# Investment Quiz: 12 Questions Part 7

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This is the last of the batch. It's timed as well.

• 1.

### Chocolate Company operates a seafood restaurant. On October 1, 2009, Chocolate determined that it will need to purchase 50,000 kilos of deluxe fish on March 1, 2010. Because of the volatile fluctuation in the price of deluxe fish, on October 1, 2009, Chocolate negotiated a forward contract with a reputable bank for Chocolate to purchase 50,000 kilos of deluxe fish onMarch 1, 2010 at a price of P50 per kilo or P2,500,000. This forward contract was designated as a cash flow hedge. The derivative forward contract provides that if the market price of deluxe fish on March 1, 2010 is more than P50, the difference is paid by the bank to Chocolate. On the other hand, if the market price on March 1, 2010 is less than P50, Chocolate will pay the difference to the bank. On December 31, 2009, the market price per kilo P60 and on March 1, 2010, the market price is .93. What is the fair value of the derivative asset or liability on December 31, 2010?

• A.

400,000 asset

• B.

400,000 liability

• C.

372,000 asset

• D.

372,000 liability

A. 400,000 asset
Explanation
The fair value of the derivative asset on December 31, 2010 is 400,000. This is because the market price of deluxe fish on March 1, 2010 was .93, which is less than the agreed price of P50 per kilo in the forward contract. As a result, Chocolate Company will pay the difference to the bank. Since the market price is lower than the agreed price, the derivative asset is considered valuable and is recorded as a 400,000 asset on December 31, 2010.

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• 2.

### Seaman Company operates a five-star hotel. The company makes very detailed long-term planning. On October 1, 2009, Seaman Company determined that they would need to purchase 8,000 kilos of Australian lobster on January 1, 2011. Because of the fluctuation in the price of Australian lobster, on October 1, 2009 the company negotiated a special forward contract with a bank for Seaman to purchase 8,000 kilos of Australian lobster on January 1, 2011 at price of P9,600,000. The price of Australian lobster was P1,200 per kilo on October 1. This forward contract was designated as a cash flow hedge.The bank has a staff of financial analysts who specialize in forecasting lobster prices. These analysts are predicting a drop in worldwide lobster prices between October 1, 2009 and January 1, 2011.On December 31, 2009, the price of a kilo of Australian lobster is P1,500. On December 31, 2010 and January 1, 2011, the price of a kilo of Australia lobster is P1,000. The appropriate discount rate throughout this period is 10%. The present value of 1 at 10% for one period is .91. The periodic system is used.What is the notional value of the forward contract?

• A.

4,800,000

• B.

7,200,000

• C.

9,600,000

• D.

12,000,000

C. 9,600,000
Explanation
The notional value of the forward contract is the agreed upon amount of the underlying asset that will be bought or sold in the future. In this case, the Seaman Company entered into a forward contract to purchase 8,000 kilos of Australian lobster on January 1, 2011. The price of the lobster was set at P9,600,000. Therefore, the notional value of the forward contract is P9,600,000.

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• 3.

### Seaman Company operates a five-star hotel. The company makes very detailed long-term planning. On October 1, 2009, Seaman Company determined that they would need to purchase 8,000 kilos of Australian lobster on January 1, 2011. Because of the fluctuation in the price of Australian lobster, on October 1, 2009 the company negotiated a special forward contract with a bank for Seaman to purchase 8,000 kilos of Australian lobster on January 1, 2011 at price of P9,600,000. The price of Australian lobster was P1,200 per kilo on October 1. This forward contract was designated as a cash flow hedge. The bank has a staff of financial analysts who specialize in forecasting lobster prices. These analysts are predicting a drop in worldwide lobster prices between October 1, 2009 and January 1, 2011. On December 31, 2009, the price of a kilo of Australian lobster is P1,500. On December 31, 2010 and January 1, 2011, the price of a kilo of Australia lobster is P1,000. The appropriate discount rate throughout this period is 10%. The present value of 1 at 10% for one period is .91. The periodic system is used.What is the derivative asset or liability on December 31, 2009?

• A.

2,400,000 asset

• B.

2,400,000 liability

• C.

2,184,000 asset

• D.

2,184,000 liability

C. 2,184,000 asset
Explanation
The derivative asset on December 31, 2009 is 2,184,000. This is because the company entered into a forward contract to purchase 8,000 kilos of Australian lobster on January 1, 2011 at a fixed price of P9,600,000. However, the price of lobster dropped to P1,500 per kilo on December 31, 2009. Therefore, the company has a derivative asset of 2,184,000, which represents the difference between the contracted price and the market price on that date.

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• 4.

### Seaman Company operates a five-star hotel. The company makes very detailed long-term planning. On October 1, 2009, Seaman Company determined that they would need to purchase 8,000 kilos of Australian lobster on January 1, 2011. Because of the fluctuation in the price of Australian lobster, on October 1, 2009 the company negotiated a special forward contract with a bank for Seaman to purchase 8,000 kilos of Australian lobster on January 1, 2011 at price of P9,600,000. The price of Australian lobster was P1,200 per kilo on October 1. This forward contract was designated as a cash flow hedge. The bank has a staff of financial analysts who specialize in forecasting lobster prices. These analysts are predicting a drop in worldwide lobster prices between October 1, 2009 and January 1, 2011. On December 31, 2009, the price of a kilo of Australian lobster is P1,500. On December 31, 2010 and January 1, 2011, the price of a kilo of Australia lobster is P1,000. The appropriate discount rate throughout this period is 10%. The present value of 1 at 10% for one period is .91. The periodic system is used. What is the derivative asset or liability on December 31, 2010?

• A.

1,600,000 asset

• B.

1,600,000 liability

• C.

800,000 asset

• D.

800,000 liability

B. 1,600,000 liability
Explanation
The derivative liability on December 31, 2010 is 1,600,000 because the forward contract was entered into to hedge against the fluctuation in the price of Australian lobster. The contract was for the purchase of 8,000 kilos of lobster at a price of P9,600,000. However, the price of lobster decreased to P1,000 per kilo on December 31, 2010. As a result, the company would need to pay less to fulfill the contract on January 1, 2011, resulting in a liability of 1,600,000.

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• 5.

### Indian Company requires 40,000 kilos of soy beans each month in its operations. To eliminated the price risk associated with the purchase of soy beans, on December 1, 2009, Indian entered into a futures contract as a cash flow hedge to buy 40,000 kilos of soy beans at P150 per kilo on January 1, 2010. The market price on December 31, 2009 and January 1, 2010 is P160 per kilo. The appropriate discount rate is 9% and the present value of 1 at 9% for one period is .917. The periodic system is used.Indian Company shall recognize on December 31, 2009 a derivative asset at:

• A.

183,400

• B.

200,000

• C.

366,800

• D.

400,000

D. 400,000
Explanation
The Indian Company entered into a futures contract to buy soy beans at a fixed price of P150 per kilo. The market price on December 31, 2009 and January 1, 2010 is P160 per kilo. Since the market price is higher than the fixed price, the Indian Company has a derivative asset because it has the right to buy soy beans at a lower price. The derivative asset is calculated by multiplying the quantity of soy beans (40,000 kilos) by the difference between the market price and the fixed price (P160 - P150 = P10), and then discounting it to present value using the appropriate discount rate. Therefore, the correct answer is 400,000.

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• 6.

### Nata Company produces bottled grape juice. Grape juice concentrate is typically bought and sold by the pound. Nata uses 50,000 pounds of grape juice concentrate each month.On November 1, 2009, Nata entered into a grape juice concentrate futures contract as a cash flow hedge to buy 50,000 pounds of concentrate on January 1, 2010 at a price of P50 per pound. The market price on December 31, 2009 and January 1, 2010 of the grape juice is P38 per pound. The appropriate discount rate is 11%. The periodic system is used.Nata Company shall recognize on December 31, 2009 a derivative liability at:

• A.

270,300

• B.

300,000

• C.

540,600

• D.

600,000

D. 600,000
Explanation
Nata Company entered into a grape juice concentrate futures contract to buy 50,000 pounds of concentrate on January 1, 2010 at a price of P50 per pound. The market price on December 31, 2009 and January 1, 2010 of the grape juice is P38 per pound. Since the market price is lower than the contract price, Nata Company will have a derivative liability on December 31, 2009. The derivative liability is calculated by multiplying the difference between the contract price and the market price by the discount rate. In this case, the derivative liability is (50,000 pounds x (P50 - P38) x 11%) = 600,000.

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• 7.

### Tall Company requires 25,000 pounds of copper each month in its operations. To eliminate the price risk associated with copper purchases, on December 1, 2009, Tall entered into a futures contract as a cash flow hedge to buy 25,000 pounds of copper on June 1, 2010. The futures price is P50 per pound.The futures contract is managed through an exchange, so Tall does not know the other party on the other side of the contract. As with most derivative contracts, this futures contract is settled by an exchange of cash on June 1, 2010 based on the price of copper on that date.The market price per pound is P45 on December 31, 2009 and P42 on June 1, 2010. What is the fair value of the derivative asset or liability on December 31, 2009?

• A.

125,000 asset

• B.

125,000 liability

• C.

200,000 asset

• D.

200,000 liability

B. 125,000 liability
Explanation
The fair value of the derivative asset or liability on December 31, 2009 can be determined by comparing the futures price (P50 per pound) with the market price per pound on that date (P45). Since the market price is lower than the futures price, the derivative would result in a liability for Tall Company. The liability would be calculated by multiplying the difference in price (P50 - P45 = P5) by the quantity needed (25,000 pounds), resulting in a liability of P125,000. Therefore, the correct answer is 125,000 liability.

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• 8.

### Legacy Company produces colorful 100% cotton T-shirts that are very popular among the youth. The company uses 150,000 kilos of cotton each month in its production process. In accordance with the company's long-term planning, the company normally procures one month supply of cotton to be used in its production process.On December 31, 2009, Legacy Company purchased a call option as a cash flow hedge to buy 150,000 kilos of cotton on July 1, 2010. The call option price is P30 per kilo. The company paid P50,000 for the call option. The market price of cotton on July 1, 2010 is P 35 per kilo.Legacy Company shall recognize gain on call option 2010 at:

• A.

350,000

• B.

375,000

• C.

700,000

• D.

750,000

C. 700,000
Explanation
Legacy Company shall recognize a gain on the call option in 2010 at 700,000. This is because the market price of cotton on July 1, 2010, is P35 per kilo, while the call option price is P30 per kilo. Therefore, the company can buy the cotton at a lower price than the market price, resulting in a gain of P5 per kilo. Since the company has a call option for 150,000 kilos of cotton, the total gain would be P5 per kilo multiplied by 150,000 kilos, which equals P750,000. However, since the company paid P50,000 for the call option, the net gain would be P750,000 minus P50,000, which equals P700,000.

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• 9.

### Book Company uses approximately 200,000 units of raw material in its manufacturing operations. On December 31, 2009, Book Company purchased a call option to buy 200,000 units of the raw material on July 1, 2010 at a price of P25 per unit. The company paid P20,000 for the call option. Book 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, 2010 is P22 per unit.Book Company shall recognize loss on call option in 2010 at:

• A.

20,000

• B.

550,000

• C.

600,000

• D.

650,000

A. 20,000
Explanation
The loss on the call option in 2010 will be recognized as the difference between the purchase price and the market price of the raw material on July 1, 2010. Since the market price is P22 per unit and the purchase price is P25 per unit, the loss per unit is P3. Therefore, the total loss on the call option will be 200,000 units multiplied by P3 per unit, which equals P600,000. However, since the call option was designated as a cash flow hedge, the loss will be recognized in other comprehensive income. Therefore, the correct answer is P20,000, which is the amount paid for the call option.

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• 10.

### Socks Company uses approximately 300,000 units of raw material in its manufacturing operations. On December 1, 2009, Socks Company purchased a call option to buy 300,000 units of the raw material on March 1, 2010 at a price of P25 per unit. Socks paid P50,000 for the call option and designated the call option as a cash flow hedge against price fluctuation for its March purchase.On December 31, 2009, the market price of the raw material is P27 per unit and on March 1, 2010, the market price is P28.What is the fair value of the call option or derivative asset on December 31, 2009?

• A.

550,000

• B.

600,000

• C.

850,000

• D.

900,000

B. 600,000
Explanation
The fair value of the call option or derivative asset on December 31, 2009 is 600,000. This is because the market price of the raw material on that date is P27 per unit, which is higher than the exercise price of P25 per unit stated in the call option. The difference between the market price and the exercise price is P2 per unit, and since Socks Company has a call option for 300,000 units, the fair value of the call option is calculated as 300,000 units multiplied by P2 per unit, which equals 600,000.

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• 11.

### On September 1, 2009, Denver Company purchased equipment from USA for \$50,000 to be paid on March 1, 2010. The exchange rate on September 1, 2009 is P45 to \$1. On the same date, Denver entered into a foreign currency forward contract and agreed to pay P2,250,000 at the rate of P45 to \$1. This forward contract is designated as a fair value hedge of the payable that is denominated in foreign currency.The peso exchange rate to the dollar is P46 on December 31, 2009 and P49 on March 1, 2010.What is the gain on foreign currency forward contract that will be recognized in the 2010 income statement?

• A.

0

• B.

50,000

• C.

150,000

• D.

200,000

C. 150,000
Explanation
The gain on the foreign currency forward contract that will be recognized in the 2010 income statement is \$150,000. This is because the forward contract was entered into to hedge the payable denominated in foreign currency. The exchange rate on December 31, 2009, is P46 to \$1, which means that the payable has decreased in value compared to the forward contract. The difference between the forward contract rate of P45 to \$1 and the spot rate of P46 to \$1 results in a gain of \$1 for each peso in the contract. Since the payable is P2,250,000, the gain on the forward contract is \$1 x 2,250,000 = \$150,000.

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• Current Version
• Aug 21, 2023
Quiz Edited by
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• Sep 23, 2009
Quiz Created by
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