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Lecture Financial risks management - Topic 7: Measuring and managing translation and transaction exposure

Topic 7 - Measuring and managing translation and transaction exposure. In this chapter, students will be able to understand: type of foreign exchange exposure; translation methods and FASB-52; methods for managing translation exposure; the definitions, implementation, and use of EaR to measure exchange rate risk. | Topic 7: Measuring and managing translation and Transaction exposure L. Gattis 1 Financial Risk Management Learning Objectives 2 Students understand and can recall type of foreign exchange exposure translation methods and FASB-52 methods for managing translation exposure the definitions, implementation, and use of EaR to measure exchange rate risk Students can calculate translation and transaction exposure and gain/loss Students can calculate EaR and CaR given balance sheet account information and exchange rate volatility Forex Exposure 3 I. Translation “Accounting” Exposure arises when reporting and consolidating financial statements require conversion from foreign currency to home currency. It is a possible accounting gain/loss on foreign assets and liabilities which are reported as losses in income or adjustments to equity (Translation exposures often lead to cashflow losses when account are liquidated) II. Cashflow Exposures Transaction Exposure: potential gains or losses on foreign transactions such as bond payments and receivables paid in the foreign currency. (Up until a payment is made, these are only translation exposures) Competitive Exposure: long-term exposure to currency change on future business. Types of Foreign Exchange Exposure Examples (U.S. MNC Perspective) 4 Translation Exposure Foreign subsidiary records ¥10,000 receivable at $.008/¥ spot exchange rate at time of sale ($80 book value), but yen devalues to $.007/¥ US$ value of receivable falls $10 to $70 which is reflected in parent company income statement or balance sheet It affects cashflows when the receivable is received Transaction Exposure Euro appreciates from $1.20 to $1.40 at the maturity of euro denominated bond that has a face value of €1,000 It costs $200 more to repay the bond after the appreciation. Competitive Exposure Your manufacturing facility is China is expected to become more costly in the future (in USD terms) due to the appreciation of the yuan. Translation Exposure . | Topic 7: Measuring and managing translation and Transaction exposure L. Gattis 1 Financial Risk Management Learning Objectives 2 Students understand and can recall type of foreign exchange exposure translation methods and FASB-52 methods for managing translation exposure the definitions, implementation, and use of EaR to measure exchange rate risk Students can calculate translation and transaction exposure and gain/loss Students can calculate EaR and CaR given balance sheet account information and exchange rate volatility Forex Exposure 3 I. Translation “Accounting” Exposure arises when reporting and consolidating financial statements require conversion from foreign currency to home currency. It is a possible accounting gain/loss on foreign assets and liabilities which are reported as losses in income or adjustments to equity (Translation exposures often lead to cashflow losses when account are liquidated) II. Cashflow Exposures Transaction Exposure: potential gains or losses on .