A Company Enters into a Futures Contract with the Intent

question 59

Multiple Choice

A company enters into a futures contract with the intent of hedging an account payable of DM350,000 due on December 31.The contract requires that if the U.S.dollar value of DM350,000 is greater than $175,000 on December 31,the company will be required to pay the difference.Alternatively,if the U.S.dollar value is less than $175,000,the company will receive the difference.Which of the following statements is correct regarding this contract?

• A) The Deutsche mark futures contract effectively hedges against the effect of exchange rate changes on the U.S.dollar value of the Deutsche mark payable.
• B) The futures contract is a contract to buy Deutsche marks at a fixed price.
• C) The futures contract is a contract to sell Deutsche marks at a fixed price.
• D) The contract obligates the company to pay if the value of the U.S.dollar increases.

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Definitions:

Net Present Value

In capital budgeting, this refers to the variance between the current value of incoming cash and the current value of outgoing cash across a specific period, utilized to determine an investment's profit potential.

Present Value

The contemporary value of money expected to be received in the future or a flow of cash, discounted by a certain rate of return.

IRR

The Internal Rate of Return (IRR) is a financial metric used to estimate the profitability of potential investments by calculating the interest rate at which the net present value of costs (cash outflows) of the investments equals the net present value of the benefits (cash inflows).

Internal Rate of Return

The specific interest rate at which the sum of all cash flows from a project equals a net present value of zero.