In December 12, 20X8, Imp Co. entered into a forward exchange contract to hedge a firm commitment to purchase equipment being manufactured to Imp's specifications. The forward contract was to purchase 100,000 Euros in 90 days as a fair value hedge of the equipment. The relevant direct exchange rates were as follows:SR = Spot rateFR = Forward rateSR FR (for Mar 12, Year 2) December 12, Year 1 $.88 $.90December 31, Year 1.98.93Imp entered into the third forward contract for speculation. At December 31, Year 1, what amount of foreign currency gain should Imp include in income from this forward contract? a) $0b) $3,000c) $5,000d) $10,000

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Business

Asia Fleming

27 August, 06:23

In December 12, 20X8, Imp Co. entered into a forward exchange contract to hedge a firm commitment to purchase equipment being manufactured to Imp's specifications. The forward contract was to purchase 100,000 Euros in 90 days as a fair value hedge of the equipment. The relevant direct exchange rates were as follows:SR = Spot rateFR = Forward rateSR FR (for Mar 12, Year 2) December 12, Year 1 $.88 $.90December 31, Year 1.98.93Imp entered into the third forward contract for speculation. At December 31, Year 1, what amount of foreign currency gain should Imp include in income from this forward contract? a) $0b) $3,000c) $5,000d) $10,000

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Janiyah Mullins · Answer 1

B) $3,000

Explanation:

Since this is defined as a derivative operation, its result must be reported either as a gain or loss as part of normal income. Imp entered a contract to buy 100,000 euros at $0.90. If the exchange rate remained at $0.90 in 90 days, no gain or loss should be recognized.

But the currency exchange increased to $0.93 per euro, so the contract now results in a $0.03 gain per euro ( = $0.93 - $0.90), so a gain of $0.03 x 100,000 = $3,000 must be reported.