F.4.9.4 CH09+10 – Flashcards
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Suppose the U.S. dollar substantially depreciates against the Japanese yen. The change in exchange
rate
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Can have significant economic consequences for both U.S. and Japanese firms
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Suppose the U.S. dollar substantially depreciates against the Japanese yen. The change in exchange
rate
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Will tend to strengthen the competitive position of import-competing U.S. car makers.
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The link between a firm's future operating cash flows and exchange rate fluctuations:
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Operating exposure
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When exchange rates change,
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U.S. firms that produce domestically and sell only to domestic customers ///can be affected ///if they
compete against imports.
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It is conventional to classify foreign currency exposures into the following types:
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economic exposure, transaction exposure, and translation exposure
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Operating exposure measures
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The extent to which the firm's operating cash flows will be affected by unexpected changes in
exchange rates.
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Economic exposure refers to:
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The extent to which the value of the firm ////would be affected//// by unanticipated changes in exchange rate.
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Currency risk
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represents random changes in exchange rates
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The exposure coefficient in the regression P=a+b*S+e is given by:
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b= Cov(P,S)/Var(S)
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The exposure coefficient b in the regression is P:
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A measure of how a change in the exchange rate affects the dollar value of a firm's assets.
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The exposure coefficient b in the regression Pinforms:
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...A. How much of a foreign currency to sell forward.
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Before you can use the hedging strategies such as a forward market hedge, options market hedge, and so
on, you should consider running a regression of the form . When reviewing the output, you
should initially focus on
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The slope coefficient b
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The link between the home currency value of a firm's assets and liabilities and exchange rate fluctuations
is:
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Asset exposure
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A purely domestic firm that sources and sells only domestically,
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Faces exchange rate risk to the extent that it has international competitors in the domestic market.
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In recent years,
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...The U.S. dollar has depreciated substantially against most major currencies of the world, especially
against the euro.
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From the perspective of the U.S. firm that owns an asset in Britain, the exposure that can be measured by
the coefficient b in regressing the dollar value P of the British asset on the dollar/pound exchange rate S
using the regression equation P is
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..Asset exposure.
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On the basis of regression Equation we can decompose the variability of the dollar value of
the asset, Var(P), into two separate components Var(P) = b2 ×Var(S) + Var(e)
The first term in the right-hand side of the equation, b2 ×Var(S) represents
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...The part of the variability of the dollar value of the asset that is related to random changes in the
exchange rate.
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On the basis of regression Equation we can decompose the variability of the dollar value of
the asset, Var(P), into two separate components Var(P) = b2 ×Var(S) + Var(e)
The second term in the right-hand side of the equation, Var(e) represents
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...Captures the residual part of the dollar value variability that is independent of exchange rate
movements.
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What does it mean to have redenominated an asset in terms of the dollar?
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...A. You have undertaken a hedging strategy that gives the asset a constant dollar value.
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A firm with a highly elastic demand for its products
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...A
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Will be unable to pass increased costs following unfavorable changes in the exchange rate without
significantly lowering the quantity sold.
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Operating exposure can be defined as:
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...The extent to which the firm's operating cash flows would be affected by random changes in exchange
rates
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The extent to which the firm's operating cash flows would be affected by random changes in exchange
rates is called
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..Operating exposure
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With regard to operational hedging versus financial hedging
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...A. Operational hedging provides a more stable long-term approach than does financial hedging.
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Which of the following are identified by your text as a strategy for managing operating exposure:
1) Selecting low-cost production sites
2) Flexible sourcing policy
3) Diversification of the market.
4) Product differentiation and R&D efforts
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...12345만
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Consider a U.S.-based MNC with a wholly-owned Italian subsidiary. Following a depreciation of the
dollar against the euro, which of the following describes ////the competitive effect of the depreciation?////
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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.
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Which of the following is false?
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...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.
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Consider a U.S.-based MNC with a wholly-owned German subsidiary. Following a depreciation of the
dollar against the euro, which of the following describes //the conversion effect of the depreciation?///
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... A given operating cash flow in euro will be translated to a higher U.S. dollar cash flow.
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Consider a U.S.-based MNC with a wholly-owned French subsidiary. Following a depreciation of
the dollar against the euro, which of the following best describes/// the mechanism of any effect of the
depreciation?/////
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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.
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Which of the following is true?
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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.
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Generally speaking, a firm is subject to high degrees of operating exposure:
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When either its cost or its price is sensitive to exchange rate changes
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Generally speaking, when both a firm's costs and its price is sensitive to exchange rate changes
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A. The firm is not subject to high degrees of operating exposure:
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The firm may not be subject to high degrees of operating exposure:
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When changes in nominal exchange rates are exactly offset by the inflation differential.
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The firm may not be able to pass through changes in the exchange rate:
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A. In markets with mainly domestics (foreign to the firm) competitors.
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Generally speaking, a firm is subject to high degrees of operating exposure when
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A. Either its cost or its price is sensitive to exchange rate changes
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What is the objective of managing operating exposure?
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A. Stabilize cash flows in the face of fluctuating exchange rates.
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Managing operating exposure:
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B. Is a long-term issue, like selecting a site for a factory.
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While maintaining multiple production sites does provide a firm valuable options,
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B. A firm may miss out on economies of scale
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A flexible sourcing policy
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B. Need not be confined just to materials and parts.
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A firm that is committed to keeping manufacturing facilities in only the home country (and not
developing multiple production sites in a variety of countries) can
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B. Lessen the effect of exchange rate changes by sourcing from where input costs are low.
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If the domestic currency is strong or expected to become strong:
A.
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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.
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A firm that is committed to keeping manufacturing facilities in only the home country (and not
developing multiple production sites in a variety of countries) can
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A.
Lessen the effect of exchange rate changes by pursuing a strategy of diversifying the markets in which
the firm's products are sold
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It can be argued that, while financial hedging can be used to stabilize a firm's cash flows,
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A. It is not a substitute for long-term operational hedging
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The price elasticity of demand for unique products tends to be
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Highly inelastic.
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The price elasticity of demand for commodity products tends to be
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Highly elastic.
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In the figure at right, label curves A and B respectively,
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Unhedged, hedged.
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If the stock market of a foreign country is consistently up when the dollar value of the currency is
down,
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A. There may not be a great deal of exchange rate risk for a U.S.-based investor.
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The recognized methods for consolidating the financial reports of an MNC are:
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current/noncurrent method, monetary/nonmonetary method, temporal method, and current rate method
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How many methods of foreign currency translation have been used in recent years? (U.S. GAAP.)
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Four
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Translation exposure, also frequently called accounting exposure, refers to the effect that an unanticipated
change in exchange rates will have on the
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Consolidated financial reports of a MNC.
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When exchange rates change, the value of a foreign subsidiary's assets and liabilities denominated in a
foreign currency change
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When they are viewed from the perspective of the parent firm.
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The sensitivity of "realized" domestic ////currency values of the firm's contractual cash flows denominated in
foreign currency to unexpected changes in the exchange rate is:
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Transaction exposure
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The management of translation exposure is best described as
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Selecting a mechanical means for handling the consolidation process for MNCs that logically deals
with exchange rate changes.
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The sensitivity of the firm's consolidated ///financial statements to unexpected changes in the exchange rate
is:
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Translation exposure
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The extent to which the value of the firm would be affected by unexpected changes in the exchange rate
is:
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Economic exposure
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Which of the following is true?
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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.
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The authoritative body in the United States that specifies accounting policy for U.S. business firms and
certified public accounting firms.
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The Financial Accounting Standards Board (FASB).
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The difference between accounting exposure and translation exposure
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Accounting exposure and translation exposure are the same thing.
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When exchange rates change
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The value of a foreign subsidiary's foreign currency denominated assets and liabilities change when
redenominated into the home currency
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Translation exposure measures:
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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
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The current/noncurrent method of foreign currency translation was generally accepted in the United
States from the 1930s until 1975, when
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FASB 8 became effective
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The underlying principle of the current/noncurrent method is that assets and liabilities should be
translated based on their maturity.
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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.
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The generally accepted method for consolidating the financial reports of an MNC from the 1930s to 1975
was:
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A. Current/noncurrent method
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Under the current/noncurrent method
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A foreign subsidiary with current assets in excess of current liabilities will cause a translation gain
(loss) if the local currency appreciates (depreciates).
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When using the current/noncurrent method, current assets are defined as
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. Assets with a maturity of one year or less
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Which of the following statements is false?
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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.
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The underlying principle of the current/noncurrent method is
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A. Assets and liabilities should be translated based on their maturity
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The underlying principle of the monetary/nonmonetary method is
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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
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According to the monetary/nonmonetary method, monetary balance sheet accounts include
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For example, cash, marketable securities, accounts receivable, notes payable, accounts payable of a
foreign subsidiary.
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The underlying philosophy of the monetary/nonmonetary method is that
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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.
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Under which accounting method are most income statement accounts are translated at the average
exchange rate for the period?
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Monetary/nonmonetary method
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Under the monetary/nonmonetary method, revenue and expense items associated with
nonmonetary accounts, such as cost of goods sold and depreciation, are translated at the historical rate
associated with the balance sheet account.
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True
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Using the temporal method, monetary accounts such as cash
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Are translated at the current /////spot///// exchange rate
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Since fixed assets and inventory are usually carried at historical costs,
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The temporal method and the monetary/nonmonetary methods will typically provide the same
translation.
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The underlying principle of the temporal method is
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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.
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The underlying principle of the current rate method is
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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
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D.All balance sheet accounts are translated at the current exchange rate, except stockholder equity.
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Which of the following is a translation method where the gain or loss due to translation adjustment does
not affect reported cash flows?
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current rate method
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The simplest of all translation methods to apply is:
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Current // rate// method
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Which of the following is a translation method where a "plug" equity account called cumulative
translation adjustment is used?
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current rate method
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FASB 8 is essentially the:
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Temporal method
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FASB 52 requires
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The current rate method of translation in some circumstances and the temporal method in others.
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The International Accounting Standards Committee
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Is now known as The International Accounting Standards Board
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The "functional currency" is defined in FASB 52 as:
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the currency of the primary economic environment in which the entity operates
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The "reporting currency" is defined in FASB 52 as:
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the currency in which the MNC prepares its consolidated financial statements
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The currency of the primary economic environment in which the entity operates is defined in FASB 52
as:
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The "functional currency"
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The actual translation process prescribed by FASB 52 is
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A two-stage process
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In implementing FASB 52,
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The functional currency of the foreign entity must be translated into the reporting currency in which the
consolidated statements are reported.
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61. A translation exposure report shows, for each account that is included in the consolidated balance
sheet,
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The amount of foreign exchange exposure that exists for each foreign currency in which the MNC has
exposure.
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If a foreign entity is only a shell company for carrying accounts that could be carried on the parent's
books,
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The functional currency would generally be the parent's currency
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A highly inflationary economy is define in FASB 52 as:
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One that has cumulative inflation of approximately 100 percent or more over a 3-year period.
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In highly inflationary economies, FASB 52 requires that the foreign entities financial statement be
remeasured from the local currency "as if the functional currency were the reporting currency". The
purpose of this requirement is
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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.
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Generally speaking,
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It is not possible to hedge both translation exposure and transaction exposure simultaneously.
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Translation exposure,
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Is not entity specific, rather it is currency specific
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The source of translation exposure
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Is a mismatch of net assets and net liabilities denominated in the same currency.
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A balance sheet hedge seeks to
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Eliminate any mismatch of net assets and net liabilities denominated in the same currency
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A derivatives hedge that seeks to eliminate translation exposure
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Really involves speculation about foreign exchange rate changes
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With regard to translation exposure versus operating exposure
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Upper management should be more concerned with operating exposure.
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With regard to research on the stock price reaction to mandated accounting changes such as FASB 52
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The results suggest that market agents do not react to cosmetic earning changes that do not affect
value.
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Under which method does the gain or loss due to translation adjustment not affect reported cash flows, as
it does with the other three translation methods?
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Current rate method
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Under FASB 52, when a net translation exposure exists,
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A cumulative translation adjustment account is necessary to bring balance to the consolidated balance
sheet after an exchange rate change.
