Answer-first summary for fast verification
Answer: A cash outflow of USD 375,000
The correct answer is C, a cash outflow of USD 375,000. This is determined by calculating the cash flow due to the variation margin on the hedge at the end of the second calendar year, which is December 31, 2024. The calculation is as follows: (Futures price on December 31, 2024 - Futures price on December 31, 2022) * Number of contracts * Pounds per contract, which equals (2.95 - 3.10) * 100 * 25,000 = USD 375,000. This reflects the cash outflow due to the increase in the futures price from the time the hedge was established to the end of the second year. The other options are incorrect because they do not accurately represent the cash flow for the specified time period or the accounting treatment of the hedge. Option A represents a cash inflow for the first fiscal year, not the second. Option B represents the accounting treatment of the gain or loss on the hedge, not the cash flow. Option D represents the accounting treatment of the gain or loss over the entire three-year period, which is not what is being asked for in the question.
Author: LeetQuiz Editorial Team
Ultimate access to all questions.
A financial analyst working for a mining company is evaluating the potential cash flow and associated accounting effects from a 3-year hedging strategy targeting the firm’s copper production. This hedge was established by selling 100 futures contracts, each with a three-year duration, at a price of USD 3.00 per pound of copper as of December 31, 2022. Each contract corresponds to a quantity of 25,000 pounds of copper. The analyst reviews the following data related to the futures prices:
| Date | Futures price (USD) |
|---|---|
| December 31, 2022 | 3.00 |
| December 31, 2023 | 2.95 |
| December 31, 2024 | 3.10 |
| December 31, 2025 | 3.15 |
Considering that the firm utilizes hedge accounting and reports cash flows resulting from variation margins on the hedge at the end of each year, what is the most precise estimate for the cash flow reported on December 31, 2024?
A
A cash inflow of USD 125,000
B
A cash outflow of USD 250,000
C
A cash outflow of USD 375,000
D
A cash outflow of USD 500,000
