How might a firm such as General Mills protect itself against fluctuations in raw material prices for breakfast cereals? Multiple Choice Buy commodity futures Sell commodity futures Buy put options on commodities Sell put options on commodities
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Step 1: Identify the risk - General Mills faces the risk of fluctuations in raw material prices for breakfast cereals, which can impact their production costs and profitability. Show more…
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P9.8 Fair Value Hedge: Put Options Overhill Farms Inc. has a large portfolio of debt securities, classified as available-for-sale. As part of this portfolio, Overhill holds $1,000,000 par value of Tyson Foods bonds, purchased at par and currently valued at 99.5. To protect against further declines in value, on November 1, 2020, Overhill purchased 3-month put options for $3,500 at an exercise price of 99.8. Overhill designates the intrinsic value of the puts as the hedge instrument and reports all income effects of the investment and its hedge in nonoperating gains (losses). Required: a. Prepare journal entries to record the purchase of the puts and relevant events on November 1, 2020, and when the books are closed at December 31, 2020. The bonds are selling for 99.3, and the options are selling for $5,300. b. On January 31, 2021, Overhill sells the bonds for their current value of 99.2 and sells the put options for their intrinsic value of $6,000. Prepare the journal entries to record the sales of the bonds and the options and calculate the net cash gain or loss realized on these sale transactions. c. How much of the realized cash gain or loss is recognized in 2020 income? In 2021 income?
Supreeta N.
Suppose you are the buying agent for a soybean crushing business that produces biodiesel for the alternative fuel industry. Part of your job responsibilities is to ensure the company has an adequate supply of soybeans so that the supply stream is not interrupted, and of course, you want to minimize the cost of the soybeans and manage future price risk. Management has asked you to evaluate long hedges for the purchase of soybeans 6 months in the future. To keep this simple, you are asked to limit your evaluation to only 5,000 bushels of soybeans (1 contract). In this evaluation, you will set up a hedge using only futures contracts, then compare this to a hedge using soybean call options. Below are the details required for this analysis: Beginning of Hedge (Current Time Period) Cash price of soybeans available for immediate delivery: $8.50/bushel Futures Price of Soybeans on a contract six months in the future: $8.80/bushel Call Option Premium on the above soybean contract with the $8.80/bushel strike price: $0.10/bushel End of Hedge 6 months later Cash price of soybeans available for immediate delivery: $9.70/bushel Futures Price of Soybeans on the original contract: $9.91/bushel Call Option Premium on the above soybean contract with the $8.80/bushel strike price: $1.23/bushel Assume no transaction fees with the brokers. At the end of the hedge and assuming the futures positions were offset, what would have been the company's final estimated cost per bushel using futures contracts only? (10 Points) At the end of the hedge, what would have been the company's final estimated cost per bushel using the soybean call options? Assume you offset your original call position and kept any gains or losses from the option transaction. (10 Points) At the end of the hedge, what would have been the company's final estimated cost per bushel assuming the option was used to create a position in the futures market, and then this position was immediately offset using the end of hedge futures price? (10 Points) As you present the outcomes to management, one manager asks what hedging approach should be taken in the future if some major trade deals in the works with China and other nations collapse, causing the price of soybeans to dramatically fall even lower than the beginning of the hedge futures price? (5 Points)
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Executives are often heavily invested in their own stock. To mitigate the effects of this concentration, which of the following actions could they take? A. Enter into an equity swap to pay the returns on their own stock in exchange for receiving Libor. B. Enter into an equity swap to pay the returns on their own stock in exchange for receiving the returns on a broad equity index. C. Buy collars on the stock. D. All of the above.
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