Title: Foundations of Multinational Financial Management 5th Edition Alan Shapiro J.Wiley
1Foundations of Multinational Financial
Management5th EditionAlan Shapiro J.Wiley
Sons
- Power Points by
- Joseph F. Greco, Ph.D.
- California State University, Fullerton
2Measuring and Managing Translation and
Transaction Exposure
3Measuring Translation and Transaction Exposure
4PART I. ALTERNATIVE MEASURES OF FOREIGN EXCHANGE
EXPOSURE Accounting and Economic Risk
- I. ALTERNATIVE MEASURES
- A. TYPES
- 1. Accounting Exposure
- arises when reporting and
consolidating financial statements require
conversion from subsidiary to parent currency. -
- 2. Economic Exposure
- arises because exchange rate changes alter
the value of future revenues and
costs. -
5Accounting Exposure
- Accounting Exposure
- Transaction risk Translation risk
6How Accounting Exposure Arises
United States
Japan
Headquarters Consolidated Financials
Subsidiary Financials
Subsidiary Financials
Germany
Subsidiary Financials
7ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE
- C. Economic Exposure
- Transaction Exposure Operating Exposure
-
- Operating Exposure arises because exchange
rate changes alter the value of future revenues
and costs. -
8PART II. ALTERNATIVE CURRENCY TRANSLATION METHODS
- I. FOUR METHODS OF TRANSLATION
- A. Current/Noncurrent Method
- 1. Current accounts use current
exchange rate for conversion. - 2. Income statement accounts use
- average exchange rate for the period.
9ALTERNATIVE CURRENCY TRANSLATION METHODS
- B. Monetary/Nonmonetary Method
- 1. Monetary accounts use current rate
- 2. Pertains to
- - Cash
- - Accounts receivable
- - Accounts payable
- - Long term debt
10ALTERNATIVE CURRENCY TRANSLATION METHODS
- 3. Nonmonetary accounts
- - Use historical rates
- - Pertains to
- Inventory
- Fixed assets
- Long term investments
- 4. Income statement accounts
- - Use average exchange rate for the
period.
11ALTERNATIVE CURRENCY TRANSLATION METHODS
- C. Temporal Method
- 1. Similar to monetary/nonmonetary
- method.
- 2. Use current method for inventory.
-
12ALTERNATIVE CURRENCY TRANSLATION METHODS
- D. Current Rate Method
- all statements use current exchange rate for
conversions.
13PART III. STATEMENT OF FINANCIAL ACCOUNTING
STANDARDS NO. 8
- I. FASB NO. 8
- A. Uniform conversion rules established
- B. Temporal method
- C. Translation gains or losses
- 1. Reported on income statement
- 2. Result net income greatly affected by
exchange rate volatility and subsequent
uncertainty.
14PART IV. STATEMENT OF FINANCIAL ACCOUNTING
STANDARDS NO. 52
- I. FASB NO. 52
- A. Dissatisfaction with FASB No. 8
- true profitability often disguised by
- exchange rate volatility.
15STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 52
- D. Translation Gains or Losses
- 1. Recorded in separate equity account on
balance sheet. - 2. Known as cumulative translation
adjustment account.
16STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 52
- E. New Distinction under FASB No. 52
- functional v. reporting currency
-
- 1. Functional currency
- for foreign subsidiary
- - The currency used in the primary
economic environment in which it
operates. -
- 2. Reporting currency
-
- - The currency the parent firm uses to
- prepare its financial statements.
-
17STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 52
- F. When Functional and Reporting Currencies are
the Same - 1. If foreign subsidiary operations are
direct extension of parent firm -
- e.g. Hong Kong assembly plant
- which sells all its products in the U.S.
- market.
18STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 52
- When Functional and Reporting Currencies are the
Same (cont) - 2. During hyperinflations in the subsidiary
countries - Hyperinflation is defined as a cumulative
inflation rate of 100 over a three-year period.
19PART VI. ACCOUNTING PRACTICE AND ECONOMIC REALITY
- I. Accounting v. Economic Exposure
- measurement of exchange rate risk indicates
major difference exists. -
- A. Accounting exposure
- reflects past decisions of the firm.
- B. Economic exposure
- 1. Focuses on future impact of exchange rate
changes. - 2. Not all future cash flows appear on the
firms balance sheet.
20Sample Problem
- Suppose on January 1, American Golfs French
subsidiary showed - Current assets of FF1 million
- Current liabilities of FF300,000
- Total assets FF2.5 million
- Total liabilities FF900,000
- Exchange rate on Jan 1 .1270
- on Dec 31 .1180
21Sample Problem
- Under FASB-52, what is the exposure if the franc
is the functional currency? - - All assets and liabilities translated at
current - rate.
- At beginning of the year
- FF2,500,000-FF900,000 FF1,600,000
- 1,600,000 x .1270 203,200
- At the end of the year
- 1,600,000 x .1180 188,800
22Sample Problem
- This involves a translation loss for American
Golf of -
- 203,200 188,800 14,400
23PART TWO
Managing Translation and Transaction Exposure
24PART III. DESIGNING A HEDGING STRATEGY
- I. DESIGNING A HEDGING STRATEGY
- A. Strategies
- a management objective
- B. Hedgings basic objective
- reduce/eliminate volatility of
- earnings as a result of exchange rate
changes.
25DESIGNING A HEDGING STRATEGY
- C. Hedging exchange rate risk
- 1. Incurs a cost
- 2. Should be evaluated as a purchase of
insurance. -
26DESIGNING A HEDGING STRATEGY
- D. Centralization is key
- 1. Important aspects
- a. Degree of centralization
- b. Responsibility for its
development - c. Implementation
-
- 2. Maximum benefits accrue from
- centralizing policy-making, formulation, and
implementation.
27PART II. MANAGING TRANSACTION EXPOSURE
- I. METHODS OF HEDGING
- A. Risk shifting
- B. Currency risk sharing
- C. Currency collars
- D. Cross-hedging
- E. Exposure netting
- F. Forward market hedge
- G. Foreign currency options
-
28MANAGING TRANSACTION EXPOSURE
- A. RISK SHIFTING
- 1. Home currency invoicing
- 2. Zero sum game
- 3. Common in global business
- 4. Firm will invoice exports in strong
currency, import in weak currency - 5. Drawback
- it is not possible with informed customers
or suppliers.
29MANAGING TRANSACTION EXPOSURE
- B. CURRENCY RISK SHARING
- 1. Developing a customized hedge contract.
-
- 2. The contract typically takes the form of a
Price Adjustment Clause, whereby a base
price is adjusted to reflect certain
exchange rate changes.
30The Zone
1.50/
1.60/
Take no action
31MANAGING TRANSACTION EXPOSURE
- B. CURRENCY RISK SHARING (cont)
-
- 3. Parties would share the currency risk
beyond a neutral zone of exchange - rate changes.
-
- 4. The neutral zone represents the
currency range in which risk is not
shared.
32MANAGING TRANSACTION EXPOSURE
- C. CURRENCY COLLARS
- 1. Contract
- - bought to protect against currency
- moves outside the neutral zone.
-
- 2. Firm would convert its foreign currency
denominated receivable at the zone
forward rate.
33MANAGING TRANSACTION EXPOSURE
- D. CROSS-HEDGING
- 1. Often forward contracts not available
- in a certain currency.
- 2. Solution a cross-hedge
- - a forward contract in a related
currency. - 3. Correlation between 2 currencies is
- critical to success of this hedge.
34MANAGING TRANSACTION EXPOSURE
- E. EXPOSURE NETTING
- 1. Protection can be gained by selecting
- currencies that minimize exposure
- 2. Netting
- MNC chooses currencies that are not
- perfectly positively correlated.
- 3. Exposure in one currency can be
- offset by the exposure in another.
35PART III. MANAGING TRANSLATION EXPOSURE
- I. MANAGING TRANSLATION EXPOSURE
- A. Choices faced by the MNC
-
- 1. Adjusting fund flows
- Altering either the amounts or the
currencies of the planned cash flows of the
parent or its subsidiaries to reduce the
firms local currency accounting exposure.
36MANAGING TRANSLATION EXPOSURE
- 2. Forward contracts
-
- Reducing a firms translation exposure by
creating an offsetting asset or liability in
the foreign currency. -
-
37MANAGING TRANSLATION EXPOSURE
- 3. Exposure netting
-
- a. Offsetting exposures in one currency
with exposures in the same or another
currency -
- b. Gains and losses on the two
currency positions will offset each
other.
38Managing Translation Exposure
- B. Basic hedging strategy for reducing
translation exposure - 1. Increasing hard-currency (likely to
- appreciate) assets.
- 2. Decreasing soft-currency (likely to
depreciate) assets. - 3. Decreasing hard-currency liabilities.
- 4. Increasing soft-currency liabilities.
-
39MANAGING TRANSLATION EXPOSURE
- How to increase soft-currency liabilities
- Reduce the level of cash,
- Tighten credit terms to decrease accounts
receivable, - Increase LC borrowing,
- Delay accounts payable, and
- Sell the weak currency forward.