Entries to record a hedge of a firm commitment with an option. The Glasner Candy Corporation has a firm commitment dated April 1 to purchase cocoa with delivery on June 15. The commitment is for 1,000 metric tons of cocoa at $700 per ton. In order to hedge against decreases in the spot prices of cocoa, the company designated an option as a hedge against changes in the fair value of the commitment. The put (sell) option was acquired on April 1 for a premium of $1,000 and has a strike price of $700 per ton. The option has a notional amount of 1,000 tons and an expiration date of June 15. Spot prices per ton and the value of the option at selected dates are as follows:
|April 1||April 30||May 31||June 15|
|Spot price per ton||$ 701||$ 696||$ 697||$ 695|
|Fair value of option||1,000||4,300||3,500||5,000|
The change in the option’s time value will be excluded from an assessment of hedge effectiveness.
1. Prepare all entries to record this hedging relationship.
2. If the option’s strike price would have been $698, would the hedge have been totally effective?
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