On December 1 20X8 Winston Corporation acquired 100 shares o

On December 1, 20X8, Winston Corporation acquired 100 shares of Linked Corporation at a cost of $40 per share. Winston classifies them as available-for-sale securities. On this same date, it decides to hedge against a possible decline in the value of the securities by purchasing, at a cost of $250, an at-the-money put option to sell the 100 shares at $40 per share. The option expires on February 20, 20X9. Selected information concerning the fair values of the investment and the options follow:

December 1, 20X8

December 31, 20X8

February 20, 20X9

Linked Corporation

Per Share:

$40

?

?

Put Option (100 shares)

Market Value

$250

$400

$400

Intrinsic Value

       0     

       ?

400

Time Value

$ 250

$ 100

      ?

Assume that Winston exercises the put option and sells Linked shares on February 20, 20X9.

1. Based on the preceding information, what is the market price of Linked Corporation stock on December 31, 20X8?

A. $40
B. $37
C. $36
D. $38

2. Based on the preceding information, what is the market price of Linked Corporation stock on February 20, 20X9?

A. $35
B. $37
C. $36
D. $40

3. Based on the preceding information, the journal entry made on December 31, 20X8 to record decrease in the time value of the options will include:

A. a debit to Loss on Hedge Activity for $150.
B. a credit to Put Option for $300.
C. a debit to Loss on Hedge Activity for $300.
D. a credit to Put Option for $100.

4. Based on the preceding information, which of the following journal entries will be made on February 20, 20X9?

A.

Cash

4,000

       Available-for-Sale Securities

4,000

B.

Cash

4,000

       Put Option

400

       Available-for-Sale Securities

3,600

C.

Loss on Hedge Activity

150

       Put Option

150

D.

Loss on Hedge Activity

400

       Available-for-Sale Securities

400

	December 1, 20X8	December 31, 20X8	February 20, 20X9
Linked Corporation
Per Share:	$40	?	?
Put Option (100 shares)
Market Value	$250	$400	$400
Intrinsic Value	0	?	400
Time Value	$ 250	$ 100	?

Solution

1. Answer is option B

Market price = (cash - intrinsic value Put option) / number of shares = (4000-(400-100))/100 = 3700/100 =37

2. Answer is option C

Market price = (cash - intrinsic value of put option) / number of shares = (4000-400)/100 = 3600/100 =36

3. Answer is option A

There will be loss of 150 (market value of put option December 1, 20x8 - market value of put option December 31, 20x8 = 250-400 =-150 =150 loss)

4. Answer is option B

Cash Dr. 4,000

Put Option cr. 400

Available-for-Sale Securities cr. 3,600