EXAMINATION about INVESTMENT 20

General Rule: Read the following carefully and answer it wisely. All solutions are needed, so put it in the last
page. (25 Points)

1. On December 15, 2011 LCD Company entered into a call option contract that gives the right but not an obligation
to purchase 3,000 shares issued by CRV Company on April 15, 2012 at an exercise price (strike price) of P100
per share. LCD Company paid P3 for each option shares. On December 31, 2011, market data suggests that LCD
Company could sell each option for P4 and CRV Company’s share are selling at P100 per share. On April 15,
2012, the fair value of each option is P10 and CRV Company’s share are selling at P110 per share. Question 1:
What amount of derivatives asset should LCD Company recognize on December 15, 2011 ?
a. None c. P12,000
b. P9,000 d. P30,000
Answer: B (3,000 option shares x P3) = P9,000

Question 2: What amount of derivatives asset should LCD recognize on December 31, 2011?
a. None c. P12,000
b. P9,000 d. P30,000
Answer: C (3,000 shares option x P4) = P12,000

Question 3: If LCD Company exercised its right on April 15, 2012, What should be the initial cost of its new investment
assuming the new investment is classified as available for sale?
c. P300,000 c. P312,000
d. P309,000 d. P330,000
Answer: D
FV of option P 30,000
Add: Option price P300,000
Cost of new investment P330,000

2. On February 1, 2011, BZR Company enters into a contract with SGB Company the obligation to deliver, and
BZR Company the right to receive the fair value of 2,500 of BZR Company’s own ordinary shares as of January
31, 2012 in exchange for P257,500 in cash or P103 per share on January 31, 2012. If BZR Company exercises
the right, the contract will be settled net in cash. If BZR Company does not exercise its right, no payment will be
made. Below is pertinent relevant information:
2.01.11 12.31.11 12.31.12
Market value of share P100 P104 P105
Fair value of options P15,000 P8,000 P5,000

Question 1: What amount of call option asset should BZR recognize on February 1, 2011?
a. None c. P 8,000
b. P3,000 d. P15,000
Answer: D
Note: The price per share when the contract is agreed on Feb 01, 2011 is P100. The initial fair value of the option
contract on Feb 01, 2011 is P15,000, which BZR Company pays to SGB in cash on that date.

Question 2: What is the intrinsic value of the option on February 1, 2011?

Question 3: What amount of gain or loss related to the call option should BZR Company recognize on December 31,
2011?
a. None c. P6,000
b. P2,000 d. P7,000
Answer: D
FV – 12.31.11 P8,000
FV – 02.01.11 15,000
Loss P7,000
Note: On Dec 31, 2011, the market price per share has increased to P104. The fair value of the call option has decreased
to P8,000, of which P5,000 is intrinsic value (P104 – P102) x 2,500 and P3,000 is remaining time value.

Question 4: What amount of gain or loss related to the call option should BZR Company recognize on January 31, 2012?
a. P2,000 c. P6,000
b. P3,000 d. P8,000
Answer: B
FV – 01.31.12 P5,000
FV – 12.31.11 8,000
Loss P3,000

3. On September 1, 2011, Jaguar Company enters into a contract with Lynx Company that gives Lynx Company the
right to receive and Jaguar Company the obligation to pay the fair value of 5,000 of Jaguar’s own ordinary shares
as of January 31, 2012 in exchange for P520,000 in cash (P104 per share) on January 31, 2012, if Lynx Company
exercises the right. The contract will be settled net in cash. If Lynx Company does not exercise its right, no
payment will be made. Below is pertinent relevant information:
9.01.11 12.31.11 1.31.12
Market value of shares P102 P106 P106
Fair value of options P25,000 P15,000 P10,000

Question 1: What amount of call option obligation should the Company recognize on September 11, 2011?
1. None c. P15,000
2. P10,000 d. P25,000
Answer: D

Question 2: What amount of gain on call option obligation should the Company recognize on December 31, 2011?
a. None c. P10,000
b. P5,000 d. P15,000
Answer: C
FV of option 12.31.11 P15,000
Less: Intrinsic value
(P106 – P104) x P5,000 P10,000
Gain on call option obligation or
Remaining time value P 5,000

Question 3: What amount of cash should the company pay upon the exercise of the option?
 a. None c. P10,000
b. P5,000 d. P15,000
Answer: C
MV of share – 01,.31.12 (P106 x 5,000) P530,000
Settlement (P104 x 5,000) P520,000
Settlement of the option contract P 10,000

4. On February 1, 2011, Gold Company enters into a contract with Silver Company that gives Gold Company the
right to sell, and Silver Company the obligation to buy the fair value of 2,000 shares of Gold Company’s own
ordinary share outstanding as of January 31, 2012 at a strike price of P196,000 (P98 per share) on January 31,
2012, if Gold Company exercise the right. The contract will be settled net in right. The contract will be settled
net in cash, however, if Gold Company does exercise the right, no payment will be made. Below is pertinent
relevant information:
2.01.11 12.31.11 1.31.12
Market value per share P100 P95 P95
Fair value of options P10,000 P8,000 P6,000

Question 1: What of option asset should Gold Company recognize on February 1, 2011?
a. None c. P 8,000
b. P5,000 d. P10,000
Answer: D
The price per share when the contract is agreed on Feb. 1, 2011 is P100. The initial fair value of the option contract on
Feb. 1, 2011 is P10,000, which Gold pays to Silver in cash on that date. Also, on that date, the option has no intrinsic
value, only time value, because the exercise price of P98 is less than the market price per share of P100. Therefore, it
would be economic for Gold to exercise the option. In other words, the put option is out of the money.

Question 2: What amount should be reported in the December 31, 2011 profit or loss related to the above contract?
a. None c. P6,000
b. P2,000 d. P8,000
Answer: B
FV of options 12.31.11 P8,000
Less: Intrinsic value (P98 – P95) x 2,000) P6,000
Loss on call option recognized in P/L or
Remaining time value P2,000
Note: On December 31, 2011, the market price per share has decreased to P95. The fair value of the put option has
decreased to P8,000, of which P6,000 is intrinsic value (P98 – P95 x 2,000), and P2,000 is the remaining time value.

Question 3: What is the net effect in the shareholder’s equity as a result of the exercise of the option?
a. None c. P6,000
b. P4,000 d. P8,000
Answer: A
FV of the option P6,000
Less: Intrinsic value (P95 – P98) x 2,000 P6,000
Net effect of Shareholders’ equity P -0-

5. On January 2, 2010, GRO company received a 2-year P1,200,000 loan, with interest payments occurring at the
end of each year and the principal to be repaid on December 31, 2011. The interest rate for the first year is the
prevailing interest rate of 8% and the rate in 2011 will be equal to the market interest rate on January 2, 2011. In
conjunction with the loan, GRO Company enters into an interest rate swap agreement to receive a swap payment
 based on the amount of the loan if the interest rate is greater than 8% and make a swap payment if the rate is less
than 8%. The interest swap payment will be made in December 31, 2011. If the interest rate on January 2, 2011
is 7%, and the PV of 7% after 1 period is 0.9345, what amount of equity reserve should GRO Company recognize
in its December 31, 2010 shareholders’ equity?
a. None c. P120,000
b. P11,214 d. P131,214
Answer: B
Notional Amount P1,200,000
Change in interest rate (8% - 7%) 1%
Change in interest P 12,000
PV of 7% after 1 period 0.9345
Amount to be reported in equity P 11,214