Question

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Exercise A-7 (Algo) Derivatives; fair value hedge-futures contract [LOA-2] Arlington Steel Company is a producer of raw steel and steel-related products. On January 3, 2022, Arlington enters into a firm commitment to purchase 10,000 tons of iron ore pellets from a supplier to satisfy spring production demands. The purchase is to be at a fixed price of $64 per ton on April 30, 2022. To protect against the risk of changes in the fair value of the commitment contract, Arlington enters into a futures contract to sell 10,000 tons of iron ore on April 30 for $64/ton (the current price). The contract calls for net cash settlement, and the company must report changes in the fair values of its hedging instruments each quarter. pped Book Required: On March 31, the price of iron ore fell to $61/ton, and then to $59/ton on April 30. 1. Calculate the net cash settlement at April 30, 2022. 2. Prepare the journal entries for the period January 3 to April 30, 2022, to record the firm commitment, necessary adjustments for changes in fair value, and settlement of the futures contract. Ask Complete this question by entering your answers in the tabs below. rint Required 1 Required 2 rences Calculate the net cash settlement at April 30, 2022. April 30 Net cash settlement < Required 1 Required 2 >

Answer 1

Futures contract is defined as the contract entered by the buyer to purchase the underlying asset at future period for a value agreed today. If there is any changes in the price of the underlying asset, the buyer has to pay the amount agreed earlier and not on the current market price.

1. On jan 3,2022 Arlington entered into a contract to purchase 10,000 tons of iron ore pellets at a fixed price of $64 on 30 april 2022 by entering into a futures contract.

Hence Arlington has to sell the iron ore pellets for $64 irrespective of change in the price at later date.

Hence Net cash settlement will be $640,000 (10,000 tons * $64) at Apr 30,2022