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Hi Sir,
I have a question on gain/loss on future contract (to be recognized in P/L) and hope you can help me out.
Why would a decrease in value of future contract is a gain to the seller of future contract?
Here’s the question – Fair Value Hedge
Joules was concerned that the price of these inventories would fall, so on 1 July 20×6 it sold 10,000 ounces in the futures market for $215 per ounce for delivery on 30 June 20×7. At 31 December 20×6, the end of Joules’s reporting period, the fair value of the inventories was $200 per ounce while the futures price for 30 June 20×7 delivery was $198 per ounce.
Answer:
Gain on Future Contract = 10,000 (215 – 198) = 170,000You have agreed to sell for 215.
If you had waited you would have sold for 198.
So you are happy!
And that makes it a gain.
I am still confused, sir. Joules is concerned that the value of inventory would fall. Why would a fall in futures price from $215 to $198 benefit Joules?
He is sad about inventory because its value has fallen – you are right
But he’s happy that the value of the derivative will have gone up
Dr P&L Cr Inventory
Dr Financial asset Cr P&LSo ….. half happy and half sad!
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