Question

Exercise A-9 (Algo) Derivatives; cash flow hedge; interest rate swap; shortcut method [LOA–3] On January 1, 2021, JPS Industries borrowed $260,000 from Austin Bank by issuing a three-year, floating rate note based on LIBOR, with interest payable semi-annually on June 30 and December of each year. JPS entered into a three-year interest rate swap agreement on January 1, 2021, and designated the swap as a cash flow hedge. The intent was to hedge the risk that interest rates will rise, increasing its semi-annual interest payments. The swap agreement called for the company to receive payment based on a floating interest rate on a notional amount of $260,000 and to pay a 6.5% fixed interest rate. The contract called for cash settlement of the net interest amount semi-annually, and the rate on each reset date (June 30 and December 31) determines the variable interest rate for the following six months. LIBOR rates in 2021 were 6.5% at January 1, 5.0% at June 30, and 7.5% at December 31. The fair values of the swap on those dates, obtained by dealer quotes, were as follows: January 1 June 30 December 31 Swap fair value $ 0 $ (2,800 ) $ 4,100 Required: 1. Calculate the net settlement on June 30, 2021. 2. Prepare journal entries for the period January 1 to December 31, 2021, to record the note payable and hedging instrument, necessary adjustments for changes in fair value, and settlement of the swap contract.

Answer 1