Class 7 Flashcards
What is translation exposure
The risk that a company’s financial statements will be impacted by FX rates when statements are consolidated into the parent company’s financial statements
When is translation exposure most important
In multinational companies that operate in different countries and deal in many currencies
How is translation methods used for the balance sheet
The assets and liab are translated from foreign to domestic currency AT the exchange rate AT the balance sheet date
How are revenues and expenses translated?
Using the AVERAGE exchange rate for the reporting period
Where are translation gains and losses due to FX usually reportefd?
In other comprehensive income
What is other comprehensive income (OCI)
gains or losses that are excluded from net income because too volatile to put in core earnings
Give two examples or items that are reported on OCI
-Foreign currency translation adjustments
-Changes in the fair value of cash flow hedges
What does the statement of comprehensive income intel?
Reconciles the net income
How do we know if a forward contract impacts the P&L statement?
It depends on whether the contract is used for hedging purposed and how the company accounts for the forward contract under the applicable accounting standards
What is mark-to-market adjustements
Since forward rates usually accounted for at fair value, the company have to adjust the value of the forward contract at each reporting date to reflect current market value
How is the fair value of a forward foreign exchange rate (FX) determined?
By the difference between the agreed-upon forward rate at the contract’s initiation and the current spot rate or the current forward rate at the same maturity at a given point in time.
What is a fair value hedge?
A forward contract used to hedge the fair value of an existing asset or liability
Name 2 types of translation exposures
1) Balance sheet exposure
2) Income statement exposure
Name 3 ways of managing translation exposure
1) hedging
2) balance sheet management
3) currency matching
What is balance sheet management
Companies reduce exposure by managing the composition of their foreign assets and liabilities
What is operating exposure in foreign exchange (FX)
Refers to long-term risk that changes in exchange rates can affect a company’s future cash flows, competitive position and overall market value
How can operating exposure impact on future cash flows?
Operating exposure affects the company’s future revenues, costs and profitability
How can operating exposure effect competitive position?
If the home company’s currency appreciates, its products become more expensive internationally company to those produced by competitors in countries with weaker currencies
How can operating exposure effect long-term strategic risk?
Has impact on cost structure, pricing strategies and product demand due to sustained currency movements
What are the 3 components of operating exposure
1) revenue exposure
2) cost exposure
3) price elasticity and demand sensitivity
What is revenue exposure?
A company’s sales and revenues streams can be impacted by exchange rate movements
What is cost exposure?
Companies with foreign suppliers or production facilities are exposed to exchange rate changes in terms of costs
What is price elasticity and demand elasticity?
The effect that exchange rate has on the demand of the product depends on price elasticity.
What are 3 ways to manage operating exposure?
1) diversify operations
2) currency matching
3) pricing flexibility
What is diversifying operations?
Diversify their production, sourcing and sales operations in a geographical way to reduce reliance on any one currency
What is currency matching?
A natural way of hedging where revenues and costs are march in the same currency
What is pricing flexibility?
Strategies that companies use to allow them to adjust prices in response to exchange rate changes which is easier to do in industries with low price elasticity
What is operating exposure?
It is competitive exposure that affects future cash flows and future advantage of this company in this industry
