Required information On January 1, 2024, Avalanche Corporation borrowed $130,000 from First Bank by issuing a two-year, 8% fixed-rate note with annual interest payments. The principal of the note is due on December 31, 2025. • Avalanche wanted to hedge against declines in general interest rates, so it also entered into a two-year SOFR-based interest rate swap agreement on January 1, 2024, and designates it as a fair value hedge. Because the swap is entered at market rates, the fair value of the swap is zero at inception. • The agreement called for the company to receive fixed interest at the current SOFR swap rate of 5% and pay floating interest tied to SOFR. This arrangement results in an effective variable rate on the note of SOFR + 3%. • The contract specifies that the floating rate resets each year on June 30 and December 31 for the net settlement that is due the following period. In other words, the net cash settlement is calculated using beginning-of-period rates. The SOFR rates on the swap reset dates and the fair values of the swap obtained from a derivatives dealer are as follows: 6/30/24 12/31/24 4% $ 1,271 12/31/25 3% Floating rate (SOFR) Fair value of interest rate swap $ (1,714) $0 Avalanche meets all criteria for hedge accounting using the shortcut method. June 30, 2024 December 31, 2024 June 30, 2025 December 31, 2025 1/1/24 5% $0 Net effect 6% 6/30/25 3% 6. Calculate the net effect on earnings of the hedging arrangement for the six-month periods ending June 30 and December 31, 202 and June 30 and December 31, 2025. Note: Indicate negative amounts with a minus sign. $ 1,300
Required information On January 1, 2024, Avalanche Corporation borrowed $130,000 from First Bank by issuing a two-year, 8% fixed-rate note with annual interest payments. The principal of the note is due on December 31, 2025. • Avalanche wanted to hedge against declines in general interest rates, so it also entered into a two-year SOFR-based interest rate swap agreement on January 1, 2024, and designates it as a fair value hedge. Because the swap is entered at market rates, the fair value of the swap is zero at inception. • The agreement called for the company to receive fixed interest at the current SOFR swap rate of 5% and pay floating interest tied to SOFR. This arrangement results in an effective variable rate on the note of SOFR + 3%. • The contract specifies that the floating rate resets each year on June 30 and December 31 for the net settlement that is due the following period. In other words, the net cash settlement is calculated using beginning-of-period rates. The SOFR rates on the swap reset dates and the fair values of the swap obtained from a derivatives dealer are as follows: 6/30/24 12/31/24 4% $ 1,271 12/31/25 3% Floating rate (SOFR) Fair value of interest rate swap $ (1,714) $0 Avalanche meets all criteria for hedge accounting using the shortcut method. June 30, 2024 December 31, 2024 June 30, 2025 December 31, 2025 1/1/24 5% $0 Net effect 6% 6/30/25 3% 6. Calculate the net effect on earnings of the hedging arrangement for the six-month periods ending June 30 and December 31, 202 and June 30 and December 31, 2025. Note: Indicate negative amounts with a minus sign. $ 1,300
Financial Accounting Intro Concepts Meth/Uses
14th Edition
ISBN:9781285595047
Author:Weil
Publisher:Weil
Chapter13: Marketable Securities And Derivatives
Section: Chapter Questions
Problem 30P
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Transcribed Image Text:Required information
On January 1, 2024, Avalanche Corporation borrowed $130,000 from First Bank by issuing a two-year, 8% fixed-rate note
with annual interest payments. The principal of the note is due on December 31, 2025.
Avalanche wanted to hedge against declines in general interest rates, so it also entered into a two-year SOFR-based
interest rate swap agreement on January 1, 2024, and designates it as a fair value hedge. Because the swap is
entered at market rates, the fair value of the swap is zero at inception.
The agreement called for the company to receive fixed interest at the current SOFR swap rate of 5% and pay floating
interest tied to SOFR. This arrangement results in an effective variable rate on the note of SOFR + 3%.
The contract specifies that the floating rate resets each year on June 30 and December 31 for the net settlement
that is due the following period. In other words, the net cash settlement is calculated using beginning-of-period
rates.
The SOFR rates on the swap reset dates and the fair values of the swap obtained from a derivatives dealer are as follows:
6/30/24
Floating rate (SOFR)
12/31/24
4%
$ 1,271
6/30/25 12/31/25
3%
3%
$0
Fair value of interest rate swap
$ (1,714)
$ 1,300
Avalanche meets all criteria for hedge accounting using the shortcut method.
June 30, 2024
December 31, 2024
June 30, 2025
December 31, 2025
1/1/24
5%
$0
6. Calculate the net effect on earnings of the hedging arrangement for the six-month periods ending June 30 and December 31, 2024,
and June 30 and December 31, 2025.
Note: Indicate negative amounts with a minus sign.
Net effect
6%
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