BAR 4 Part 2 Flashcards
Indirect method v direct method
POV of Europe, indirect method = 1 euro= X US dollars
Appreciation of US dollar -> reudction in # of dollars taken to convert into 1 euro
Depreication of US dollar -> increase in # of dollars taken to convert into 1 euro
POV of Europe, direct method = 1 US dollars= X euros
Translation method:
Under translation method, B/S is translated using current year-end exchange rate. Common stock and APIC is translated using historical exchange rate, and RE is roll forward calculation
Under translation method, I/S is translated first than B/S. Gains/loss plugged into accumulated balance of OCI
Under translation method, RE starts with beginning amount than adds translated current NI and subtract translated dividends declared in current period ie rollward RE account by transferring NI to this account
Under translation method, all I/S items are transplanted using average exchange rate. B/S translated using current exchange rate; historical exchange rate used for common stock/APIC translate ion
For individual transactions
: a) spot rate is used at every valuation date b) weighted average rate used in transactions of foreign F/S
Remeasurement method
under remeasurment (temporal) method, all monetary B/S items are remeasurment using current year end exchange rate. Non-monetary B/S items are remeasuerd using historical exchange rate
Functional currency:
primary economic environment currency which specific entity operates which can be local currency
Functional currency can’t be local currency if foreign entity operates in high inflationary environment ie approx 100% over 3 years
Reporting currency: currency of entity ultimately reporting financial results of foreign entity. Understand if question is asking functional currency of parent or subsidiary
currency of entity ultimately reporting financial results of foreign entity. Understand if question is asking functional currency of parent or subsidiary
Foreign currency of company may be:
a) foreign entity’s local currency, one which entity keeps its books
b) currency which F/S will be presented ie currency of parent company
c) foreign currency other than 1 which foreign entity maintains books”
Under both translation and remeasurement methods
Under both methods, sales revenue is translated at weighted average rate
Under both methods, cash is translated at year-end spot rate
under both methods, common stock is translated using historical method
Derivative contract:
swap, forward contract, call option, futures contract. Derivative: contract between parties based on underlying financial asset. Value is driven by value activity of underlying asset. Value is determined by notional amount and underlying
all derivatives are valued on B/S at fair value
Characteristics of derivative contract future contract:
a) made through clearinghouse b) standardized notional amounts and settlement dates
Swap:
private agreement between 2 parties
Forward contract:
privately negotiated between 2 parties w/ assistance of intermediary. Advantage of forward contract: flexible terms
Primary disadvantage: a) no active markets for private negotiations b) lack standardization and not controlled through regulated mechanism c) risk that 1 of counterparties will default on settlement date
A derivative may be designated and qualify as fair value hedge if following are met:
a) formal documentation of hedging relationship between derivative and hedged item
b) hedge must be expected to be highly effective in offsetting changes in fair value of hedged item and effect invests is asssessed @least every 3 months
c) hedged item is specifically identified
d) hedged item presents exposure to changes fair value that could affect income
Options is a
zero-sum game for 2 parties, if not exercised option write pockets call premium at expense of option buyer
Buyer of call option has right but not obligation to excerise call option, when its “in the money”= underlying asset stock price exceeds strike price and buyer will likely exercise call option. If “out of money” underlying asset stock price is less than strike price and buyer will likely not excerise call option
Buyer of call option must pay a premium
Hedging is used for
a) managing interest rate risk b) managing foreign exchange risk c) managing variability in expected CF d) speculative purposes
