Graduating Seniors Manufacturing, Inc. (GSMI)
Graduating Seniors Manufacturing, Inc. (GSMI) frequently buys palladium from PreciousMetals, Inc. Precious Metals requires a firm six month commitment in order to do business withthem. On January 1, 2014, GSMI enters into a contract with Precious Metals to purchase 10,000pounds of palladium at the current forward price of $315 per pound with settlement to occur onJune 30, 2014. GSMI wants to actually pay the market price for palladium as of June 30. GSMIenters into a forward contract to sell 10,000 pounds of palladium at the current forward price of$315 per pound. The firm commitment contract and the forward contract both have zero value atinception. Palladium spot prices and the contract fair values are:Forward Contract Fair ValueSpot Price Price (June 30) Forward Firm CommitmentJanuary 1 $300 $315 0 0March 31 295 300 $147,100 ($147,100)June 30 280 N/A 350,000 ( 350,000)Required:1. Why did GSMI hedge its fixed price contract with Precious Metals?2. Did management make a good or bad decision? Explain.3. What journal entry should be made on March 31?4. What price did GSMI end up paying for the palladium after accounting for the forwardcontract? Show how you determined the price.5. Would this have been a good hedge if the settlement price of the forward contract on June30 was $320?
