A Cash Flow Hedge: Use of an Option to Hedge an Anticipated Purchase
Mega Company believes the price of oil will increase in the coming months. Therefore, it decides to purchase call options on oil as a price-risk-hedging device to hedge the expected increase in prices on an anticipated purchase of oil.
On November 30,20X1, Mega purchases call options for 10,000 barrels of oil at $30 per barrel at a premium of $2 per barrel, with a March 1, 20X2, call date. The following is the pricing information for the term of the call:
Date | Spot Price | Futures Price (for March 1, 20×2, delivery) |
November 30, 20×1 | $30 | $31 |
December 31, 20×1 | 31 | 32 |
March 1, 20×2 | 33 |
|
The information for the change in the fair value of the options follows:
Date | Time Value | Intrinsic Value | Total Value |
November 30, 20×1 | $20,000 | $ −0− | $20,000 |
December 31, 20×1 | 6,000 | 10,000 | 16,000 |
March 1, 20×2 |
| 30,000 | 30,000 |
On March 1, 20X2, Mega sells the options at their value on that date and acquires 10,000 barrels of oil at the spot price. On June 1, 20X2, Mega sells the oil for $34 per barrel.
Required
a. Prepare the journal entry required on November 30,20X1,to record the purchase of the call options.
b. Prepare the adjusting journal entry required on December 31, 20X1, to record the change in time and intrinsic value of the options.
c. Prepare the entries required on March 1, 20X2, to record the expiration of the time value of the options, the sale of the options, and the purchase of the 10,000 barrels of oil.
d. Prepare the entries required on June 1, 20X2, to record the sale of the oil and any other entries required as a result of the option.
We need at least 10 more requests to produce the solution.
0 / 10 have requested this problem solution
The more requests, the faster the answer.