F.4.9.4 CH09+10 – Flashcards

economic exposure, transaction exposure, and translation exposure

The extent to which the firm's operating cash flows will be affected by unexpected changes in exchange rates.

The extent to which the value of the firm ////would be affected//// by unanticipated changes in exchange rate.

represents random changes in exchange rates

b= Cov(P,S)/Var(S)

A measure of how a change in the exchange rate affects the dollar value of a firm's assets.

...A. How much of a foreign currency to sell forward.

The slope coefficient b

Asset exposure

Faces exchange rate risk to the extent that it has international competitors in the domestic market.

...The U.S. dollar has depreciated substantially against most major currencies of the world, especially against the euro.

..Asset exposure.

...The part of the variability of the dollar value of the asset that is related to random changes in the exchange rate.

...Captures the residual part of the dollar value variability that is independent of exchange rate movements.

...A. You have undertaken a hedging strategy that gives the asset a constant dollar value.

...A . Will be unable to pass increased costs following unfavorable changes in the exchange rate without significantly lowering the quantity sold.

...The extent to which the firm's operating cash flows would be affected by random changes in exchange rates

..Operating exposure

...A. Operational hedging provides a more stable long-term approach than does financial hedging.

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A. The cash flow in euro could be ////altered due an alteration//// in the firm's competitive position in the marketplace.

...The competitive effect is defined as a given operating cash flow in a foreign currency will be converted into a lower dollar amount after a currency depreciation.

... A given operating cash flow in euro will be translated to a higher U.S. dollar cash flow.

A. The change in the cash flow in euro due an alteration in the firm's competitive position in the marketplace is in part a function of the elasticity of demand for the firm's product.

A. The competitive effect is that a currency depreciation may affect operating cash flow in the foreign currency by altering the firm's competitive position in the marketplace.

When either its cost or its price is sensitive to exchange rate changes

A. The firm is not subject to high degrees of operating exposure:

When changes in nominal exchange rates are exactly offset by the inflation differential.

A. In markets with mainly domestics (foreign to the firm) competitors.

A. Either its cost or its price is sensitive to exchange rate changes

A. Stabilize cash flows in the face of fluctuating exchange rates.

B. Is a long-term issue, like selecting a site for a factory.

B. A firm may miss out on economies of scale

B. Need not be confined just to materials and parts.

B. Lessen the effect of exchange rate changes by sourcing from where input costs are low.

A firm can choose to locate production facilities in a foreign country where costs are low due to either the undervalued currency or underpriced factors of production.

A. Lessen the effect of exchange rate changes by pursuing a strategy of diversifying the markets in which the firm's products are sold

A. It is not a substitute for long-term operational hedging

Highly inelastic.

Highly elastic.

Unhedged, hedged.

A. There may not be a great deal of exchange rate risk for a U.S.-based investor.

current/noncurrent method, monetary/nonmonetary method, temporal method, and current rate method

Four

Consolidated financial reports of a MNC.

When they are viewed from the perspective of the parent firm.

Transaction exposure

Selecting a mechanical means for handling the consolidation process for MNCs that logically deals with exchange rate changes.

Translation exposure

Economic exposure

The competitive effect is defined as the impact that a currency depreciation may have on the operating cash flow in the foreign currency by altering the firm's competitive position in the marketplace.

The Financial Accounting Standards Board (FASB).

Accounting exposure and translation exposure are the same thing.

The value of a foreign subsidiary's foreign currency denominated assets and liabilities change when redenominated into the home currency

the change in the value of a foreign subsidiaries assets and liabilities denominated in a foreign currency, as a result of exchange rate change fluctuations, when viewed from the perspective of the parent firm

FASB 8 became effective

Current assets and liabilities, which by definition have a maturity of one year or less, are converted at the current exchange rate. Non-current assets and liabilities are translated at the historical exchange rate.

A. Current/noncurrent method

A foreign subsidiary with current assets in excess of current liabilities will cause a translation gain (loss) if the local currency appreciates (depreciates).

. Assets with a maturity of one year or less

Under the current/noncurrent method, revenue and expense items that are associated with current assets or liabilities, such as depreciation expense, are translated at the historical rate that applies to the applicable balance sheet item.

A. Assets and liabilities should be translated based on their maturity

Monetary balance sheet accounts should be translated at the spot rate; nonmonetary accounts are translated at the historical rate in effect when the account was first recorded

For example, cash, marketable securities, accounts receivable, notes payable, accounts payable of a foreign subsidiary.

Monetary accounts have a similarity because their value represents a sum of money whose currency equivalent after translation changes each time the exchange rate changes.

Monetary/nonmonetary method

True

Are translated at the current /////spot///// exchange rate

The temporal method and the monetary/nonmonetary methods will typically provide the same translation.

Monetary accounts are translated at the current exchange rate; other accounts are translated at the current exchange rate if they are carried on the books at current value; items carried at historical cost are translated at historic exchange rates.

D.All balance sheet accounts are translated at the current exchange rate, except for stockholders' equity. A "plug" equity account named cumulative translation adjustment (CTA) is used to make the balance sheet balance, since translation gains or losses do not go through the income statement according to this method & D.All balance sheet accounts are translated at the current exchange rate, except stockholder equity.

current rate method

Current // rate// method

current rate method

Temporal method

The current rate method of translation in some circumstances and the temporal method in others.

Is now known as The International Accounting Standards Board

the currency of the primary economic environment in which the entity operates

the currency in which the MNC prepares its consolidated financial statements

The "functional currency"

A two-stage process

The functional currency of the foreign entity must be translated into the reporting currency in which the consolidated statements are reported.

The amount of foreign exchange exposure that exists for each foreign currency in which the MNC has exposure.

The functional currency would generally be the parent's currency

One that has cumulative inflation of approximately 100 percent or more over a 3-year period.

To prevent large important balance sheet accounts, carried at historical values, from having insignificant values once translated into the reporting currency at the current rate.

It is not possible to hedge both translation exposure and transaction exposure simultaneously.

Is not entity specific, rather it is currency specific

Is a mismatch of net assets and net liabilities denominated in the same currency.

Eliminate any mismatch of net assets and net liabilities denominated in the same currency

Really involves speculation about foreign exchange rate changes

Upper management should be more concerned with operating exposure.

The results suggest that market agents do not react to cosmetic earning changes that do not affect value.

Current rate method

A cumulative translation adjustment account is necessary to bring balance to the consolidated balance sheet after an exchange rate change.