RadCo International – 2017
RadCo International, a U.S.-based software company, has sold software to a Japanese distributor for years, but the sales have always been denominated in U.S. dollars so that RadCo didn’t have to worry about foreign exchange risk. In 2017, however, RadCo’s sales staff finally convinced RadCo senior management to denominate export sales in Japanese yen. However, the finance staff noted that now RadCo would be exposed to possible foreign exchange gains and losses, and the accounting staff had to figure out how to record the transaction.
On January 1, 2017, RadCo switched its invoicing to yen. Although sales for the first four months had already been committed in dollars, the sales staff responsible for Japanese sales estimated that they would deliver approximately ¥10,000,000 of software to the distributor on April 30, 2017. With that information, the finance staff began discussions with Citibank to determine how it could deal with the foreign exchange risk. As part of the discussions, the relevant exchange rates provided by Citibank were as follows:
|
¥120.20 |
the yen/dollar spot rate on January 1, 2017 |
|
¥87.16 |
the forward rate on January 1 quoted for April 30, 2017 delivery |
|
¥88.24 |
the strike price for a put option for April 30, 2017 delivery; the premium on the option is $0.0002 per yen. |
As the year progressed, Citibank delivered the following relevant exchange rate information to the finance staff:
|
¥112.39 |
the spot rate on March 31, 2017 |
|
¥88.55 |
the forward exchange rate quoted on March 31, 2017 for settlement on April 30, 2017 |
|
¥106.29 |
the spot rate on April 30, 2017 |
On April 30, 2017, RadCo delivers software priced at ¥10,000,000 to the distributor as estimated, and the distributor wires the cash to RadCo’s account in Citibank. Armed with this information, the accounting staff now has to make the proper journal entries.
Requirements
1. If RadCo decides not to hedge the transaction with a forward contract on January 1, 2017, what would the foreign exchange transaction gain or loss be? Show all necessary journal entries.
2. If RadCo decides to hedge the transaction with a forward contract on January 1, 2017, what would the net foreign exchange transaction gain or loss be? Show all necessary journal entries.
3. If RadCo decides to hedge the transaction with a forward contract on March 31, 2017, what would the net foreign exchange transaction gain or loss be? Show all necessary journal entries.
4. If RadCo decides to hedge the transaction with a foreign currency option on January 1, 2017 and the option is exercised on April 30, 2017, what would the net foreign exchange transaction gain or loss be? Show all necessary journal entries.
5. If RadCo decides to hedge the transaction with a foreign currency option on January 1, 2017 and the option is not exercised on April 30, 2017, what would the net foreign exchange transaction gain or loss be? Show all necessary journal entries.
6. Based on your solutions to the alternatives 1 through 5, which alternative should RadCo choose?
