lobal XYZ Corp is a U S conglomerate that operates in a number of countries Its functional and reporting currency is the U S dollar In order to mitigate various risks, it makes extensive use of hedging and other risk mitigation strategies Task 1 For each of the risk scenarios in column A below, select from the options in column B the most appropriate means of mitigating the risk described in column A Assume all scenarios meet the various requirements for hedge accounting A1 lock copy cut paste A B 1 Risk Description Possible Strategies 2 Global XYZ acquires bauxite ore from an independent supplier for use as a raw material in several of its products Due to certain political tensions, Global is concerned that the market price of bauxite will increase significantly What action should Global take to hedge the risk associated with the market price of bauxite Enter into a futures contract to sell bauxite Enter into a put option contract for bauxite Enter into a forward contract to buy bauxite 3 Global XYZ made a short term borrowing of $1,000,000, using inventory recently purchased for $1,100,000 as security The lender required Global to hedge the value of the inventory used as collateral as additional security for the loan What action should Global take to hedge the risk associated with the value of its inventory Enter into a forward contract to sell inventory Enter into a call option contract for inventory Enter into a forward contract to buy inventory 4 Global has a 100 owned subsidiary in Mexico whose functional and reporting currency is the peso Global is concerned that the dollar will strengthen against the peso and adversely affect the translation into Globals functional currency of its net asset investment in the subsidiary What action should Global take to mitigate the effect of changes in the exchange rate on translation of its investment in the subsidiary Enter into a forward contract to sell pesos Incur debt (borrow) in pesos Enter into an interest rate swap contract 5 Global has a forecasted purchase of electronic components during the coming year from a Hong Kong supplier payable in Hong Kong dollars The forecasted purchase meets the requirements for hedging Global is concerned that the U S dollar will weaken against the Hong Kong dollar during the next 12 months What action should Global take to hedge the dollar cost of the forecasted purchase Enter into a futures contract to sell Hong Kong dollars Enter into a put option contract for Hong Kong dollars Enter into a forward contract to buy Hong Kong dollars Task 2 For each of the hedging situations described in column A below, determine the total (net) effect (i e , loss cost or gain saving) that would result from the transaction and or hedging action described In column B record the amount of the total (net) effect, and in column C select from the options to indicate the nature of the amountwhether the results is a loss cost or a gain saving Disregard tax consequences and any other factors not described in each situation Round all answers to the nearest dollar A1 lock copy cut paste A B C 1 Hedging Situation Total (Net) Amount Nature of Amount 2 Global XYZ Corp has a subsidiary, Global Mine, Inc , engaged in mining operations To meet its demand for diesel fuel, Global Mine acquires 100,000 gallons of diesel every quarter In December 20X0, the company projected that the price of diesel would temporarily increase dramatically during the first and second quarters of 20X1 To hedge that possibility, on January 2, 20X1, the firm acquired a futures contract for 100,000 gallons of diesel at $2 50 per gallon for delivery on April 1, 20X1 The contract cost $3,000 On April 1, 20X1, the spot rate for diesel was $2 75 per gallon What was the total net effect (cost or benefit) of the diesel fuel purchase and the hedging arrangement 123 Gain Saving Loss Cost 3 Global XYZ Corp sold finished goods to a French customer on October 15, 20X1, for which payment of 50,000 is due from the customer on December 16, 20X1 At the date of the sale the exchange rate (spot rate) was $1 10 per 1 00 In order to hedge the dollar value of its receivable from the French customer, on the date of the sale Global entered into a forward contract to sell 50,000 in 60 days at $1 08 per euro (the 60 day forward rate) There were no costs associated with acquiring the contract On December 16 the spot exchange rate was $1 11 per euro What was the total net effect (cost or benefit) of the collection of the receivable and the forward contract 123 Gain Saving Loss Cost 4 Global XYZ Corp arranged to borrow $1,000,000 on a five year, variable rate loan with interest of LIBOR plus 3 00 , with interest to be paid annually and principal at maturity The interest rate will be reset at the end of each year based on the then existing LIBOR In anticipation of the loan, and because it is concerned about the unpredictability of its interest cost for the loan, Global also arranged a $1,000,000 interest rate swap under which it will pay the counterparty 6 00 fixed interest and receive LIBOR plus 2 00 from the counterparty Both the loan and interest rate swap were executed on December 31, 20X1, effective January 1, 20X2 At that date LIBOR was 3 50 Neither the loan nor the swap involved any cost to execute What net amount of interest will Global pay for 20X2 as a result of the loan and the interest rate swap Will the 20X2 interest paid by Global be more (loss) or less (gain) with the interest rate swap than it would have been without the swap 123 Gain Saving Loss Cost 5 Global XYZ made a short term investment of temporary excess cash in 10,000 shares of common stock of one of its independent suppliers at a cost of $42 per share While Global believes that the prospects of the investee company are very good, it is concerned that the general economy may contract and cause the investees stock to decline in value To hedge that possibility, Global invests in a put option on the investees stock at a cost of $3 00 per option share, with a strike price of $38 00 Global holds the investment for one year and sells the stock when the market price is $40 per share What total net amount of loss or gain did Global recognize from the sale of the 10,000 shares and the related hedge using the put option 123 Gain Saving Loss Cost Click to select

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lobal XYZ Corp. is a U.S. conglomerate that operates in a number of countries. Its functional and reporting currency is the U.S. dollar. In order

lobal XYZ Corp. is a U.S. conglomerate that operates in a number of countries. Its functional and reporting currency is the U.S. dollar. In order to mitigate various risks, it makes extensive use of hedging and other risk mitigation strategies.

Task 1

For each of the risk scenarios in column A below, select from the options in column B the most appropriate means of mitigating the risk described in column A. Assume all scenarios meet the various requirements for hedge accounting.

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Risk Description

Possible Strategies

Global XYZ acquires bauxite ore from an independent supplier for use as a raw material in several of its products. Due to certain political tensions, Global is concerned that the market price of bauxite will increase significantly. What action should Global take to hedge the risk associated with the market price of bauxite?

Enter into a futures contract to sell bauxite. Enter into a put option contract for bauxite. Enter into a forward contract to buy bauxite.

Global XYZ made a short-term borrowing of $1,000,000, using inventory recently purchased for $1,100,000 as security. The lender required Global to hedge the value of the inventory used as collateral as additional security for the loan. What action should Global take to hedge the risk associated with the value of its inventory?

Enter into a forward contract to sell inventory. Enter into a call option contract for inventory. Enter into a forward contract to buy inventory.

Global has a 100%-owned subsidiary in Mexico whose functional and reporting currency is the peso. Global is concerned that the dollar will strengthen against the peso and adversely affect the translation into Globals functional currency of its net asset investment in the subsidiary. What action should Global take to mitigate the effect of changes in the exchange rate on translation of its investment in the subsidiary?

Enter into a forward contract to sell pesos. Incur debt (borrow) in pesos. Enter into an interest rate swap contract.

Global has a forecasted purchase of electronic components during the coming year from a Hong Kong supplier payable in Hong Kong dollars. The forecasted purchase meets the requirements for hedging. Global is concerned that the U.S. dollar will weaken against the Hong Kong dollar during the next 12 months. What action should Global take to hedge the dollar cost of the forecasted purchase?

Enter into a futures contract to sell Hong Kong dollars. Enter into a put option contract for Hong Kong dollars. Enter into a forward contract to buy Hong Kong dollars.

Task 2

For each of the hedging situations described in column A below, determine the total (net) effect (i.e., loss/cost or gain/saving) that would result from the transaction and/or hedging action described. In column B record the amount of the total (net) effect, and in column C select from the options to indicate the nature of the amountwhether the results is a loss/cost or a gain/saving. Disregard tax consequences and any other factors not described in each situation. Round all answers to the nearest dollar.

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Hedging Situation

Total (Net) Amount

Nature of Amount

Global XYZ Corp. has a subsidiary, Global Mine, Inc., engaged in mining operations. To meet its demand for diesel fuel, Global Mine acquires 100,000 gallons of diesel every quarter. In December 20X0, the company projected that the price of diesel would temporarily increase dramatically during the first and second quarters of 20X1. To hedge that possibility, on January 2, 20X1, the firm acquired a futures contract for 100,000 gallons of diesel at $2.50 per gallon for delivery on April 1, 20X1. The contract cost $3,000. On April 1, 20X1, the spot rate for diesel was $2.75 per gallon. What was the total net effect (cost or benefit) of the diesel fuel purchase and the hedging arrangement?

123

Gain/Saving Loss/Cost

Global XYZ Corp. sold finished goods to a French customer on October 15, 20X1, for which payment of 50,000 is due from the customer on December 16, 20X1. At the date of the sale the exchange rate (spot rate) was $1.10 per 1.00. In order to hedge the dollar value of its receivable from the French customer, on the date of the sale Global entered into a forward contract to sell 50,000 in 60 days at $1.08 per euro (the 60-day forward rate). There were no costs associated with acquiring the contract. On December 16 the spot exchange rate was $1.11 per euro. What was the total net effect (cost or benefit) of the collection of the receivable and the forward contract?

123

Gain/Saving Loss/Cost

Global XYZ Corp arranged to borrow $1,000,000 on a five-year, variable-rate loan with interest of LIBOR plus 3.00%, with interest to be paid annually and principal at maturity. The interest rate will be reset at the end of each year based on the then existing LIBOR. In anticipation of the loan, and because it is concerned about the unpredictability of its interest cost for the loan, Global also arranged a $1,000,000 interest rate swap under which it will pay the counterparty 6.00% fixed interest and receive LIBOR plus 2.00% from the counterparty. Both the loan and interest rate swap were executed on December 31, 20X1, effective January 1, 20X2. At that date LIBOR was 3.50%. Neither the loan nor the swap involved any cost to execute.

What net amount of interest will Global pay for 20X2 as a result of the loan and the interest rate swap?

Will the 20X2 interest paid by Global be more (loss) or less (gain) with the interest rate swap than it would have been without the swap?

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Gain/Saving Loss/Cost

Global XYZ made a short-term investment of temporary excess cash in 10,000 shares of common stock of one of its independent suppliers at a cost of $42 per share. While Global believes that the prospects of the investee company are very good, it is concerned that the general economy may contract and cause the investees stock to decline in value. To hedge that possibility, Global invests in a put option on the investees stock at a cost of $3.00 per option/share, with a strike price of $38.00. Global holds the investment for one year and sells the stock when the market price is $40 per share. What total net amount of loss or gain did Global recognize from the sale of the 10,000 shares and the related hedge using the put option?

123

Gain/Saving Loss/Cost

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