Reference no: EM13518259

1.  Which statement below is the most correct in terms of a cash flow hedge under SFAS 133?

a.  An option can be a cash flow hedge without regard to who wrote the (written) option.

b.  A written option cannot be a cash flow hedge, but option might be a cash flow hedge if the company is not the writer of the option

c.  A company must be the writer of a option in order for that option to be a cash flow hedge

d.  Written options might hedge recorded assets and liabilities, but they may not hedge forecasted purchases and sales since those forecasted transactions are not yet recorded in the ledgers.

2.  Rather than purchase a new option, ABC Company decided to designate an option purchased last year as a cash flow hedge of a forecasted transaction that seemed probable on January 20.  Is this designation allowed on January 20 for an option already on the books?

a.  The option may not be designated as a hedge on January 20 but might have been designated a hedge on when the option was purchased.

b.  An option may not be designated a cash flow hedge irrespective of its purchase date.

c.  The option may be redesignated as a cash flow hedge on January 20.

d.  The answer depends upon whether the option is traded on a market exchange.  Custom options not traded on the open market cannot be properly valued in order to be redesignated as a cash flow hedge subsequent to the purchase date.

3.  AggiesInternational Corporation faces the risk of price declines on its forecasted sales of corn, soybeans, and rice to Japan.  Sales quantities are also uncertain.  As a hedge, this company enters into a contract (with a $0 premium) to sell as much as it wants to the Shimura Company for a contracted fixed price and contracted proportions of all three grains per ton.  In other words, for a fixed price and fixed proportions, AggiesInternational has an option to sell as much as it wants to Shimua for a period of six months.  Can this option be a cash flow hedge under SFAS 133 rules.

a.  No because the notional is not fixed, and no because the forecasted transaction is a compounding of three grains subject to varying price risks.

b.  No because the notional is not fixed even though it would otherwise be yes since the forecasted transaction contains fixed proportion s of grains for which there is a single variable (portfolio) price per ton that can be hedged.

c.  Yes because the notional is fixed but no, in the final analysis, because the forecasted transaction is a compounding of three grains subject to varying price risks.

d.  Yes because the notional is fixed, and yes since the forecasted transaction contains a fixed proportion of grains for which there is a single variable portfolio price that can be hedged.

4.  Purdy Jewelry has a contract to purchase, at spot prices, 100 ounces of gold per month from a supplier over the next six months.  Can Purdy enter into a portfolio of gold futures contracts as gold purchasing cash flow hedge (assuming that a futures contract is available for exactly 100 ounces for each of the months)?

a.  Yes, because the order contract is really comprised of six commitments that can be hedged with six separate futures contracts (in a single portfolio) under SFAS 133 rules.

b.  No, because one contract cannot be separated, under SFAS 133 rules, into six items to be hedged with six separate futures contracts.

c.  No, because futures contracts cannot be used as cash flow hedges.

d.  No because purchase orders of raw materials cannot be hedged for cash flows under SFAS 133.

5.  CallEmUp Company paid $10,000 for a six-month call option to purchase a specified number of common shares of Apple Corporation.  With high probability, it will purchase, as a an available-for-sale investment under SFAS 115, those Apple shares on the date the option expires no matter what the price of each share on that day.  If the price is more than the strike price, CallEmUp will exercise its expiring call option.  If the price is higher than the market price, the company will pay the market price and weep over the fact that it wasted $10,000 on the premium of a useless option.  On the date that the option is purchased, can this option be viewed as a cash flow hedge of the forecasted purchase of Apple’s common shares?

a.  No because cash flow hedges cannot be entered into for available-for-sale security investments, and no because the option only hedges in one direction for price increases and not price decreases.

b.  Yes, cash flow hedges can be entered into for available-for-sale security investments but no, in the final analysis, because the option only hedges in one direction for price increases and not price decreases.

c.  No, because cash flow hedges cannot be entered into for available-for-sale security investments, but otherwise yes even though the option only hedges in one direction for price increases and not price decreases.

d.  Yes, cash flow hedges can be entered into for available-for-sale security investments and yes even though the option only hedges in one direction for price increases and not price decreases.

6.Suppose that one month after the purchase of the call option in the above question, when CallEmUp Company closes its books, the call option is in-the-money for $250,000.  Assume that the option will not be exercised until it expires in five months.  If this call option is revalued to $250,000 on the books, how should the gain be booked at this point in time and disposed of later in time.  Assume for this question that the call option, rightly or wrongly, is being accounted for as a cash flow hedge.

a.  All unrealized holding gains or losses will be booked to Other Comprehensive Income (OCI) until the option is derecognized from becoming expired, exercised, or of improbable value do to a low probability of purchasing the  Apple Corporation shares.

b. All unrealized holding gains or losses will be booked to current earnings until the option is derecognized from becoming expired, exercised, or of improbable value do to a low of purchasing the  Apple Corporation shares.

c. All unrealized holding gains or losses will be netted against the carrying value of the call option until the option is derecognized from becoming expired, exercised, or of improbable value do to a low probability of purchasing the  Apple Corporation shares.

d.  Unrealized holding gains or losses will not be booked and are noted in a footnote to the financial statements until the option becomes expired, exercised, or of improbable value do to changed probability of purchasing the  Apple Corporation shares.

7.  Assume the same facts as in the previous question except that you are now to assume that the Apple Corporation shares will be carried as trading securities under SFAS 115 rather than available-for-sale securities. On the date that the option is purchased, can this option be viewed as a cash flow hedge of the forecasted purchase of Apple’s common shares?

a.  No because cash flow hedges cannot be entered into for trading security investments, and no because the option only hedges in one direction for price increases and not price decreases.

b.  Yes, cash flow hedges can be entered into for trading security investments but no, in the final analysis, because the option only hedges in one direction for price increases and not price decreases.

c.  No, because cash flow hedges cannot be entered into for trading security investments, but otherwise yes even though the option only hedges in one direction for price increases and not price decreases.

d.  Yes, cash flow hedges can be entered into for trading security investments and yes even though the option only hedges in one direction for price increases and not price decreases.

8.  LongIntoSwap Company has a ten-year variable rate note that it hedged with an interest rate swap for the first five years.  Choose the best statement below:

a.  Yes, interest rate swaps can be used to hedge variable interest rates.  Also, yes --- only a portion of a single hedged item can be hedged under SFAS 133.

b. Yes, interest rate swaps can be used to hedge variable interest rates.  However, no --- a portion of a single hedged item cannot be hedged under SFAS 133.

c. No, interest rate swaps cannot be used to hedge variable interest rates.  Otherwise, yes  --- only a portion of a single hedged item can be hedged under SFAS 133.

d. No, interest rate swaps cannot be used to hedge variable interest rates.  Also, no --- a portion of a single hedged item cannot be hedged under SFAS 133.

9. )  LongIntoSwap Company has a two-year variable rate note that it hedged with an interest rate swap for four years.  Choose the best statement below:

a. Yes, interest rate swaps can be used to hedge variable interest rates.  Also, yes --- only a portion (half of two years) of a single hedging instrument  can be used to hedge two-year note under SFAS 133 rules. 

b. Yes, interest rate swaps can be used to hedge variable interest rates.  However, no --- a portion (half of a four-year swap) of a single hedging instrument  cannot be used to hedge two-year note under SFAS 133 rules.

c. No, interest rate swaps cannot be used to hedge variable interest rates.  Otherwise, yes  --- only a portion of a single hedged item can be hedged under SFAS 133.

d. No, interest rate swaps cannot be used to hedge variable interest rates.  Also, no --- a portion of a single hedged item cannot be hedged under SFAS 133.

10.  Suppose Exxon has a 22% share and Texaco has a 65% share of the FarOutOil Company off-shore drilling venture.  The equity method is used by Exxon to account for this investment.  FarOutOil has a $100 million variable interest rate note which was co-signed by Texaco in order to obtain the loan.  Can Exxon designate a SFAS 133 cash flow hedge on an interest rate swap to pay fixed and receive variable interest cash flows large enough to hedge its 22% (equity) share of the profits of FarOUtOil Company?

a.  Yes.  The swap has a notional, an underlying, settles in cash, and requires no premium. 

b.  Yes.  The swap has a notional, an underlying, settles in cash, and requires no premium.  However, SFAS 133 explicitly prohibits hedges that protect equity-method earnings.

c.  No.  The swap has a notional (the loan principal), settles in cash, and requires no premium.  However, it does not have a qualified underlying for a SFAS 133 derivative instrument.

d.  No.  The swap has an underlying (the loan principal), settles in cash, and requires no premium.  However, it does not have a qualified notional for a SFAS 133 derivative instrument. 

11.  Weeping Corporation has a $2 million deferred loss in Other Comprehensive Income (OCI) as a result of fair value losses on a forward contract over the past 12 months.  The forward contract  is a cash flow hedge of a forecasted inventory purchase.  The forecasted operating profit on the inventory is $1 million (before accounting for any ultimate settlement loss on the forward instrument).  How much of the OCI balance should be transferred to current earnings even though the forecasted transaction will not transpire for another six months?

a.  Half of the $2 million in OCI should be transferred to current earnings now.

b.  All of the $2 million should be transferred to current earnings now.

c.  None of the $2 million should be transferred to current earnings now.

d.  Any part between zero and 100% of the $2 million can be chosen at management discretion.

12.  Which of the following cannot be designated as a derivative hedge of the foreign currency risk exposure?

a.  A recognized firm commitment (a foreign currency fair value hedge).

b.  An  unrecognized firm commitment (a foreign currency fair value hedge).

c.  An available-for-sale security (a foreign currency fair value hedge),

d.  A forecasted transaction.

13.  Ticky Tech Manufacturing Company has a firm commitment to buy 1,000 units of raw material per month at a unit price of 5,000DM Deutsch Marks.  Can this firm commitment be designated as a hedged item on a foreign currency risk exposure of 500 units each month?

a.  Yes with respect to any 500 units out of the 1,000 each month.

b.  Yes with respect any designated 500 units designated in advance out of the 1,000 units each month..  For example, they could be the designated first 500 purchased or the last 500 purchased in a given month.

c.  No with respect to any 500 units out of the 1,000 each month.

d.  No with respect any designated 500 units designated in advance out of the 1,000 units each month..  For example, they could be the designated first 500 purchased or the last 500 purchased in a given month.

14.  GuessAtIt Company headquartered in the U.S. has a forecasted transaction to purchase bonds having a coupon rate of 10%.  Can these bonds be designated as a hedged item for cash flow risk provided all other conditions are met to be such a hedged item?

a.  No if the debt is denominated in a foreign currency.

b.  No if the debt is denominated in the U.S. dollar.

c.  Both answers above are correct.

d.  None of the above.