To record expiration of the options and the decline fair value.
Investment in optionsCashCost of goods soldInvestment in futuresFirm commitmentInventory
Investment in optionsCashCost of goods soldInvestment in futuresFirm commitmentInventory
To record purchase of the commodity.

d. Compute the cash gain or loss from hedging versus not hedging in parts b and c.

Do not use negative signs with any answers below.

Commodity cost with futures hedge
Commodity cost without hedging
Cash loss from hedging as opposed to not hedging with futures
Commodity cost with options hedge
Commodity cost without hedging
Cash loss from hedging as opposed to not hedging with options