ACC711: ADVANCED ACCOUNTING PRACTICE & REPORTING II
Tutorial 7: Foreign Currency Translation
1. Explain what is meant by indirect form of quotation and direct form of quotation?
Indirect form of quotation is the number of foreign currency units needed to buy/sell one
unit of domestic currency.
Direct form of quotation is the number of domestic currency units needed to buy/sell one
unit of foreign currency.
2. A trader enters into a short forward contract on 100 million yen. The forward exchange rate
is $0.0080 per yen. How much does the trader gain or lose if the exchange rate at the end of
the contract is (a) $0.0074 per yen; (b) $0.0091 per yen?
(a) The trader sells 100 million yen for $0.0080 per yen when the exchange rate is $0.0074
per yen. The gain is 100 0.0006 millions of dollars or $60,000.
(b) The trader sells 100 million yen for $0.0080 per yen when the exchange rate is $0.0091
per yen. The loss is 100 0.0011 millions of dollars or $110,000.
3. A trader enters into a short cotton futures contract when the futures price is 50 cents per
pound. The contract is for the delivery of 50,000 pounds.
How much does the trader gain or lose if the cotton price at the end of the contract is
(a) 48.20 cents per pound;
The trader sells for 50 cents per pound something that is worth 48.20 cents per pound.
Gain ($0.50 – $0.4820) 50,000 = $900
(b) 51.30 cents per pound?
The trader sells for 50 cents per pound something that is worth 51.30 cents per pound.
Loss ($0.5130 – $0.50) 50,000 = $650
4. Suppose that on October 24, 2013, a company sells one April 2014 live-cattle futures
contract. It closes out its position on January 21, 2014. The futures price (per pound) is 91.20
cents when it enters into the contract, 88.30 cents when it closes out the position and 88.80
cents at the end of December 2013. One contract is for the delivery of 40,000 pounds of
cattle. What is the profit? How is it taxed if the company is (a) a hedger and (b) a speculator?
Assume that the company has a December 31 year end.
The total profit is 40,000 × (0.9120 – 0.8830) = $1,160
a) If you are a hedger this is all taxed in 2014.
b) If you are a speculator
40,000 × (0.9120 – 0.8880) = $960 is taxed in 2013.
40,000 × (0.8880 – 0.8830) = $200 is taxed in 2014.
5. One orange juice future contract is on 15,000 pounds of frozen concentrate. Suppose that in
September 2013 a company sells a March 2015 orange juice futures contract for 120 cents
per pound. In December 2013, the futures price is 140 cents. In December 2014, the futures
1|Page
price is 110 cents. In February 2015, the futures price is 125 cents. The company has a
December year end. What is the company's profit or loss on the contract? How is it realized?
What is the accounting and tax treatment of the transaction is the company is classified as a)
a hedger and b) a speculator?
The price goes up during the time the company holds the contract from 120 to 125 cents per
pound. Overall the company therefore takes a loss of 15,000 × $0.05 = $750. If the company
is classified as a hedger this loss is realized in 2015, If it is classified as a speculator it
realizes a loss of 15,000 × $0.20 = $3,000 in 2013, a gain of 15,000 × $0.30 = $4,500 in 2014
and a loss of 15,000 × $0.15 = $2,250 in 2015.
6. The expected return on the S&P 500 is 12% and the risk-free rate is 5%. What is the expected
return on the investment with a beta of (a) 0.2, (b) 0.5, and (c) 1.4?
a) 0.05 + 0.2 (0.12 – 0.05) = 0.064 or 6.4%
b) 0.05 + 0.5 (0.12 – 0.05) = 0.085 or 8.5%
c) 0.05 + 1.4 (0.12 – 0.05) = 0.148 or 14.8%
7. A company wishes to hedge its exposure to a new fuel whose price changes have a 0.6
correlation with gasoline futures price changes. The company will lose $1 million for each 1
cent increase in the price per gallon of the new fuel over the next three months. The new
fuel's price change has a standard deviation that is 50% greater than price changes in gasoline
futures prices.
a. If gasoline futures are used to hedge the exposure what should the hedge ratio be?
The hedge ratio should be 0.6 × 1.5 = 0.9.
b. What is the company's exposure measured in gallons of the new fuel?
$1,000,000
= = $100,000,000
0.01
The company has an exposure to the price of 100 million gallons of the new fuel.
c. What position measured in gallons should the company take in gasoline futures?
= $100,000,000 × 0.9 = $90,000,000
It should therefore take a position of 90 million gallons in gasoline futures.
d. How many gasoline futures contracts should be traded? Each contract is on 42,000
gallons.
90,000,000
= 2,142.9
42,000
Or, rounding to the nearest whole number, 2143.
2|Page
