Question

Derivatives:

Problem 1: On January 2, 2017, Jones Company purchases a call option for $300 on Merchant common stock. The call option gives Jones the option to buy 1,000 shares of Merchant at a strike price of $50 per share. The market price of a Merchant share is $50 on January 2, 2017. On March 31, 2017, the market price for Merchant stock is $53 per share, and the time value of the option is $200. REQUIRED: (a) Prepare the journal entry to record the purchase of the call option on January 2, 2017. (b) Prepare the journal entry(ies) to recognize the change in the fair value of the call option as of March 31, 2017. (c) What was the effect on net income of entering into the derivative transaction for the period January 2, 2017 to March 31, 2017?

Answer 1

Ans: Journal entries

S.no	Account title and explanation	Debit($)	Credit($)
1	Call option	$300
	Cash		$300
	(being call option purchased)
2	Unrealized gain or loss -income	$100
	Call option(300-200)		$100
	Call option	3000
	Unrealized gain or loss- income($53-50)=3*1000		3000
	( to record change in fair value)
3	effect of net income of entering into the derivative transaction
	Unrealized holding gain(3000-100) =$2900