FAR 56 - Foreign Currency Hedges Flashcards Preview

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Flashcards in FAR 56 - Foreign Currency Hedges Deck (45):
1

Which of the following is not a characteristic associated with foreign currency transactions?
A. Are denominated in a foreign currency.
B. Can include contracts to exchange currencies.
C. Are affected by changes in currency exchange rates.
D. Occur only when initiated by a foreign entity.

D. Foreign currency transactions do not occur only when initiated by a foreign entity. A foreign currency transaction occurs when a domestic entity (e.g., U.S. entity) agrees to settle a transaction (pay, receive, exchange, etc.) in a non-domestic (e.g., non-dollar) currency, regardless of whether the transaction is initiated by the domestic entity or the foreign entity.

2

Which one of the following sets correctly identifies the characteristics of foreign currency transactions for a U.S. entity?
Transaction Denominated In
Transaction Measured In

Non-dollars/foreign currency, Dollars
For a U.S. entity, a foreign currency transaction will be denominated (settled) in non-dollars, but measured and recorded on the U.S. entity's books in dollars.

3

Forward exchange contracts may be used to:
Hedge Risk
Speculate

yes, yes
Forward exchange contracts may be used both to hedge risk and to speculate. When used to hedge risk, the intent is to use the change in value of the forward exchange contract (hedging instrument) to offset, in part at least, an opposite change in value of whatever is being hedged (hedged item). When used to speculate, the forward exchange contract is entered into with the intent of making a profit on the change in its value.

4

Which one of the following is not associated with forward contracts?
A. The contract may require a future purchase or sale.
B. The contract provides for using the market price at the date the contract is fulfilled.
C. The contract may permit a future purchase or sale.
D. The contract specifies the subject matter of the exchange.

B. Forward contracts establish the price at the time the contract is executed, not at the time the contract is fulfilled.

5

Which of the following statements concerning foreign exchange forward contracts is/are correct?

I. A foreign currency forward exchange contract will result in the exchange of currencies.
II. All forward contracts require the exchange of currencies.

I only.
A foreign currency forward exchange contract will result in the exchange of currencies (Statement I). Unlike foreign currency option contracts, which give the right (but not an obligation) to exchange currencies, foreign currency forward exchange contracts establish an obligation to exchange currencies.
All forward contracts do not require the exchange of currencies (Statement II). The subject matter of a forward contract may be virtually any asset or liability (e.g. agricultural commodities); they are not limited to the exchange of currencies only.

6

When used for speculative purposes, which of the following contracts is likely to result in a foreign currency loss to the contract holder who initiated the contract?
Foreign Currency Forward Exchange Contract
Foreign Currency Option Contract

Yes, No
While a foreign currency forward exchange contract entered into for speculative purposes is likely to result in a foreign currency loss (or gain) for the contract holder, a foreign currency option contract entered into for speculative purposes is not likely to result in a foreign currency loss for the contract holder.. Since the contract holder has the option of whether or not to exercise the contract option to exchange currencies, it is not likely that the option would be exercised if it would result in a loss.

7

For accounting purposes, which of the following are forward contracts?
Foreign Currency Forward Exchange Contracts
Foreign Currency Option Contracts

Yes, yes
Both foreign currency forward exchange contracts, which establish an obligation to exchange currencies, and foreign currency option contracts, which give the right (but not an obligation) to exchange currencies, are forward contracts for accounting purposes.

8

T/F: Accounting for both foreign currency forward exchange contracts and foreign currency option contracts is essentially the same.

True

9

T/F: Currencies are commodities.

True

10

T/F: A foreign currency forward exchange contract establishes a legal obligation to exchange currencies.

True.
Not true in a foreign currency option contract.

11

T/F: A foreign currency option contract establishes a legal obligation to exchange currencies.

False.
True in a foreign currency forward exchange contract.

12

T/F: For accounting purposes, all forward contracts are considered to be for hedging purposes.

False.
General rules are: 1. The transaction terms provide that the trans will be settled in a foreign currency. 2. The domestic entity will ultimately pay or receive a foreign currency.

13

T/F: Forward exchange contracts are agreements to exchange commodities in the future at an exchange rate set at the present.

True

14

Which of the following exchange rates may be used in accounting for a forward contract hedging instrument?
Spot Rate
Forward Rate

Yes, yes
Both the spot rate and the forward rate will be used in accounting for a forward contract used for hedging. The forward rate is used as the basis for determining the change in value of a forward contract. As the forward rate changes, so also will the carrying value of the forward contract, resulting in exchange gains and losses. The spot rate is used to determine the premium or discount on the forward contract. Specifically, the difference between the spot rate and the forward rate at the date of the forward contract is the premium (or discount) on the forward contract, which enters into the determination of income over the life of the contract.

15

Which one of the following is not a characteristic of hedging?
A. Typically involves offsetting transactions or positions.
B. Assures no gain or loss on the item being hedged.
C. Is a strategy for managing risks.
D. Can be used for obligations to be satisfied in a foreign currency.

B. While the intent of hedging is to mitigate the risk of loss (or gain) attributable to the item being hedged, hedging does not assure that no gain or loss will be incurred on the hedged item. Only in a perfect hedge does no gain or loss occur. In order to be a perfect hedge, the hedging instrument would need to have a 100% inverse correlation to the hedged item. Such an outcome is rare.

16

Even if the use of a forward contract for hedging prevents a loss (or gain) from exchange rate changes on the hedged item, which of the following may result in a cost to an entity that uses forward contracts for hedging purposes?

I. Fees imposed by the counterparty to the forward contract.
II. A difference between the spot rate and the forward rate when the forward exchange contract is executed.

Both I and II. A firm that engages in a forward contract will both incur fees imposed by the counterparty and incur the cost of the difference between the spot rate and the forward rate at the time the forward contract is executed. The difference between the spot rate and the forward rate is the premium (or discount) on the forward contract and must be amortized over the life of the contract as a financing expense, not an exchange gain or loss.

17

T/F: When the hedged item is a receivable, the hedging instrument must then be a payable.

True.
Because a hedging instrument is intended to offset changes in the hedged item, when the hedged item is a receivable, the hedging instrument would have to be a payable.

18

T/F: Hedging generally involves two transactions for which a loss on one would be offset at least in part by a gain on the other.

True

19

T/F: Hedging the future receipt of a foreign currency would require a contract to sell that foreign currency in the future.

True

20

Based on preliminary discussions with a foreign customer, Alcoco, a U.S. entity, budgeted a significant sale to the foreign entity denominated in its foreign currency expected in June 2009. To hedge the risk of an adverse exchange rate change on the dollar value of the expected sale, on January 2, 2009, Alcoco entered into a forward exchange contract to sell an amount of the foreign currency equal to the expected sale. On March 31, 2009, the value of the expected sale amount in dollars had decreased by $3,800. The fair value of the forward contract at that date had increased by $4,000. Which one of the following is the amount that should be recognized in current income for the forward contract only (the hedging instrument) in Alcoco's quarterly financial statements as of March 31?

$200
The ineffective portion of the (cash flow) hedge should be reported in current income. The effective portion of the hedge ($3,800) should be reported in other comprehensive income, and the ineffective portion ($200) should be reported in current income. The effective portion of the hedge is the amount of change in the forward contract (hedging instrument) equal to the change in the fair value of the expected sale amount (the hedged item) ($3,800); the ineffective portion is the difference ($200) and should be reported in current income.

21

Which one of the following is not a criterion that must be met in order to use a forward contract to hedge a forecasted transaction?
A. A specific forecasted transaction (or group of similar transactions) must be identified.
B. The forecasted transaction must be at risk from foreign currency price changes.
C. The forecasted transaction must be expected to be initiated by the entity hedging the forecasted transaction.
D. The hedge must be highly effective in offsetting the effects of exchange rate changes.

C. The use of a forward contract to hedge a forecasted transaction does not require that the forecasted transaction be expected to be initiated by the entity hedging the forecasted transaction. The forecasted transaction could be expected to be initiated by the other party to the transaction; for example, it could be expected that another party initiate a purchase.

22

At the beginning of its fiscal year, a U.S. firm planned a transaction to purchase specialized equipment from a foreign manufacturer. The firm subsequently entered into a contract with the foreign firm. Which of the U.S. firm's actions could be hedged?
Plan to Purchase
Contract to Purchase

Yes, yes
The U.S. firm could hedge both its plan to purchase the equipment and, subsequently, its contract to purchase the equipment. The first would be a hedge of a forecasted transaction, and the second would be a hedge of a firm commitment.

23

Which one of the following correctly reflects a set of events that may result in a sequence of related hedges?
A. Firm commitment -> forecasted transaction -> recognized liability.
B. Firm commitment -> recognized liability -> forecasted transaction.
C. Forecasted transaction -> firm commitment -> recognized liability.
D. Forecasted transaction -> recognized liability -> firm commitment.

C. A forecasted transaction (a planned or expected transaction) would occur before a firm commitment, which would occur before a recognized liability. A forecasted transaction is a non-firm but intended (perhaps even budgeted) transaction. A firm commitment exists when an entity has a contractual obligation or right, but has not yet recorded the obligation or right because it does not meet the requirement of GAAP. A recognized liability would be one that is already booked by the entity. Thus, the correct sequence would be forecasted transaction -> firm commitment -> recognized liability.

24

What general kind of hedge is the hedge of a forecasted transaction to be denominated in a foreign currency?
A. Fair value.
B. Cash flow.
C. Economic.
D. Income.

B. The hedge of a forecasted transaction to be denominated in a foreign currency is a cash flow hedge. The risk being hedged is the variability in expected cash flows (inflows or outflows) on the planned transaction that would result from changes in the exchange rate.

25

Which of the following statements concerning the hedging of the fair value of a foreign currency commitment is/are correct?

I. The change in fair value of a forward contract used to hedge a foreign currency firm commitment will be recognized as a gain or loss in current income.
II. The change in fair value of a hedged foreign currency firm commitment will be recognized as a gain or loss in current income.

Both I and II. The change in fair value of both a foreign currency firm commitment and a forward contract used to hedge a foreign currency firm commitment will be recognized as a gain or loss in current income. To the extent the two do not exactly offset each other, there will be a net effect on current income.

26

Which one of the following is not a characteristic associated with hedging foreign currency firm commitments?
A. The hedged item is for purchase or sale to be recorded in the future.
B. The hedged item is for an already booked asset or liability.
C. The hedged item is evidenced by a contract or similar legal commitment.
D. The risk being hedged exists prior to an asset or liability being recognized.

B. A firm commitment exists when an entity has a contractual obligation or right, but has not yet recorded the obligation or right because it does not meet the requirements of GAAP. Therefore, an asset or liability has not been booked (recognized) already.

27

What kind of hedge can be used to hedge a foreign currency firm commitment?

A forward contract used to hedge a foreign currency firm commitment can be either a CASH FLOW hedge (as permitted by the FASB's Derivatives Implementation Group) or a FAIR VALUE hedge (as permitted by FASB #133).

28

For accounting purposes, a hedge to offset the risk of exchange rate changes on a planned transaction would be classified as the hedge of:
A. A firm commitment.
B. A forecasted transaction.
C. A recognized asset.
D. An unrecognized asset.

B. A hedge to offset the risk of exchange rate changes on a planned transaction would be the hedge of a forecasted transaction. A forecasted transaction is a non-firm, but planned or expected transaction that will be denominated in a foreign currency.

29

T/F: In order for a forward contract to qualify as a hedge of a foreign currency commitment, the commitment must be firm.

True

30

T/F: A forward (exchange) contract which hedges a firm foreign currency commitment should be revalued as of the balance sheet date.

True

31

T/F: Because a forecasted transaction has not been booked, it is not at risk of exchange rate changes.

False.
All foreign currency transactions are at resk of exchange rate changes.

32

T/F: The full amount of change in the fair value of a forward contract that hedges a forecasted transaction will always be recognized as a gain or loss in current period net income.

False.
The G/L should be deferred and reported in OCI

33

T/F: Any qualified hedge of a firm foreign currency commitment is considered a fair value hedge for accounting purposes.

False.
It could be either a fair value hedge or a cash flow hedge.

34

T/F: The effective portion of a hedge of a forecasted transaction should be deferred and reported as an item of "Other Comprehensive Income."

True

35

T/F: Any qualified hedge of a forecasted transaction is considered a cash flow hedge for accounting purposes.

True

36

T/F: A firm foreign currency commitment could refer to an existing account payable which is payable in a foreign currency.

False.
A hedge is used to offset the risk of exchange rate changes on a firm commitment for a future purchase or sale denominated in a foreign currency; a contract has been entered into, but the related transation has not been recorded under GAAP.

37

T/F: A gain or loss that results from revaluing a forward exchange contract which hedges the fair value of a firm foreign currency commitment should be recognized in the income statement.

True

38

Which of the following statements concerning the hedging of recognized foreign currency assets or liabilities is/are correct?

I. The hedged asset or liability already has been booked by the hedging entity.
II. The hedged asset or liability must be denominated in a foreign currency.
III. The hedge can be treated only as a fair value hedge.

I and II only. It is correct that in hedging a recognized foreign currency asset or liability the hedged item (asset or liability) has been booked by the hedging entity (Statement I) and that the hedged asset or liability must be denominated in a foreign currency (Statement II). Statement III is not correct; the hedge of a recognized foreign currency asset or liability generally can be treated either as a cash flow hedge or as a fair value hedge, generally, at management’s discretion.

39

T/F: Both investments in equity securities and investments in debt securities denominated in a foreign currency and classified as available-for-sale cannot be hedged.

False.
These both CAN be hedged.

40

Which of the following statements concerning the hedging of an investment in a foreign operation is/are correct?

I. The hedged item is the result of translating the foreign operation's financial statements.
II. Only forward contracts can be used to hedge an investment in a foreign operation.

I only. In the hedging of an investment in a foreign operation, the hedged item is the result of translating the foreign operation's financial statements from a foreign currency to the functional currency (Statement I). The intent of the hedge is to offset changes in the translated results that are caused by changes in exchange rates. Statement II is not correct; either derivatives (e.g., forward contracts) or non-derivatives can be used to hedge an investment in a foreign operation. For example, borrowing in the same foreign currency would hedge the investment, but the borrowing is not necessarily a derivative (e.g., forward contract).

41

Hedging a recognized asset is intended to offset the risk of exchange rate changes between which of the following dates?
A. Between the dates a contractual right is established and when the right is fully satisfied.
B. Between the dates a contractual right is established and when the right is recognized.
C. Between the dates a transaction is planned and when the related asset is recognized.
D. Between the dates an asset is recognized and when the asset is fully satisfied.

D. The time between when an asset is recognized and when the asset is fully satisfied would be intended to offset the risk of changes in the exchange rate on a recognized asset (or liability).

42

Tramco has an investment classified as available-for-sale which is denominated in 80,000 units of a foreign currency. In order to hedge its investment, Tramco acquired a forward exchange contract for 100,000 units of the foreign currency in which its investment is denominated. During the year, the value of the investment decreased $9,000 and the value of the forward contract increased by $10,000. For the year, which one of the following amounts should Tramco recognize from the forward contract as hedging (offsetting) the decrease in value of the investment?

$8,000
Because the forward contract was designated as hedging the investment, a change in the value of the investment would be offset by a change in the value of the forward contract. However, because the amount of the forward contract (100,000 foreign currency units) exceeded the amount of the investment being hedged (80,000 foreign currency units - FCU), only 80,000 FCU/100,000 FCU = .80 of the change in the forward contract can be used to offset a change in the investment. The other .20 change in the forward contract must be treated as speculative. Therefore, .80 of the $10,000 change in the value of the contract, or $8,000, can be used to offset the $9,000 change in the value of the investment. The other $2,000 must be treated as a speculative gain.

43

T/F: In a FV hedge, the change in values of both the investment (hedged item) and the forward contract (hedging instrument) will be reported in current income.

True

44

What general kind of hedge, if any, is the hedge of an available-for-sale investment denominated in a foreign currency?

I. Fair value.
II. Cash flow.

I only. The hedge of an available-for-sale investment denominated in a foreign currency is a fair value hedge. The risk hedged is the effect of exchange rate changes on the fair value in dollars of the investment.

45

What general kind of hedge, if any, is the hedge of a recognized asset or liability?

I. Fair value.
II. Cash flow.

Either I or II. The hedge of a recognized asset or liability may be either a fair value hedge or a cash flow hedge, depending on management's designation. However, the hedge of a recognized asset or liability denominated in a foreign currency generally will be a cash flow hedge.

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