Currency Hedges

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    Question # 172 | Blueprint Area: 3 D : Derivatives and Hedge Accounting (e.g. Swaps, Options, Forwards)

    On December 12, year 1, Imp Co. entered into a forward exchange contract to purchase 100,000 euros in 90 days. The relevant exchange rates are as follows:

    Spot rate Forward rate (for 3/12, yr 2)
    December 12, year 1 $1.86 $1.80
    December 31, year 1 $1.96 $1.83
    Imp entered into the forward contract to hedge a commitment to purchase equipment being manufactured to Imp's specifications.At December 31, year 1, what amount of foreign currency transaction gain should Imp include in income from this forward contract?

    A. $0
    B. $ 3,000
    C. $ 5,000
    D. $10,000
    You answered A. The correct answer is D.
    A forward exchange contract is an agreement to exchange different currencies at a specified future date and at a specified rate (the forward rate). A forward contract is a foreign currency transaction. The account­ing for a gain or loss on a foreign currency transaction that is intended to hedge an identifiable foreign currency commitment (for example, an agreement to purchase or sell equipment) is considered a foreign currency hedge and works like a fair value hedge. Gains and losses on this qualifying fair value hedge shall be recognized currently in earnings. The gain or loss realized on this forward exchange contract is computed by multiplying the foreign currency amount of the contract by the difference between the spot rate at the balance sheet date and the spot rate at the inception of the contract (or the spot rate last used to measure a gain or loss on that contract for an earlier period). The spot rate is the exchange rate for immediate delivery of currencies exchanged.

    Foreign currency units to be purchased 100,000
    Times: Excess of spot rate at the balance sheet date over the spot rate at the inception of the contract ($1.96 – $1.86) × $0.10
    Foreign currency transaction gain $10,000

    The above is from Ninja MCQ's. Is this answer correct? I thought you use the futures rate when you bought a futures contract not the spot rate. Wouldn't the answer be B?

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