Ahnuld Corporation, a health juice
producer, recently expanded its sales through exports to foreign markets.
Earlier this year, the company negotiated the sale of several thousand cases of
turnip juice to a retailer in the country of Tcheckia. The customer is
unwilling to assume the risk of having to pay in U.S. dollars. Desperate to
enter the Tcheckian market, the vice president for international sales agrees
to denominate the sale in tchecks, the national currency of Tcheckia. The
current exchange rate for 1 tcheck is $2.00. In addition, the customer indicates
that it cannot pay until it sells all of the juice. Payment of 100,000 tchecks
is scheduled for six months from the date of sale.
Fearful that the tcheck might
depreciate in value over the next six months, the head of the risk management
department at Ahnuld Corporation enters into a forward contract to sell tchecks
in six months at a forward rate of $1.80. The forward contract is designated as
a fair value hedge of the tcheck receivable. Six months later, when Ahnuld
receives payment from the Tcheckian customer, the exchange rate for the tcheck
is $1.70. The corporate treasurer calls the head of the risk management
department into her office.
Treasurer: I see that your decision
to hedge our foreign currency position on that sale to Tcheckia was a bad one.
Department head: What do you mean? We have a gain on that forward contract.
$10,000 better off from having
entered into that hedge. Treasurer: That’s not what the books say. The
accountants have recorded a net loss of $20,000 on that particular deal. I’m
afraid I’m not going to be able to pay you a bonus this year. Another bad deal
like this one and I’m going to have to demote you back to the interest rate
Department head: Those bean counters
have messed up again. I told those guys in international sales that selling to
customers in Tcheckia was risky, but at least by hedging our exposure, we
managed to receive a reasonable amount of cash on that deal. In fact, we ended
up with a gain of $10,000 on the hedge. Tell the accountants to check their
debits and credits again. I’m sure they just put a debit in the wrong place or
some accounting thing like that.
Have the accountants made a mistake?
Does the company have a loss, a gain, or both from this forward contract?