On June 1, our company purchases $10 million book value ofcorporate bonds that we classify as available-for-sale (AFS). Weintend to sell these securities on September 30 to meet plannedfunding needs. Since an increase in interest rates will cause thefair value of the securities to decrease, we decide to hedgeagainst the risk of loss in the fair value of the debt securitiesthat would result if the interest rates were to rise. As a result,we sell September Treasury note futures contracts on June 1 in theamount of the debt securities. We have determined that the hedgingrelationship between the futures contracts and the debt securitiesis highly effective (both at the inception of the relationship andon an ongoing basis) in achieving offsetting changes in the fairvalue that are due to changes in the benchmark interest rate.Accordingly, this transaction is designated as a fair value hedge.Interest rates rise as we had predicted, and the prices of thecorporate bonds (the hedged item) and the futures contracts (thehedging instrument), and the resulting gains and losses, are asfollows:
Date............................................SecuritiesLoss............Futures..............Gain Net
August ......................................$(100,000)....................$75,000.............$(25,000)
September ...................................(50,000)......................50,000....................0
We sell the debt securities on September 30 at their fair valueof $9,850,000.
Prepare the journal entries to record the following:
a. Purchase of the debt securities and futures contracts on June1
b. Accrue changes in fair value of AFS debt securities andfutures contract in August
c. Accrue changes in fair value of AFS debt securities andfutures contract in September
d. Record sale of securities in September
