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Finance 407: Multinational Financial Management
1
Topic #11: Measuring and managing translation exposure
L. Gattis
The Pennsylvania State University
Review Poll
2
Dell records a 500,000 Danish kroner accounts payable when the spot rate of the kroner is Kr5.5/USD. One month later, the Kroner appreciates to Kr5.0 and the payable is still outstanding. What gain or loss will Dell report in its USD financials if they revise the exchange rate?
A. $250,000 B. $9,091 C. $0 D.$9,091 E.$250,000
Learning Objectives
3
Students understand and can recall type of foreign exchange exposure translation methods and FASB52
methods for managing translation exposure
the definitions, implementation, and use of EaR to measure exchange rate risk
Students can calculate
translation exposure and gain/loss
Students can calculate EaR given balance sheet account information and exchange rate volatility
Forex Exposure
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I. Translation “Accounting” Exposure
arises when reporting and consolidating financial statements require conversion from foreign currency to home currency. It is a possible accounting gain/loss on foreign assets and liabilities which are reported as losses in income or adjustments to equity
(Translation exposures often lead to cashflow losses when account are liquidated)
II. Cashflow Exposures
1. Transaction Exposure: potential gains or losses on foreign transactions such as bond payments and receivables paid in the foreign currency. (Up until a payment is made, these are only translation exposures)
2. Competitive Exposure: longterm exposure to currency
change on future business.
Types of Foreign Exchange Exposure Examples (U.S. MNC Perspective)
Translation Exposure
Foreign subsidiary records ¥10,000 receivable at $.008/¥ spot exchange rate at time of sale ($80 book value), but yen devalues to $.007/¥
US$ value of receivable falls $10 to $70 which is reflected in parent company income statement or balance sheet
It affects cashflows when the receivable is received
Transaction Exposure
Euro appreciates from $1.20 to $1.40 at the maturity of euro denominated bond that has a face value of 1,000
It costs $200 more to repay the bond after the appreciation.
Competitive Exposure
Your manufacturing facility is China is expected to become more
costly in the future (in USD terms) due to the appreciation of
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