International Accounting, T. Doupnik Ch 6

Front 1

put option

Back 1

is for the sale of foreign currency by the holder of the option. An option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time. This is the opposite of a call option, which gives the holder the right to buy shares. It is a financial contract between two parties, the seller (writer) and the buyer of the option. The buyer acquires a short position with the right, but not the obligation, to sell the underlying instrument at an agreed-upon price (the strike price). If the buyer exercises his right to sell the option, the seller is obliged to buy it at the strike price. In exchange for having this option, the buyer pays the writer a fee (the option premium). The terms for exercising the option's right to sell it differ depending on option style. A European put option allows the holder to exercise the put option for a short period of time right before expiration, while an American put option allows exercise at any time before expiration.

Front 2

call option

Back 2

A call option is a financial contract between two parties, the buyer and the seller of this type of option. It is the option to buy shares of stock at a specified time in the future.[1] Often it is simply labeled a "call". The buyer of the option has the right, but not the obligation to buy an agreed quantity of a particular commodity or financial instrument (the underlying instrument) from the seller of the option at a certain time (the expiration date) for a certain price (the strike price). The seller (or "writer") is obligated to sell the commodity or financial instrument should the buyer so decide. The buyer pays a fee (called a premium) for this right.
The buyer of a call option wants the price of the underlying instrument to rise in the future; the seller either expects that it will not, or is willing to give up some of the upside (profit) from a price rise in return for the premium (paid immediately) and retaining the opportunity to make a gain up to the strike price (see below for examples).

Front 3

strike price

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The fixed price at which the owner of an option can purchase, in the case of a call, or sell, in the case of a put, the underlying security or commodity. It's the price at which the stock will be bought or sold when the option is exercised.
The strike price is often called the exercise price.
For example, an IBM May 50 Call has a strike/exercise price of $50 a share. When the option is exercised the owner of the option will buy (Call option) 100 shares of IBM stock for $50 a share.

Front 4

intrinsic value

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An option is said to have intrinsic value if the option is in-the-money. When out-of-the-money, its intrinsic value is zero.
The intrinsic value for an in-the-money option is calculated as the absolute value of the difference between the current price (S) of the underlying and the strike price (K) of the option, floored to zero.
For a call option
IVcall = max{0,S − K}
while for a put option
IVput = max{0,K − S}
For example, if the strike price for a call option is USD $1 and the price of the underlying is USD $1.20, then the option has an intrinsic value of USD $0.20.
The total value of an option is the sum of its intrinsic value and its time value.

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time value

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In finance, the value of an option consists of two components, its intrinsic value and its time value. Time value is simply the difference between option value and intrinsic value. Time value is also known as extrinsic value, or instrumental value.

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Accounting – sale transaction
One transaction perspective

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Treats sale and collection as one transaction
Transaction is complete when foreign currency is received and converted, and sale is measured at converted amount.
This approach is not allowed under IAS or U.S. GAAP

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Two transaction perspective

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Treats sale and collection as two transactions
Sale is one transaction and collection is a second transaction.
Sale is based on current exchange rate.
If exchange rate changes, collection is for different amount.
Difference is considered Foreign exchange gain or loss and reported separately from Sales in the income statement.
+ a foreign exchange gain or loss arises at the balance sheet date, if the exchange rate changes at that period - due to the revaluation & should be reported in income statement in that period (ACCRUAL APPROACH to account for unrealized foreign exchange gains and losses)
Required by IAS 21 & SFAS 52
Concepts are identical for purchase transaction.

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Transaction types, exposure type and gain or loss – export sales

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Export sale  asset exposure--if foreign currency appreciates -> foreign exchange gain (more $ will be received) .

Export sale -> asset exposure (A/R)--if foreign currency depreciates -> foreign exchange loss (less $ will be received).

Hint 8

about Receiving $

Front 9

Transaction types, exposure type and gain or loss – import purchases

Back 9

Import purchase -> liability exposure (A/P) -> if foreign currency appreciates -> foreign exchange loss (more $ should be paid).

Import purchase -> liability exposure -- if foreign currency depreciates -> foreign exchange gain (less $ should be paid).

Hint 9

about Paying $

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Balance sheet Date before collection of Payment

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a foreign exchange gain or loss arises at the balance sheet date, if the exchange rate changes at that period - due to the revaluation & should be reported in income statement in that period (ACCRUAL APPROACH to account for unrealized foreign exchange gains and losses)
- Any changes in ExRate from BSheet date to date of payment = as the second period -> 2d foreign exchange gain or loss.

Front 11

Hedging Foreign Exchange Risk/
Definition

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protecting against losses from exchange rate fluctuations. Companies often use foreign currency forward contracts and foreign currency options.

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Foreign currency forward contract

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an agreement to buy or sell foreign currency at a future date.

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Foreign currency option

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the right to buy or sell foreign currency for a period of time.

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Exchange Rate Mechanisms/
Independent float

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currency value allowed to move freely with little government intervention.

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Pegged to another currency –

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currency value fixed (pegged) in terms of a particular foreign currency (e.g., U.S. dollar), and central bank intervenes to maintain the exchange rate.

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European Monetary System (Euro) –

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twelve countries use a single currency, which floats against other currencies such as the U.S. dollar.

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Spot rate –

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today’s price for purchasing or selling a foreign currency.

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Forward rate –

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today’s price for purchasing or selling a foreign currency for some future date.
There is now up-front cost to enter into a forward contract.

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Premium --

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when the forward rate is greater than the spot rate for a particular day.
+if a foreign interest is less than the domestic rate, the foreign currency sells at a premium.

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Discount --

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when the forward rate is less than the spot rate for a particular day.
+ when the interest rate in the foreign country exceeds the interest rate domestically, the FC sells at a disc in the forward contract.

Front 21

Option contracts//
Foreign currency option –

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gives the right, but not the obligation, to trade foreign currency for some period.
Option must be purchased by paying an option premium. - a function of 2 components: intrinsic and time value.

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Strike price –

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the exchange rate at which currency will be exchanged when option is exercised.
There are generally several strike prices to choose from at any particular time.

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in the money

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an option with a positive intrinsic value

Front 24

Export sale –

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a company sells to a foreign customer and later receives payment in the customer’s currency.
The exporter is exposed to the FExchange risk.

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Import purchase –

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a company purchases from a foreign supplier and later pays in the supplier’s currency.
- transaction exposure exsisits for the importer