Phillips Company provides engineering, design, construction, and maintenance services for construction projects. Phillips’ main office is located in San Diego, California but they are a global business providing services in Europe, Asia, and parts of South America. On 9/1/20x1, Phillips purchased $300,000 of inventory from a non-U. S. vendor. In order to get the best price offered, Phillips Company agreed to pay the vendor in the vendor’s local currency, called “the FC”. Additionally, to avoid a penalty, Phillips must make payment to its foreign vendor by February 2, 20x2. At the 9/1 spot rate, Phillips must pay their vendor FC 591,000 by the due date. Assume that Phillips Company pays the vendor on 2/2/20x2.

The various FC/$ exchange rates during this period was:

Spot rate (FC = $1):

9/1/20x1 - 1.97

12/31/20x1 - 1.95

2/2/20x2 - 2.00

Phillips Company has a December 31 year-end.

Required:

Assuming the Phillips pays for the inventory purchase on February 2, 20x2, as agreed:

Prepare Phillips Company’s journal entries relating to the inventory purchase for the following dates:

9/1/20x1,

12/31/20x1, and

2/2/20x2.

Explain how Phillips Company can hedge their foreign currency exchange risk using (no journal entries required):

Forward foreign currency exchange contracts and

Foreign currency options.

In your explanation, discuss the type of forward contract and type of foreign currency option they would enter into to hedge their foreign currency risk. Additionally:

Discuss the basic difference between a forward exchange contract and a foreign currency option from the holder’s perspective.

For Phillips Company’s foreign vendor, explain the type of foreign currency risk they incur relating to this transaction, including any gain or loss they might incur as a result of fluctuations in the FC/$ exchange rate. U.

In your explanation, discuss the type of: (a) forward exchange contract or (b) foreign currency option contracts, they would obtain to hedge their foreign currency risk. No journal entries are required.