Question

3. Top, a US Company, has a 100% owned subsidiary in Japan. The functional currency for the subsidiary is the Japanese yen. The subsidiary purchases merchandise on credit from a German company, with payment due in US dollars. Between the date of sale and the due date of the payable, the yen strengthens against the US dollar. What will be the result to Top.

a.   there will be a foreign exchange gain

2. there will be a foreign exchange loss
3. there will be no foreign exchange gain or loss
4. there will be both a foreign exchange gain and loss
5. there will be a bad debt expense to the German company

4. Face Co. uses the US dollar as its functional currency in Country X. At December 31, 2015 Face’s subsidiary has a net asset position in Country X of euro 100,000. Which correctly describes the action that Face will take on December 31, 2015 to hedge its euro exposure ?

1. Face will enter into a spot contract to purchase euros and sell US dollars
2. Face will enter into a spot contract to purchase US dollars and sell euros
3. Face will enter into a forward contract to purchase euros and sell US dollars
4. Face will enter into a forward contract to purchase US dollars and sell euros
5. Face will purchase an FX option contract giving it the right but not the obligation to purchase euros and sell US dollars

5. At the close of business on December 31, 2015 Booker Corp pays a $30,000 premium to purchase a foreign currency option giving Booker the right but not the obligation to purchase 100,000 euros and sell $140,000 US dollars in six months as a hedge of a future euro rental obligation.

What is reported on the balance sheet at December 31, 2015 (in US dollars)

1. asset of $0
2. asset of $30,000
3. asset of $130,000
4. asset of $140,000
5. asset of $170,000

Answer 1

Question 3 - Answer is A - There will be a foreign exchange gain

Explanation: There is foreign exchange exposure to the Japanese subsidiary since it has payable in a foreign currency i.e. in US Dollars while its functional currency is Yen.

The Yen has strengthened against Dollar. For example, suppose that Japanese firm has $100 payable. This transaction was entered into on a date when say Yen/$ = 70. Hence total payable = Yen 700 [100*70]. Now when Yen strengthens, it means that Yen/$ will be value lower than 70, say 50. Hence on date of payment $/Yen = 50. Now total payable = 100*50 = Yen 500 as compared to the original payment of Yen 700. Hence there is a foreign exchange gain.

Question 4 - Answer is d - Face will enter into a forward contract to purchase US dollars and sell euros

Explanation: The functional currency is USD while the asset is held in Euros. Hence Face co. is facing transaction exposure. It stands to gain if the Euro rises and USD falls. Thus, it will face an adverse situation if USD strengthens and Euro falls. Hence to hedge its position, it will enter into a forward contract to sell euros and buy US dollars.

Question 5 - Answer is b - Asset of $30,000

Explanation: The option premium paid is shown as an asset on the date of payment. It is subsequently revalued at each reporting date to reflect the payoff. Hence, as on date of payment asset of $30,000 will be recorded.

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