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Hedging

1. Which of the following qualifies as a hedged item?
a. a company's work in process inventory of unfinished washers, dryers, and refrigerators
b. Credit card receivable at Sears, Roebuck and Company.
c. Bushels of corn owned by the Farmers' Cooperative.
d. Salaries Payable to employees of Ford Motor Company.
e. a three-year note issued by General Motors and payable in U.S. dollars
f. A three year note issued by DaimlerChrysler and payable in Euros.

2. Which of the following qualifies as a hedging instrument?

a. an electricity futures contract purchased by Alliant Energy, an electrical power company.
b. a crop insurance contract purchased by Farmers' Cooperative that pays the co-op for crop looses from drought or flood
c. an option to buy shares of common stock in Ford Motor Company
d. an option to sell shares of common stock in General Motors.
e. a four year lease for office space in downtown Toronto.

3. Which of the following qualifies as an eligible risk for hedge accounting?

a. Alliant Energy's risk that summer demand for electricity may exceed the company's power generating capacity
b. Ford Motor Company's risk that not enough steel will be available in six months when the company must purchase steel to produce a new sport utility vehicle.
c. the risk to American Express that its members won't pay their credit card bills.
d. The risk to Farmers' Cooperative that corn mold will destroy its inventory of corn held in silos for sale next year.
e. The possibility of changes in the exchange rate of U.S. dollars for Mexican pesos for Coca Cola Company, which has a major foreign investment in Mexico.

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Use has been made of material at the following sites in answering the questions:

http://www.pwc.com/extweb/pwcpublications.nsf/4bd5f76b48e282738525662b00739e22/fd077b7701e363b585256de100637bba/$FILE/Hedging%20Relationships.pdf

1. Which of the following qualifies as a hedged item?
a. a company's work in process inventory of unfinished washers, dryers, and refrigerators
b. Credit card receivable at Sears, Roebuck and Company.
c. Bushels of corn owned by the Farmers' Cooperative.
d. Salaries Payable to employees of Ford Motor Company.
e. a three-year note issued by General Motors and payable in U.S. dollars
f. A three year note issued by DaimlerChrysler and payable in Euros.

Answer: a. a company's work in process inventory of unfinished washers, dryers, and refrigerators

To be qualified as a hedged item, the risk should be that the fair value or cash flows of the hedged item will change in response to some future event such as a change in interest rates, foreign exchange rates, credit risk or market prices.

Here, the market price of the inventory can change (market price risk). The company is hedging the risk of changes in the overall fair value of the inventory.

b) Credit card receivables at Sears does not qualify as a hedged item as the creditworthiness of the credit card companies is not changing.
c) Similarly, Bushels of corn, if protected by insurance contracts are not hedged items ( insurance is not under the provisions of hedge accounting)
d) Salaries payable do not create risk to be hedged.

e) and f) Three year notes payable are not foreign-currency-denominated debt instruments.
Three-year notes issued by General Motors and payables in US dollars and issued by Daimler Chrysler and payable in Euros do not have risk of foreign exchange rates as the currencies in which the notes are denominated are the same as the currencies in the area of operation.

2. Which of the following qualifies as a hedging instrument?

a. an electricity futures contract purchased by Alliant Energy, an electrical power company.
b. a crop insurance contract purchased by ...

Solution Summary

Answers to 3 multiple choice questions on hedging

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