Question
Impact on earnings of an option and an interest rate swap. Millikin Corporation decided to hedgetwo transactions. The first transaction is a forecasted transaction to
Impact on earnings of an option and an interest rate swap. Millikin Corporation decided to hedgetwo transactions. The first transaction is a forecasted transaction to buy 500 tons of inventory in60 days. The company was concerned that selling prices might increase, and it acquired a 60-day option to buy inventory at a price of $1,200 per ton. Upon acquiring the option, the companypaid a premium of $10 per ton when the spot price was $1,201. At the end of 30 days, the optionhad a value of $19 per ton and a current spot price of $1,214 per ton. Upon expiration of theoption, the spot price was $1,216 per ton. In another transaction, the company borrowed $3,000,000 at a fixed rate of 8%; after threemonths, the company became concerned that variable rates would be lower than 8%. Inresponse, the company entered into an interest rate swap whereby it paid variable rates to acounterparty in exchange for a fixed rate of 8%. The reset rate for the first 30 days of the swapwas 8.1% and was 7.8% for the second 30 days of the swap. The fair value of the swap was$3,000 after the first 30 days and $3,300 after 60 days. Determine the impact on earnings of the above hedges for the first and second 30-day period.
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started