Unit 6 Flashcards
Accounting and foreign currency
What is the purpose of International accounting ?
Purpose of International accounting is to provide managers the data they need to make
decisions and provide people outside the organization the information they need
(governments, suppliers, investors)
What is Consolidation
The process of translating subsidiary results and aggregating them into one financial
report
Name and explain the 2 approaches to currency translation
Current rate method
- An approach in foreign currency translation in which assets and liabilities are valued at
current spot rates
Temporal method
- An approach in foreign currency translation in which monetary accounts are valued at
the spot rate and accounts carried at historical cost are translated at their historic
exchange rates
What is the functional currency ?
The primary currency of a business
Which two sources can firms raise capital from ?
o Internal sources, retained earnings
o External sources, equity or debt
Name and explain the 2 trends in foreign capital use
Increasing use of foreign stock markets (equity);
o Firms issue stock on foreign exchanges directly
o Control by foreigners is a concern, especially in sensitive industries
Increasing use of foreign debt markets;
o Trend is to tap local markets first
o Offshore financial centres (Hong Kong, Switzerland, the Cayman Islands, and the
Bahamas) may also be a source of capital
* Offshore financial centres are locations that specialise in financing nonresidents,
with low taxes and few banking regulations
Decisions made by a financial manager related to raising capital include?(6)
▪ In what currency should the capital be raised, considering estimates of longterm strengths and
weaknesses?
▪ How should the capital be structured between equity and debt?
▪ What sources of capital are available? (bank loan, swap, IPO, issuance of additional stock,
etc.)
▪ If using a capital market, which one?
▪ Are other sources of money available? (JV partner, private financing, host government)
▪ How much money and for how long?
Why are funds moved? Give three utilizations:
As they move funds, firms can also achieve cash flow management objectives;
▪ dealing with funds whose repatriation is blocked
▪ achieving tax management objectives by locating profits in low-tax environments
▪ reducing foreign exchange risk by moving away from areas that have high risk of devaluation
What is a Fronting loan
o A loan made through an intermediary, usually a bank, from parent company to subsidiary
What is Transfer pricing
o Pricing that is established for transactions between members of the enterprise
Explain international finance centres (6)
▪ Helpful in managing volatility of floating exchange rates
▪ Useful in accessing growing number of FX and capital markets
▪ Helpful in hedging the risks related to differences in inflation rates among markets
▪ Supported by development of electronic funds transfer capabilities
▪ Management of idle cash can generate profits
▪ Use of derivatives have developed as a way to manage risks
What is multilateral netting
o Strategy in which subsidiaries transfer net intracompany cash flows through a
centralized clearing center
o reduces transactions costs
o reduces FX costs
o allows firm to benefit from investment of idle funds (opportunity costs)
Explain leading and lagging
o Timing payments early (lead) or late (lag), depending on anticipated currency
movements, so that they have the most favorable impact for the company;
- Lead approach: collect receivables early when the foreign currency is expected to
weaken and fund payables early when the foreign currency is expected to
strengthen - Lag approach: collect receivables late when the currency is expected to strengthen
and fund payables late when the currency is expected to weaken
What is transaction exposure
Change in the value of a financial position created by foreign currency changes between
the establishment and the settlement of a contract
6 ways to hedge against transaction exposure
- By leading or lagging
▪ Leading payment when foreign currency expected to appreciate, and vice versa - Exposure netting
▪ To be exposed to currencies that move in opposite directions - Forward market hedge
▪ Foreign currency contract sold or bought forward to protect against foreign currency
movement – locking the exchange rate (buy Euros now at a more favourable exchange
rate) - Currency option hedge
▪ An option to buy or sell a specific amount of foreign currency at a specific time in order
to protect against foreign currency risk
▪ Call option when foreign currency expected to appreciate - Money market hedge
▪ A method to hedge foreign currency exposure by borrowing and lending in the domestic
and foreign money markets – another way of locking the exchange rate, but without
forward market hedge fee - Swap contract
▪ An agreement to exchange currencies at specified rates and on a specified date or
sequence of dates
