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SOUTHERN MINDANAO ACADEMIC REVIEW & TRAINING SERVICES

2F Ritzleen Building, Lukban Street, General Santos City, Philippines


+639065703473
CPA Review
OCTOBER 2016 ARIEL C. NACION
General Santos City, Region XII FA&R

DERIVATIVES
FORWARD CONTRACTS
1. Consider the following forward contract to buy 100 units of inventories:

Agreement date: June 1, 2015 Forward rate: P 1,000/unit


June 30, 2015 Market price: P 1,100/unit
December 31, 2015 Market price: P 1,300/unit
March 1, 2016 Market price: P 1,050/unit

Determine the following:


Forward contract asset/liability as of: Forward contract gain/loss for the period ending:
June 1, 2015 June 1, 2015
June 30, 2015 June 30, 2015
December 31, 2015 December 31, 2015
March 1, 2016 March 1, 2016

2. Playlist Co. is a golf course developer that constructs approximately 5 courses each year. On January
1, 2016, Playlist Co. has agreed to buy 5,000 trees on January 31, 2017 to be planted in the courses
it intends to build. In recent years, the price of trees has fluctuated wildly. On January 1, 2016,
Playlist Co. entered into a forward contract with a reputable bank. The price is set at P 500 per
tree.

The forward contract provides that if the market price on January 31, 2017 is more than P 500, the
difference is paid by the bank to Playlist. On the other hand, if the market price is less than P 500,
Playlist will pay the difference to the bank. This derivative was designated as a cash flow hedge.

The market price on December 31, 2016 is P 800 and the market price on January 31, 2017 is P 700.
The appropriate discount rate is 8% and the PV of 1 at 8% for 1 period is 0.926.

Determine the following amounts:


Notional amount
A. P 1,500,000 B. P 2,500,000 C. P 500,000 D. P0
Value of the derivative on January 1, 2016
A. P 1,500,000 B. P 2,500,000 C. P 500,000 D. P0
Value of the derivative on December 31, 2016
A. P 1,500,000 A B. P 1,389,000 L C. P 1,500,000 L D. P 1,389,000 A
Amount recognized as gain on derivatives in 2016
A. P 1,500,000 P/L B. P 1,389,000 P/L C. P 1,500,000 OCI D. P 1,389,000 OCI
Value of derivative on January 31, 2017, before settlement
A. P 1,000,000 A B. P 1,000,000 L C. P 500,000 L D. P 500,000 A
Amount recognized as loss on derivatives in 2017
A. P 500,000 P/L B. P 1,500,000 P/L C. P 500,000 OCI D. P 1,500,000 OCI
Net cash settlement for the derivatives on January 31, 2017
A. P 1,000,000 R B. P 1,000,000 P C. P 2,500,000 R D. P 2,500,000 P
Amount recorded as purchases on January 31, 2017
A. P 3,500,000 B. P 4,000,000 C. P 1,000,000 D. P 2,500,000
Net cash flow of Playlist on January 31, 2017
A. P 4,000,000 B. P 5,500,000 C. P 2,500,000 D. P 1,000,000

3. Consider the following forward contract to sell 100 units of inventories:

Agreement date: June 1, 2015 Forward rate: P 1,000/unit


December 31, 2015 Market price: P 1,100/unit
March 1, 2016 Market price: P 900/unit

DERIVATIVES Page 1 of 4
FA&R SMARTS CPA REVIEW

Determine the following:


Forward contract asset/liability as of: Forward contract gain/loss for the period ending:
June 1, 2015 June 1, 2015
December 31, 2015 December 31, 2015
March 1, 2016 March 1, 2016

4. Bounce Co. operates a seafood restaurant. On October 1, 2016, Bounce Co. determined that it will
need to purchase 50,000 kilos of deluxe fish on March 1, 2017. Because of the volatile fluctuation in
the price of deluxe fish, on October 1, 2016, Bounce negotiated a forward contract with a reputable
bank for Bounce to purchase 50,000 kilos of deluxe fish on March 1, 2017 at a forward price of P
50/kilo or P 2,500,000 in total. This forward contract was designated as a cash flow hedge.

On December 31, 2016, the market price is P 60/kilo and March 1, 2017, the market price of deluxe
fish per kilo dramatically drops to P 48. The appropriate discount rate is 8% and the present value of
1 at 8% for one period is 0.93.

Determine the following amounts:


Fair value of the derivative on December 31, 2016
A. P 500,000 A B. P 500,000 L C. P 465,000 A D. P 465,000 L
Forward contract gain or loss on December 31, 2016
A. P 500,000 P/L B. P 500,000 OCI C. P 465,000 OCI D. P 465,000 P/L
Fair value of the derivative on March 1, 2017
A. P 100,000 A B. P 100,000 L C. P 93,000 A D. P 93,000 L
Forward contract loss on March 1, 2017
A. P 100,000 P/L B. P 100,000 OCI C. P 600,000 OCI D. P 400,000 P/L
Purchases recorded on March 1, 2017
A. P 2,500,000 B. P 2,400,000 C. P 3,000,000 D. P 500,000
Net settlement by Bounce on the derivative on March 1, 2017
A. P 100,000 Rec. B. P 100,000 Pay C. P 400,000 Pay D. P 400,000 Rec.
Net cash flows of Bounce on March 1, 2017
A. P 2,500,000 B. P 2,400,000 C. P 3,000,000 D. P 500,000

5. On July 1, 2013, Sarah Company sold some limited edition art prints to Plastic Company for ¥
47,850,000 to be paid on September 30 of that year. The current exchange rate on July 1, 2013, was
¥ 110=P 1, so the total payment at the current exchange rate would be equal to P 435,000. Sarah
entered into a forward contract with a universal bank to guarantee the number of pesos to be
received. According to the terms of the contract, if ¥47,850,000 is worth less than P 435,000, the
bank will pay Sarah the difference in cash. Likewise, if ¥47,850,000 is worth more than P4 35,000,
Sarah must pay the bank the difference in cash.

Assuming the exchange rate on September 30 is ¥ 115=P 1, what amount will Sarah pay to, or receive from, the
bank (rounded to the nearest peso)?
A. P 18,913 P B. P 18,913 R C. P 87,000 P D. P 87,000 R
Assuming the exchange rate on September 30 is ¥ 105=P 1, what amount will Sarah pay to, or receive from, the
bank (rounded to the nearest peso)?
A. P 87,000 P B. P 87,000 R C. P 20,714 P D. P 20,714 R

FUTURES CONTRACT
6. Villegas Co. produces bottled grape juice. Grape juice concentrate is typically bought and sold by the
pound. Villegas uses 50,000 pounds of grape juice concentrate each month.

On November 1, 2014, Villegas entered into a grape juice concentrate futures contract as a cash flow
hedge to buy 50,000 pounds of concentrate on February 1, 2015 at a price of P 50 per pound.

The market price on December 31, 2014 and February 1, 2015 of the grape juice concentrate is P 38
per pound. The appropriate discount rate is 11%. The periodic system is used.

What amount should be recognized by Villegas on December 31, 2014 as derivative?


A. P 540,540 A B. P 540,540 L C. P 600,000 L D. P 600,000 A

DERIVATIVES MAY 2017 Page 2 of 4


FA&R SMARTS CPA REVIEW
7. PBB Co. regularly hedges its purchase requirements and the sale of its finished products in the
futures market. On December 1, 2014, PBB Co. entered into the following 3 contracts designated as
cash flow hedge:

Futures price Market price


Type of contract Quantity January 1, 2014 December 31, 2014
Purchase sugar 20,000 60 75
Purchase milk 50,000 100 91
Sell ice cream 30,000 220 195

All 3 contracts are to be settled on January 1, 2015. What is the derivative value (net) on December 31, 2014?
A. P 300,000 A B. P 600,000 A C. P 900,000 L D. P 1,050,000 L

8. In July of 2016, Sue enters into a forward agreement with Ann to lock in a sales price for wheat. Sue
anticipates selling 300,000 bushels of wheat at the market in March of 2017. Ann agrees to a forward
with Sue to buy 300,000 bushels at P 6.20. Sue’s cost for the wheat is P 5.90 per bushel. The
contract allows for net settlement.

At a market price of P 6 per bushel, consider the:

Unhedged gain (loss) for the sale of 300,000 bushels


A. P 60,000 B. (P 30,000) C. P 90,000 D. P 30,000
Economic income (loss) for the sale of 300,000 bushels, under the forward agreement
A. P 60,000 B. (P 30,000) C. P 90,000 D. P 30,000

What is the economic income (loss) for sales transactions at a market price of P 6.30 per bushel?
A. P 90,000 B. P 120,000 C. (P 30,000) D. P 60,000

Consider the same basic facts, but instead of a forward contract Sue purchases put options to sell
300,000 bushels at P 6.20 per bushel. The options cost P 0.05 a bushel.

Determine the following:


Economic income (loss) at a market price of P 6/bushel
A. P 60,000 B. P 75,000 C. P 90,000 D. P 30,000
Economic income (loss) at a market price of P 6.10/bushel
A. P 60,000 B. P 30,000 C. P 75,000 D. P 15,000
Economic income (loss) at a market price of P 6.30/bushel
A. P 90,000 B. P 120,000 C. P 105,000 D. P 60,000

OPTION
9. Harry Co. produces colorful 100% cotton T-shirts that are very popular among the youth. The entity
uses 150,000 kilos of cotton each month in its production process. In accordance with the entity’s
long-term planning, the entity normally procures one month supply of cotton to be used in its
production process.

On December 31, 2014, Harry purchased a call option as a cash flow hedge to buy 150,000 kilos of
cotton on July 1, 2015. The call option price is P 30/kilo. The entity paid P 50,000 for the call
option.

The market price of cotton on July 1, 2015 is P 35 per kilo.

Determine the following:


Value of the call option on December 31, 2014
A. P0 B. P 50,000 C. P 700,000 D. P 750,000
Gain on call option recognized in 2015
A. P 750,000 OCI B. P 700,000 P/L C. P 700,000 OCI D. P 750,000 P/L
Net cash settlement on the derivatives on July 1, 2015
A. P 375,000 B. P 350,000 C. P 700,000 D. P 750,000
Savings on purchasing the option
A. P 375,000 B. P 350,000 C. P 700,000 D. P 750,000
Purchases on July 1, 2015
A. P 750,000 B. P 5,250,000 C. P 4,500,000 D. P 700,000

DERIVATIVES MAY 2017 Page 3 of 4


FA&R SMARTS CPA REVIEW
10. Antoinette Co. uses approximately 200,000 units of raw material in its manufacturing operation. On
December 31, 2014, Antoinette purchased a call option to buy 200,000 units of raw material on July
1, 2015 at a price of P 25/unit. The entity paid P 20,000 for the call option. Antoinette designated
the call option as a cash flow hedge against price fluctuation for its July purchase.

The market price of the raw material on July 1, 2015 is P22/unit.

What is the loss on call option recognized in 2015?


A. P 600,000 B. P 550,000 C. P 650,000 D. P 20,000
What is the amount of recorded purchases on July 1, 2015?
A. P 20,000 B. P 600,000 C. P 5,000,000 D. P 4,400,000

11. On June 18, Glory Corporation entered into a firm commitment to purchase specialized equipment
from the Hotty Trading Company for ¥ 80,000,000 on August 20. The exchange rate on June 18 is ¥
100 = P1. To reduce the exchange rate risk that could increase the cost of the equipment in pesos,
Glory pays P 12,000 for a call option contract. This contract gives Glory the option to purchase ¥
80,000,000 at an exchange rate of ¥ 100 = P 1 on August 20.

On August 20, the exchange rate is ¥ 93 = P 1.

How much did Glory save by purchasing the call option?


A. P 12,000
B. P 48,215
C. P 60,215
D. Glory would have been better off not to have purchased the call option

Assume that the exchange rate is ¥ 106 = P 1


How much did Glory save by purchasing the call option?
A. P 12,000
B. P 33,283
C. P 45,283
D. Glory would have been better off not to have purchased the call option

12. On January 1, 2016, Emily, Inc. paid P 20,000 for call option to purchase 100 units of shares
for P100/share on March 1, 2016. The following data are available:
January 1, 2016 February 1, 2016 March 1, 2016
Market value P 100 P 280 P 450
Fair value of the option 20,000 30,000 35,000

What is the loss on call option – time value element – on February 1, 2016?
A. P 20,000 B. P 12,000 C. P 8,000 D. P 18,000
What is the gain on call option – intrinsic value element – on February 1, 2016?
A. P 20,000 B. P 12,000 C. P 8,000 D. P 18,000
What is the loss on call option – time value element – on March 1, 2016?
A. P 35,000 B. P 12,000 C. P 17,000 D. P0
What is the gain on call option – intrinsic value element – on March 1, 2016?
A. P 35,000 B. P 12,000 C. P 17,000 D. P0

13. On January 1, 2017, Meme, Inc. paid P 10,000 to acquire put option for 100 units of unique furniture
for P 50,000 each, with an expiration date of December 31, 2017. On December 31, 2017, the selling
price of the furniture was P 46,000 each.

What amount did Meme gain by purchasing the put option?


A. P 400,000
B. P 390,000
C. P 410,000
D. Meme would have been better off not to have purchased the option.

If the selling price on December 31, 2017 was P 50,500, how much would Meme lose?
A. Zero B. P 50,000 C. P 40,000 D. P 10,000

NOTHING FOLLOWS.

DERIVATIVES MAY 2017 Page 4 of 4