Problem #2

Preston Company uses nylon as raw materials to manufacture their products. Preston

Company is planning to purchase nylon from Tangsun Company on January 30, 2015 with

payment on that date of 1.5 million in Chinese yuan. On November 1, 2014, Preston entered

into a 90-day forward contract to buy 1.5million yuan for $0.15 per yuan (the spot rate is

$0.17). Preston anticipates significant increases in the USD value per yuan. The forward

contract is to be settled net.

On December 31, 2014, Preston's year-end, the forward rate for delivery on January 30,

2015 is $0.20 per yuan. The spot and forward rates on January 30, 2015 are $0.22 per yuan.

Preston uses a 6% discount rate relating to their hedging activity. Preston purchases 1.5

million yuan on January 30 when the forward contract expires.

Monthly effective interest rate = 4.08627%

Monthly discount (or interest) rate = 6%/12 months = 0.5%

Required: Prepare the necessary journal entries to account for this cash flow hedge and

related purchase of nylon by follow the steps below:

Step 1. calculate contract discount

Step 2. prepare amortization schedule for contract discount

Step 3. calculate FV of forward contract

Step 4. prepare journal entries

1) On 11/1/14

2) On 12/31/14

3) On 1/30/15