...Foreign Currency Transactions IAS 21 The Effects of Changes in Foreign Exchange Rates AND IAS 39 Financial Instruments: Recognition and Measurement Five Basic Types of Transactions: 1. Non-hedged foreign currency transactions (p.p.523-527)(example provided) • use two transaction approach – record transaction at spot rate (IAS 21.21) and adjust monetary asset or liability to year end spot rate through profit or loss (IAS 21.23) • foreign currency gains/losses will occur throughout the transaction 2. Speculative foreign currency positions (p.p.527-530)(example provided) • occurs when a company is essentially betting that a foreign currency will either appreciate (take a long position) or depreciate (take a short position) • since the transaction is speculative, it is by definition not hedged and hence any gains and losses will be recorded in income • If a forward exchange contract is used, both the receivable and payable to the bank will be recorded in journal entries, but will be netted against each other for financial statement presentation purposes Hedges • Used when there is both a hedged item (i.e. a receivable, payable, future cash inflow or future cash outflow) and a hedging item (forward exchange contract, offsetting loan payable or receivable) • Firms with good borrowing and investing capacity can replicate a forward exchange contract by borrowing and lending in foreign currencies...
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...Chapter 9 Foreign currency transactions and Hedging foreign exchange risk Answers to Questions 1. Under the two-transaction perspective, an export sale (import purchase) and the subsequent collection (payment) of cash are treated as two separate transactions to be accounted for separately. The idea is that management has made two decisions: (1) to make the export sale (import purchase), and (2) to extend credit in foreign currency to the foreign customer (obtain credit from the foreign supplier). The income effect from each of these decisions should be reported separately. 2. Foreign currency receivables resulting from export sales are revalued at the end of accounting periods using the current spot rate. An increase in the value of a receivable will be offset by reporting a foreign exchange gain in net income, and a decrease will be offset by a foreign exchange loss. Foreign exchange gains and losses are accrued even though they have not yet been realized. 3. Foreign exchange gains and losses are created by two factors: having foreign currency exposures (foreign currency receivables and payables) and changes in exchange rates. Appreciation of the foreign currency will generate foreign exchange gains on receivables and foreign exchange losses on payables. Depreciation of the foreign currency will generate foreign exchange losses on receivables and foreign exchange gains on payables. 4. Hedging is the process of eliminating exposure to foreign exchange risk...
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...multinational accounting: foreign currency transactions and financial instruments L.O.11-1: Understand how to make calculations using foreign currency exchange rates The accounting issues * Foreign currency transactions of a U.S. company include sales, purchases, and other transactions giving rise to a transfer of foreign currency or the recording of receivables or payables that are denominated in a foreign currency. * Translation is the process of restating foreign currency transactions to their U.S. dollar equivalent values. * Many U.S. corporations have multinational operations. * The foreign subsidiaries prepare their financial statements in their home currencies * The foreign currency amounts in these financial statements have to be translated into their U.S. dollar equivalents before they can be consolidated with the U.S. parent’s financial statements that uses U.S. dollar as its reporting currency unit Foreign currency exchange rates * Foreign currency exchange rates between currencies are established daily by foreign exchange brokers who serve as agents for individuals or countries wishing to deal in foreign currencies * Some countries maintain an official fixed rate of currency exchange and have established fixed exchange rates for dividends remitted outside the country. * The determination of exchange rates * Exchange rates change because of a number of economic factors affecting the supply of and demand for a nation’s currency. * Factors...
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...not assume any foreign exchange risk. Foreign exchange risk is a core risk to Aspen’s business because they have many customers outside of the United States. We believe that transferring this risk to the customers would limit Aspen’s growth on the foreign markets: Aspen should keep its current marketing strategy, which includes credit installment payments and payments in local currencies for Japan, the UK and Germany. The current risk management program hurts the company because it doesnot consider Aspen’s expenses abroad that balance sales exposures to currency fluctuations. We then recommend that Aspen hedge completely its exposure but after “natural hedging”, which we recommend increasing thanks to the larger financial capacities allowed by its IPO. Using options for aggregated positions (by estimating yearly sales per currency),rather than having multiple forwards contracts, seems reasonable becauseit would enable the company to benefit from good moves in the currency exchange rates, to pay less in transaction costs because of the larger amounts and at the same time use its current human resources (limited hedging skills) by avoiding complex, expensive products. Business and Marketing Strategy Aspen Tech’s business strategy and marketing strategy create financing needs due to the position Aspen puts itself in with its customers. Aspen allows installment payments that hurt the company’s cash flows and in turn require financing to generate enough cash flow to pay for Aspen’s...
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................................ 1 1.0 Sizable exposure to the foreign exchange risk .............................................................................. 1 2.0 Types of exposure ............................................................................................................................ 1 2.1 Capital Adequacy ........................................................................................................................ 2 2.2 Cash flow ...................................................................................................................................... 2 2.3 Fair value & income statement .................................................................................................. 3 2.4 Net investment in foreign operations ......................................................................................... 3 2.5 Translation exposure................................................................................................................... 3 Question 2 ............................................................................................................................................... 3 3.0 Policies of managing foreign currency exchange rate risk .......................................................... 3 3.1 Holding and issuing derivative financial instruments .............................................................. 4 3.1.1 Cash flow hedges ..............................................................
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...Exposure………………………………………………………………………..9 3. Transaction and Translation Exposure…………………………………………….……..11 4. Other Strategies used by Companies to Hedge Exposure……………………...………19 5. Case Studies: Hedging Strategy used by Companies………………………….………..20 2 INTRODUCTION Foreign exchange exposure represents a material risk for multinational corporations which are unrelated to business operations. One needs to identify each foreign exchange exposure, the risk it represents and methods and costs available to limit such exposure. The value of a firm’s assets, liabilities and operating income changes continuously due to change in factors such as exchange rates, interest rates, inflation etc. In other words, a firm is “exposed” to uncertain changes in a number of variables in its environment. Exposure may therefore be defined as a measure of sensitivity of the value of a financial item to changes in the macro economic variables mentioned above. Risk refers to the variability of the value of the item. FOREIGN EXCHANGE EXPOSURE Foreign Exchange Exposure occurs because of unanticipated change in the exchange rate. For example the difference in the spot rate & one month forward rate is 0.30 rupee per USD and after one month rupee depreciates by 30 paisa there would be no FE exposure but if actual depreciation is more, then exposure would be said to exist. The definition of foreign exchange exposure can be summarized using the following equation: ΔV=β0 + β1 (ΔSu) where: V is the change in the value of the...
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...Measuring/Managing Translation and Transaction Exposure Chapter 10 Lecture Notes Measuring Translation and Transaction Exposure 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. Accounting Exposure B. Accounting Exposure = Transaction risk + Translation risk [pic] 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. PART II. ALTERNATIVE CURRENCY TRANSLATION METHODS (ACCY) 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. B. Monetary/Nonmonetary Method 1. Monetary accounts use current rate 2. Pertains to - Cash - Accounts receivable - Accounts payable - Long term debt 3. Nonmonetary accounts - Use historical rates - Pertains to: Inventory, Fixed assets, Long term investments 4. Income statement accounts - Use average...
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...TECHNOLOGY INC.: Currency Hedging Review 1) What are Aspen Technology’s main exchange rate exposures? How does Aspen Tech’s business strategy give rise to these exposures as well as to the firm’s financing need? The main exchange rates exposures are: British pounds, Deutsch Mark, Japanese Yen and Belgian Francs. Aspen faces foreign currency risks due to sales and expenses in those foreign currencies. Expenses include R&D costs (20% of overall R&D are in UK), headquarters, sell force etc. and represent 52% of Aspen expenses. If Aspen sells its products in local currency, it’s because its clients need to plan their P&L and don’t want to see their expenses fluctuate with the currency change. Besides, Aspen grants deferred payment for 5 years, impacting heavily their working capital. They can afford to grant 5 years receivable because their clients are highly rated multinational, which cannot cancel the payment (that carry a huge financing spread) and the market’s demand is inelastic. The market is looking for high quality product: with two years development needed to get a customized software, the switching costs is very high and benefits to Aspen (90% of its clients re-conduct their contracts). However, Aspen succeed to finance its need by selling its receivables to two financial institutions - guarantying a hedge to the currency - depending on the nature of the receivable (where it comes from, the amount etc.). Aspen hedge all its receivable and do not use...
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...sound-proof currency hedging strategy in place to manage the risks. Aspen’s current currency hedging strategy is to hedge 100% of its booked sales. This is an unnecessary strategy, primarily because Aspen turns around and sells these receivables for cash. We would therefore recommend that Aspen only hedge the portion of receivables that they do not sell right away. They should then maintain an active strategy of hedging in the future any further sales of receivables. Also, since Aspen is selling these receivables with limited recourse, they should hedge the amount of these receivables equal to the portion of receivables held in allowance for doubtful accounts. This way they will only be risking the credit of these accounts and not currency risk on top of that. As a measure of risk, Aspen could calculate VaR for their cash flows. For each time period in the future, they could calculate the 99% VaR using historical currency data. This can give them a better idea of the safety or lack there of their cash flows. Another issue that Aspen has not been addressing is their expenses in foreign countries. They have not been adjusting hedging policies for these expenses, and they should be. A simple solution to this problem would be to set aside a portion of each country’s sales proportionate to the estimated expenses. Therefore any fluctuations in that country’s currency would not affect Aspen. In the case of entering a new country with its own currency, they can subtract...
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...BACKER ADHESIVES CASE STUDY | Foreign Exchange Risk Management | Date | 3, Sep, 2014 | | | | Paper | Managing Global Business | Lecturer | Dr. Romie Littrell | | | | Student | Siyoung Jo / Zongjie Liu / Kathy Liu | Introduction Brief Company Situation Baker Adhesives is a small company which made specialty adhesives in USA. Market was dominated by a handful of big competitors with international access and slim margins. Baker specialized in accommodating specialty markets with consistent sales and relatively high margins. However, US Manufacturers were relocating overseas and achieved “Economy of Scale”. Therefore Baker Adhesives would be under intense pressure of finding markets abroad. Baker had no long debt but line of credit of USD 180,000 and had an excellent relationship with the local bank from the beginning. The production facilities are old but were readily adaptable and had been well maintained. Baker also possessed a good chemist and a flexible production system, even though his father who was a brilliant chemist and the founder of this company had recently retired. * 2. Problem finding In Feb. 2006, Baker’s first international foray was dealing with Brazilian toy manufacturer Novo of 1,210 gallons. Novo was considering a second order 50% larger than original one. Baker was excited about the fact that they can expand their business to abroad as well as they can generate big margins from their sales with Novo. ...
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...90-day forecasts of the percentage rate of depreciation of the dollar relative to the yen is 4%. a. Provide a qualitative description of Intel’s transaction exchange risk. Answer: Intel is a U.S. company, and it is scheduled to receive yen in the future. A weakening of the yen versus the dollar causes a given amount of yen to convert to fewer dollars in the future. This loss of value could be severe if the yen depreciates by a significant amount. b. If Intel chooses not to hedge its transaction exchange risk, what is Intel’s expected dollar revenue? Answer: If Intel chooses not to hedge, the expected dollar revenue is the expected dollar value of the ¥100,000,000. The expected spot rate incorporates a 1% weakening of the dollar. This means that the expected yen price of the dollar is 1% less than the current spot rate of ¥103/$ or Et[S(t+90,¥/$)] = 0.99 [pic]¥103/$ = ¥101.97/$ Hence, Intel expects to receive ¥100,000,000 / ¥101.97/$ = $980,681 c. If Intel does not hedge, what is the range of possible dollar revenues that incorporates 95.45% of the possibilities? Answer: We are told that the standard deviation of the rate of depreciation of the dollar is 4%. The standard deviation of the future spot rate is therefore 4% of the current spot rate or 0.04 [pic]¥103/$ = ¥4.12/$. Thus, plus or minus 2 standard deviations around the conditional expected future spot rate is ¥101.97/$ + ¥8.24/$ = ¥110.21/$ ¥101.97/$ - ¥8.24/$ =...
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...equity instrument of another entity. Such a definition, in turn, generates a need to define a financial asset; a financial liability; and, an equity instrument. According to paragraph 11 of AASB 132, ‘financial asset’ means any asset that is: (a) cash; (b) an equity instrument of another entity; (c) a contractual right: (i) to receive cash or another financial asset from another entity; or (ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; or (d) a contract that will or may be settled in the entity’s own equity instruments and is: (i) a non-derivative for which the entity is or may be obliged to receive a variable number of the entity’s own equity instruments; or (ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments. For this purpose the entity’s own equity instruments do not include instruments that are themselves contracts for the future receipt or delivery of the entity’s own equity instruments. A financial liability, on the other hand, means any liability that is (a) a contractual obligation: (i) to deliver cash or another financial asset to another entity; or (ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity; or a contract that will or may be settled in the entity’s...
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...Chapter 17 International Accounting and Financial Management True / False Questions 1. The purpose of all accounting is to provide internal and external decision-makers with the financial data they need to make their decisions. True False 2. There are three points at which operating in a foreign currency raises accounting issues: when transactions are made in foreign currencies, when foreign subsidiaries consolidate their results to the parent company, and when debt is acquired in foreign currencies. True False 3. FASB 52 requires that companies record foreign currency based transactions at the spot rate at the time of the transaction. True False 4. Consolidation is when a company's various results are aggregated into one report. True False 5. The current rate translation method translates current assets at the rate in effect when they were acquired. True False 6. The temporal method of translation translates fixed assets at the rates in effect the day the assets were acquired. True False 7. Whether to use the current or temporal rates depends on the functional currency of the foreign operation. True False 8. Accounting is an objective, fact-based discipline and not influenced by culture. True False 9. Accounting standard convergence is unlikely, given the complexities of the systems, all of which would require harmonization. True False 10. With convergence...
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...Why should we hedge? Business is exposed to several risks, currency risk being one of them Objective of hedging is to ensure: Predictability in Income Statement thereby reducing cash flow volatility. Revenue is generated & receivables are collected at budgeted rates Maintaining margins on long term projects as these projects are priced & bid with an exchange rate assumption, which needs to be protected to ensure desired margins Managing the translation risks in case of multiple geographies & overseas entities Best Practices A good risk management and hedging policy should be debated, understood & approved at the highest level (Board) The policy should indentify risks entity is exposed to, ways to measure these risks & suggest methods to mitigate these risks Should specify clear identification of responsibilities, authorities & limitations on its implementation Should state the purpose of hedging clearly - profit, protection, reducing volatility. Should suggest appropriate risk management tools like Sensitivity Analysis, VAR to contain risks Should be reviewed periodically by board in view of changing risks, market dynamics. Enctheirage use of natural hedges to reduce hedging costs METHODS OF HEDGING Methods of hedging can be classified as a. Internal methods b. External methods ...
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...Transaction Exposure When conducting business aboard, cash inflows are affected when a variety of currencies are involved. In the case of Nike’s proposal to expand in India, there are ways to migrate exchange rate risks by exposing the possible risks before they affect the company’s profit margin. One method is the transaction exposure. Transaction exposure is the degree to which the value of future cash transactions that are affected by exchange rate fluctuations. According to Madura, “Transaction exposure can have a substantial impact on a firm’s earnings. It is not unusual for a currency to change by as much as 10 percent in a given year. If an exporter denominates its exports in a foreign currency, a 10 percent decline in that currency will reduce the dollar value of its receivables by 10 percent. This effect could possibly eliminate any profits from exporting” (Thomson South-Western 2006). To assess transaction exposure, Nike will need to estimate its net cash flows in each currency and measure the potential impact of the currency exposure. According to Madura, “To measure its transaction exposure, an MNC needs to project the consolidated net amount in currency inflows or outflows for all its subsidiaries, categorized by currency….Estimating the consolidated net cash flows per currency is a useful first step when assessing an MNC’s exposure because it helps to determine the MNC’s overall position in each currency” (Thomson South-Western 2006). The standard deviation...
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