Measuring and Managing Translation and Transaction Exposure

1
Measuring and Managing Translation and
Transaction Exposure

• Chapter 10

2
??????????????

• 10.1 ???????????
• 10.2 ????????
• 10.3 ??FASB-52
• 10.4 ??????
• 10.5 ??????
• 10.6 ??????

3
PART 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.

4
Accounting Exposure

• Accounting Exposure
• Transaction risk???? Translation risk????

5
How Accounting Exposure Arises

• Translation Risk

United States
Japan
Headquarters Consolidated Financials


Subsidiary Financials
Subsidiary Financials



Germany
Subsidiary Financials

6
????

• ???????(accounting exposure)
• ???????,????????????????????????????????
• ???????????????
• ???????????
• ??????????,???????????
• ??????????????????????????

7
ALTERNATIVE 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.

8
???? 1/2

• ????????,?????????
• ??2???
• ????
• ?????????????,??????????????
• ????????????????????,??????????????
• ???????????,??????????,??,????????????,???????????

9
???? 2/2

• ????
• ???????,??????????????
• ????????????????????????????
• ?????????,????????????????,?????????

10
PART II. ALTERNATIVE CURRENCY TRANSLATION METHODS
1/2

• ??????????????????????,?????????????????????,?????
  ??????????????
• ???????????????,????,????????????????

11
PART II. ALTERNATIVE CURRENCY TRANSLATION METHODS
2/2

• ?????????
• ???/?????
• ???/??????
• ???
• ?????

12
PART 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.

13
???/????? 1/2

• ?????????????????????????(current exchange
  rate)????????
• ????????????????????????
• ????????????????

14
???/????? 2/2

• ??????,???????????????????????????,???????????????
  ?
• ???????????????????????????????

15
ALTERNATIVE CURRENCY TRANSLATION METHODS

• B. Monetary/Nonmonetary Method???/?????
• 1. Monetary accounts use current rate
• 2. Pertains to
• - Cash
• - Accounts receivable
• - Accounts payable
• - Long term debt

16
ALTERNATIVE 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.

17
???/????? 1/2

• ????????
• ????????????????????,???????????????????
• ???????????????
• ?????(???????????????????)???????,???????(??????
  ????????)?????????

18
???/????? 2/2

• ????????????????????????????,?????????????
• ??????????????????????????????

19
ALTERNATIVE CURRENCY TRANSLATION METHODS

• C. Temporal Method???
• 1. Similar to monetary/nonmonetary
• method.
• 2. Use current method for inventory.

20
??? 1/2

• ???/?????????
• ?????
• ??????,????????????,??????????????????,???????????
  
• ??????
• ????/?????????,???????????????????
• ????????,?????????????????(?????????)

21
??? 2/2

• ?????????????????????,??,?????????????????????????
  ???????????????????

22
ALTERNATIVE CURRENCY TRANSLATION METHODS

• D. Current Rate Method?????
• all statements use current exchange rate for
  conversions.

23
?????

• ???????????????????????????????
• ???????????????
• ????????????????????????,??????????,????????????

24
FASB-8

• ???????
• ????(temporal method)???
• ?????????????????
• ????????????????(????????)???(??)?
• ??
• ??????????????
• ???????????????????????????????????

25
FASB-52

• ?1981???
• ???????????????????????
• ???????????????????????????????????,??????????????
  ???
• ???????
• ??????????????????????????,?????????
• ????????????????

26
FASB-52????? 1/2

• ?????(functional currency)
• ??????????????????
• ???????????????????????
• ?????(hyperinflationary country,??????????????????
  100???),?????????

27
FASB-52???? 2/2

• ?????
• ????????????????????
• ???????????????

28
FASB-52??????

• ????????????????????????,??????????
• ?????????,???????????????????????????????????????
  
• ??????????????,??????????????????
• ????????????????????,??????????????????????,??????
  ?????????????????????

29
FASB-52??? 1/3

• Sterling Ltd.???????????????
• ??????????????,??????1???1.50???
• ???????11.40
• ?????11.30
• ????????11.45
• ?????200?
• ????????0????200?

30
FASB-52??? 2/3
?? 10.4 Sterling Ltd. ??????,FASB-52 (????)
31
FASB-52??? 3/3
?? 10.5 Sterling Ltd. ????????,FASB-52 (????)
32
FASB-52?????

• ????????????????,?????????????,???????????????
• ????????????????????????????,????????????,??????
  ????????????????????????????

33
????

• ????????????????????????????????
• ???????????????????????????
• ???????,????????Sterling Ltd.
• ??????120,000(?1,000,000?880,000),
• ??????580,000(?????????????120,000???700,000?????
  ???)?

34
PART 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.

35
Sample 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

36
Sample 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

37
Sample Problem

• This involves a translation loss for American
  Golf of
• 203,200 188,800 14,400

38
PART TWO
Managing Translation and Transaction Exposure
39
PART 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.

40
DESIGNING A HEDGING STRATEGY

• C. Hedging exchange rate risk
• 1. Incurs a cost
• 2. Should be evaluated as a purchase of
  insurance.

41
DESIGNING A HEDGING STRATEGY

• D. Centralization is key

42
??????? 1/2

• ???(centralization)???
• ??,??????(treasurer)?????????????????,???????????
• ???????????????????(portfolio effect)?????????????
  ???????
• ?????????????????????????????,??????????????

43
??????? 2/2

• ???(decentralization)???
• ?????????,???????????,????????????????????????????
  ???????
• ???????????????????????????,????????????????

44
?????????

• ????(Exposure Neting)
• ????????????????
• ??????????????????????,?????????????????(??)??????
  ??????(??)????

45
???????? 1/3

• ????(Orange County)?????(Barings
  PLC)???,??Metallgesellschaft?Kidder
  Peabody?????(Sumitomo)???????(Union Bank of
  Switzerland)???(Procter Gamble)?????????

46
???????? 2/3

• ??????????????????????,??????????????????
• ???????????????????????????
• ??????????????????????????,???????????????????????
  ???????
• ???????????????????????????

47
???????? 3/3

• ????????
• ???????????????????????????????

48
??????
?? 10.8 ?????????????
49
????????? 1/3

• ??????
• ???????????????????????(??????),?????????????????
  
• ???????????
• ?????????????????????????????????????????????????
  ????????????

50
????????? 2/3

• ???????????????????????????,?????????????????,???
  ?????????????????

51
????????? 3/3

• ??????
• ??????????
• ????????????????????????????
• ????
• ??????????????????????,???????????????????

52
??????? 1/2

• ????????????????????????????????
• ??1
• ?????????????????????????
• ???????????,???????????????,??????,?????(arbitrage
  ) ?

53
??????? 2/2

• ??2
• ?????????????????,????????????????
• ???????????????????,???????????????????????

54
PART 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

55
MANAGING 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.

56
MANAGING 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.

57
The Zone

• Take no actions

1.50/
1.60/
Take no action
58
MANAGING 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.

59
????(risk shifting)??????(currency risk sharing)

• ????(risk shifting)
• ???????,????????????
• ???????,????????????

60
????(risk shifting)??????(currency risk sharing)

• ??????(currency risk sharing)
• ???????????????????????(price adjustment clause)
  
• ????????(neutral zone),?????,??????????????

61
???????? 1/2

• ??????0.981.02/
• ????????1.00?????
• ???????,??1.10
• ???????,??0.90

62
?? 10-11 ???????
63
MANAGING 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.

64
MANAGING 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.

65
MANAGING 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.

66
PART 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.

67
MANAGING TRANSLATION EXPOSURE

• 2. Forward contracts
• Reducing a firms translation exposure by
  creating an offsetting asset or liability in
  the foreign currency.

68
MANAGING 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.

69
Managing 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.

70
MANAGING 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.