BEC 9 - Issues at Entity Level - Currency Exchange/Price Levels

Question 1

What is a risk management strategy that seeks to offset losses resulting from changes in exchange rates between currencies by using contracts, swaps and other instruments which will result in changes counter to (opposite of) changes in the currency exchange rate?

Answer 1

“foreign currency risk hedging”.

Question 2

Distinguish between a foreign currency exchange contract and a foreign currency option contract.

Answer 2

Under a foreign currency exchange contract, the obligation to buy or sell a foreign currency is firm; the exchange must occur. Under a foreign currency option contract, the party holding the option has the right (option) to buy (call) or sell (put), but does not have to exercise that option; the exchange will occur according to a decision made by the option holder.

Question 3

Define “economic risk” as it relates to currency exchange rates.

Answer 3

The possible unfavorable impact of change in currency exchange rates on a firm’s future international earning power. Exchange rates may change so that future revenue, costs and prices are adversely impacted.

Question 4

Define “transaction risk” as it relates to currency exchange rates.

Answer 4

The possible unfavorable impact of changes in currency exchange rates on transactions denominated in a foreign currency. Exchange rates may change so that transactions to be settled in a foreign currency result in receiving fewer dollars or paying more dollars to settle.

Question 5

Define “translation risk” as it relates to currency exchange rates.

Answer 5

The possible unfavorable impact of changes in currency exchange rates on the financial statements of an entity when those statements are converted from one currency to another currency. Exchange rates may change so that domestic (dollar) values of financial statement items are adversely impacted.

Question 6

Identify the three specific kinds of risk associated with changes in currency exchange rates.

Answer 6

Kinds of risk associated with changes in currency exchange rates:

1. Transaction risk;
2. Translation risk;
3. Economic risk.

Question 7

Define “foreign currency forward exchange contract”.

Answer 7

Agreement to buy or sell a specified amount of a foreign currency at a specified future date at a specified (forward) rate.

Question 8

Define “currency exchange rate risk”.

Answer 8

The risk of loss or other unfavorable outcome that results from changes in exchange rates between currencies.

Question 9

For U.S. income tax purposes, in setting transfer prices, the resulting income should be allocated based on what factors?

Answer 9

1. Functions performed by separate affiliates;

2. Risks assumed by separate affiliates.

Question 10

What significant outcomes does the setting of transfer prices impact?

Answer 10

1. Profit recognized by separate units;
2. Allocation of taxes between units;
3. Measures of separate unit performance.

Question 11

In addition to minimizing total income taxes, what other savings may be accomplished by the setting of transfer prices?

Answer 11

In addition to income taxes, the setting of transfer prices may affect:

1. Withholding taxes, that may apply to the transfer of cash as dividends, interest or royalties;
2. Import duties, which are applied to goods based on transfer prices;
3. Profit repatriation restrictions, which limit the amounts of profits that can be transferred out of a country.

Question 12

Amount (price) at which goods or services are transferred between affiliated entities.

Answer 12

Define “transfer price”.

Question 13

Identify and describe three major bases for setting transfer prices.

Answer 13

1. Cost: The transfer price is a function of the cost to the selling unit;
2. Market Price: The transfer price is based on the price of the good or service in the market (if available);
3. Negotiated Price: The transfer price is based on a negotiated agreement between buying and selling affiliates.