Questions
1. Solution. Comment on the type of risks that Nicoll Construction exposed to?
2. Solution. Construct a memo to Derek Nicoll and the Board of Directors that summarizes the possible outcomes and compares the general results for a forward or futures hedge with those of an option hedge. The option would need to be a put, because Nicoll construction would need to protect itself against a decline in the deutsche mark. Link to Development of Currency Financial Instruments. Link to Glossary.
Be sure to include the following:
(a) Describe the outcome for the firm if no hedging strategy is used, the dollar appreciates against the deutsche mark and the bid is successful. Not successful.
(b) Describe the outcome for the firm if no hedging strategy is used, the dollar depreciates against the deutsche mark and the bid is successful. Not successful.
(c) Describe the outcome for the firm if Mr. Nicoll elects to use a short forward or future hedge and the dollar appreciates and the bid is successful. Not successful.
(d) Describe the outcome for the firm if Mr. Nicoll elects to use a short forward or future hedge and the dollar depreciates and the bid is successful. Not successful.
(e) Describe the outcome for the firm if Mr. Nicoll elects to use an option hedge (buy put) and the dollar appreciates and the bid is successful. Not successful.
(f) Describe the outcome for the firm if Mr. Nicoll elects to use an option hedge (buy put) and the dollar depreciates and the bid is successful. Not successful.
3. Solution. Construct a Table that compares the outcomes from a Forward/Futures Hedge and Option Hedge with the deutsche mark on the two alternative spot rates given for January 15, x2. Link to rates.
4A. Solution.Which strategy would you suggest that Mr. Nicoll use? Link to overview.
4B. Solution. Comment on how the company would disclose their strategy in their year end financials. (I.E. -- it is year end and they have not found out if they have won the contract.)
5. Solution. How would the Company disclose their strategy in their year end financials, knowing that the contract had been awarded.
6. Solution. Prepare the necessary journal entries for December 1st and 31st, to record your chosen strategy following current accounting principals. Assume that they have not found out if they have won the contract. The DM is increasing against the US dollar. The option contract value of a put with a strike price of 5450 is trading at .20. If you have assumed the futures/forward stratgey for simplicity, assume forward contract for calculations. You have agreed to receive .5405 DM and pay the broker the current spot price (December 1, x1). Discount/Premium must calculated. View Rates.
7A. Solution. Prepare the necessary journal entries for December 1st and 31st, to record your chosen strategy following current accounting principals. Nicoll knows at year end that they have been awarded the contract. However, they will not ship goods until January 3, x2. They will receive payment from Hamburg client on January 15, x2. Use same info for calculations as in (6) above.
7B. Solution. Use information from 7A, to prepare settlement journal entries for January 15th.
8. Solution. How would the recent Exposure Draft, "Accounting for Derivatives" affect journal entries when
A. Status of contract not known
B. Status of contract known -- accepted
