Class 7

Question 1

What is translation exposure

Answer 1

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

Question 2

When is translation exposure most important

Answer 2

In multinational companies that operate in different countries and deal in many currencies

Question 3

How is translation methods used for the balance sheet

Answer 3

The assets and liab are translated from foreign to domestic currency AT the exchange rate AT the balance sheet date

Question 4

How are revenues and expenses translated?

Answer 4

Using the AVERAGE exchange rate for the reporting period

Question 5

Where are translation gains and losses due to FX usually reportefd?

Answer 5

In other comprehensive income

Question 6

What is other comprehensive income (OCI)

Answer 6

gains or losses that are excluded from net income because too volatile to put in core earnings

Question 7

Give two examples or items that are reported on OCI

Answer 7

-Foreign currency translation adjustments
-Changes in the fair value of cash flow hedges

Question 8

What does the statement of comprehensive income intel?

Answer 8

Reconciles the net income

Question 9

How do we know if a forward contract impacts the P&L statement?

Answer 9

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

Question 10

What is mark-to-market adjustements

Answer 10

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

Question 11

How is the fair value of a forward foreign exchange rate (FX) determined?

Answer 11

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.

Question 12

What is a fair value hedge?

Answer 12

A forward contract used to hedge the fair value of an existing asset or liability

Question 13

Name 2 types of translation exposures

Answer 13

1) Balance sheet exposure
2) Income statement exposure

Question 14

Name 3 ways of managing translation exposure

Answer 14

1) hedging
2) balance sheet management
3) currency matching

Question 15

What is balance sheet management

Answer 15

Companies reduce exposure by managing the composition of their foreign assets and liabilities

Question 16

What is operating exposure in foreign exchange (FX)

Answer 16

Refers to long-term risk that changes in exchange rates can affect a company’s future cash flows, competitive position and overall market value

Question 17

How can operating exposure impact on future cash flows?

Answer 17

Operating exposure affects the company’s future revenues, costs and profitability

Question 18

How can operating exposure effect competitive position?

Answer 18

If the home company’s currency appreciates, its products become more expensive internationally company to those produced by competitors in countries with weaker currencies

Question 19

How can operating exposure effect long-term strategic risk?

Answer 19

Has impact on cost structure, pricing strategies and product demand due to sustained currency movements

Question 20

What are the 3 components of operating exposure

Answer 20

1) revenue exposure
2) cost exposure
3) price elasticity and demand sensitivity

Question 21

What is revenue exposure?

Answer 21

A company’s sales and revenues streams can be impacted by exchange rate movements

Question 22

What is cost exposure?

Answer 22

Companies with foreign suppliers or production facilities are exposed to exchange rate changes in terms of costs

Question 23

What is price elasticity and demand elasticity?

Answer 23

The effect that exchange rate has on the demand of the product depends on price elasticity.

Question 24

What are 3 ways to manage operating exposure?

Answer 24

1) diversify operations
2) currency matching
3) pricing flexibility

Question 25

What is diversifying operations?

Answer 25

Diversify their production, sourcing and sales operations in a geographical way to reduce reliance on any one currency

Question 26

What is currency matching?

Answer 26

A natural way of hedging where revenues and costs are march in the same currency

Question 27

What is pricing flexibility?

Answer 27

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

Question 28

What is operating exposure?

Answer 28

It is competitive exposure that affects future cash flows and future advantage of this company in this industry