Portofino Company made purchases on account from three foreign suppliers on December 15, 2012, with payment made on January 15, 2013. Information related to these purchases is as follows:
Portofino Company's fiscal year ends December 31.
Required
1. Use historical exchange rate information available on the Internet at www.oanda.com to find interbank exchange rates between the U.S. dollar and each foreign currency for the period December 15, 2012, to January 15, 2013.
2. Determine the foreign exchange gains and losses that Portofino would have recognized in net income in 2012 and 2013, and the overall foreign exchange gain or loss for each transaction. Determine for which transaction it would have been most important for Portofino to hedge its foreign exchange risk.
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3. Portofino could have acquired a one-month call option on December 15, 2012, to hedge the foreign exchange risk associated with each of the three import purchases. In each case, the option would have had an exercise price equal to the spot rate at December 15, 2012, and would have cost $200. Determine for which hedges, if any, Portofino would have recognized a net gain on the foreign currency option.
SOLUTION
1. Below are spreadsheets for the calculation of the foreign exchange gains (losses) related to Portofino Company’s foreign currency accounts payable. Note: These exchange rates were obtained by using the “Historical Exchange Rates” link found under “Foreign Exchange Tools” in the left hand column of Oanda’s homepage. These rates are “interbank +/- 0%” rates. Exchange rates will be different if obtained using the “Currency Converter” link under the “Travelers” column (same as “FX Converter” under “Currency Tools”).
Foreign Currency Account Payable
Exchange Rate on 12/15/2012
U.S. Dollar Value on 12/15/2012
Exchange Rate on 12/31/2012
U.S. Dollar Value on 12/31/2012
Foreign Exchange Gain (Loss) on 12/31/2012
Brazilian reais (BRL)
65,000
0.4792
31,148.00
0.4880
31,720.00
(572.00)
Guatemalan quetzals (GTQ)
250,000
0.1250
31,250.00
0.1265
31,625.00
(375.00)
Mexican pesos (MXN)
400,000
0.0781
31,240.00
0.0768
30,720.00
520.00
Total
93,638.00
94,065.00
(427.00)
Foreign Currency Account Payable
Exchange Rate on 12/31/2012
U.S. Dollar Value on 12/31/2012
Exchange Rate on 1/15/2013
U.S. Dollar Value on 1/15/2013
Foreign Exchange Gain (Loss) on 1/15/2013
Brazilian reais (BRL)
65,000
0.4880
31,720.00
0.4916
31,954.00
(234.00)
Guatemalan quetzals (GTQ)
250,000
0.1265
31,625.00
0.1245
31,125.00
500.00
Mexican pesos (MXN)
400,000
0.0768
30,720.00
0.0791
31,640.00
(920.00)
Total
94,065.00
94,719.00
(654.00)
2.
Portofino would have reported a net foreign exchange loss of $427.00 in 2012 and a net foreign exchange loss of $654.00 in 2013 related to these three foreign currency payables. The cumulative gain/loss recognized on each of the three foreign currency payables was:
BRL 65,000 = $806.00 loss
GTQ 250,000 = $125.00 gain
MXN 400,000 = $400.00 loss
It would have been most important to hedge the BRL 65,000 account payable on December 15, 2012.
3.
Portofino would have benefited from the purchase of a call option on the transactions in Brazilian reais and Mexican pesos. The net cash outflow on the BRL payable would have been $606 less ($806 loss avoided less $200 cost of option); the net cash outflow on the MXN payable would have been $200 less ($400 loss avoided less $200 cost of option). A net gain on both of these options would have been recognized.
[A call option purchased on 12/15/12 in GTQ would have had no value at 1/15/13.]