On December 31, 2020 Beaver Inc. has 1,000 tractors in inventory that were originally purchased for...

On December 31, 2020 Beaver Inc. has 1,000 tractors in inventory that were originally purchased for $15,000 each. Beaver Inc. wants to hedge exposure to future declines in monitor prices. To do this it purchases a three-year put option to sell monitors at a fixed price. The option is designated as a fair value hedge and gives Beaver Inc. the option to sell up to 1,000 tractors at $15,000 per item.

Required:

1. On December 31, 2021 the market price for tractors is $14,000. What entry does Beaver Inc. make on this date to account for its put option?

2. On December 31, 2022 the market price for tractors is $12,000. What entry does Beaver Inc. make on this date to account for its put option?

Expert Solution

On December 31, 2020 Beaver Inc. pruchased 1000 tractors for $15,000 each. And they have decided to but 3 year put otion to sell at $15000 each irrespective of the market price. That means on December 31, 2023 Beaver Inc. will sell 1000 tractors at $15,000 each irrespective of the market price at that time.

For subquestion A :-)

So on December 31,2021 the Beaver Inc. will make an entry of +$1000 per tractor for its put option as the current market price at that time is $14000 each.

That if they sell at the current market price of $14000 each, they will have surplus $1000 when they will sell at $15000 each at the end of 3 years put option sale contract.

For subquestion B :-)

So on December 31,2022 the Beaver Inc. will make an entry of +$3000 per tractor for its put option as the current market price at that time is $12000 each.

That if they sell at the current market price of $12000 each, they will have surplus $3000 when they will sell at $15000 each at the end of 3 years put option sale contract.

jeff jeffy answered 2 years ago

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