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International: Financial Management

international financial mangemnet

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53 views

International: Financial Management

international financial mangemnet

Uploaded by

fatimamaham
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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INTERNATIONAL

FINANCIAL
MANAGEMENT
Fifth Edition
EUN / RESNICK

McGraw-Hill/Irwin Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Management of
Translation Exposure

10

Chapter Ten

Chapter Objective:
This chapter discusses the impact that
unanticipated changes in exchange rates may have
on the consolidated financial statements of the
multinational company.
10-2

Translation Methods
Current/Noncurrent

Method
Monetary/Nonmonetary Method
Temporal Method
Current Rate Method

10-3

Current/Noncurrent Method
The

underlying principal is that assets and


liabilities should be translated based on their
maturity.

10-4

Current assets translated at the spot rate.


Noncurrent assets translated at the historical rate in
effect when the item was first recorded on the books

Current/Noncurrent Method

Current assets
translated at the
spot rate.
e.g. 2 = $1

Noncurrent assets
translated at the
historical rate in
effect when the
item was first
recorded on the
books.
e.g. 3 = $1

10-5

Monetary/Nonmonetary Method

10-6

The underlying principle is that monetary accounts have a


similarity because their value represents a sum of money
whose value changes as the exchange rate changes.
All monetary balance sheet accounts (cash, marketable
securities, accounts receivable, etc.) of a foreign subsidiary
are translated at the current exchange rate.
All other (nonmonetary) balance sheet accounts (owners
equity, land) are translated at the historical exchange rate
in effect when the account was first recorded.

Monetary/Nonmonetary Method

10-7

All monetary balance


sheet accounts are
translated at the
current exchange
rate. e.g. 2 = $1
All other balance
sheet accounts are
translated at the
historical exchange
rate in effect when the
account was first
recorded. e.g.3 = $1

Temporal Method
The

underlying principal is that assets and liabilities


should be translated based on how they are carried
on the firms books.
Balance sheet account are translated at the current
spot exchange rate if they are carried on the books at
their current value.
Items that are carried on the books at historical costs
are translated at the historical exchange rates in
effect at the time the firm placed the item on the
books.
10-8

Temporal Method

10-9

Items carried on the


books at their
current value are
translated at the spot
exchange rate.
e.g. 2 = $1
Items that are
carried on the books
at historical costs are
translated at the
historical exchange
rates.
e.g. 3 = $1

Current Rate Method


All

balance sheet items (except for stockholders


equity) are translated at the current exchange rate.
Very simple method in application.
A plug equity account named cumulative
translation adjustment is used to make the
balance sheet balance.

10-10

Current Rate Method

10-11

All balance sheet


items (except for
stockholders equity)
are translated at the
current exchange
rate.
A plug equity
account named
cumulative
translation
adjustment is used
to make the balance
sheet balance

FASB Statement 52
The

Mechanics of the FASB 52 Translation


Process

Function Currency
Reporting Currency

Highly

10-12

Inflationary Economies

The Mechanics of FASB Statement 52


Function

Currency

The currency that the business is conducted in.

Reporting

10-13

Currency

The currency in which the MNC prepares its


consolidated financial statements.

The Mechanics of FASB Statement 52


Two-Stage

10-14

Process

First, determine in which currency the foreign entity


keeps its books.
If the local currency in which the foreign entity keeps its
books is not the functional currency, remeasurement into
the functional currency is required.
Second, when the foreign entitys functional currency is
not the same as the parents currency, the foreign entitys
books are translated using the current rate method.

The Mechanics of FASB Statement 52


Parents currency
Foreign
entitys books
kept in?

Nonparent
Currency

Functional
Currency?

Parents
Currency

Local currency
Current Rate
Translation

Parents Currency
10-15

Third

currency

Temporal
Remeasurement

Highly Inflationary Economies


Foreign

entities are required to remeasure


financial statements using the temporal method
as if the functional currency were the reporting
currency.

10-16

International Accounting Standards

10-17

Since January 2005, all companies doing business in the


European Union have to use the accounting standards
promulgated by the International Accounting Standards
Board (IASB).
Similar to the American FASB, the IASB publishes it
standards in a series of pronouncements called
International Financial Reporting Standards.
It also adopted and maintains the pronouncements of the
predecessor body, the IASC, called International
Accounting Standards (IAS).

International Accounting Standards


IAS

21, The Effects of Changes in Foreign


Exchange Rates is the European standard for
handling foreign currency translation.
IAS 21 most closely resembles the
monetary/nonmonetary translation method
discussed earlier in the chapter.
Thus, in the European Union, a different
translation method is used than in the United
States.
10-18

Management of Translation Exposure


Translation

Exposure vs. Transaction

Exposure
Hedging Translation Exposure
Balance Sheet Hedge
Derivatives Hedge
Translation Exposure vs. Operating
Exposure
10-19

Translation Exposure versus


Transaction Exposure
Translation

Exposure
The effect that unanticipated changes in
exchange rates has on the firms
consolidated financial statements..

Transaction

Exposure
The effect that unanticipated changes in
exchange rates has on the firms cash
flows.

10-20

Hedging Translation Exposure


If

the managers of the firm wish to manage


their accounting numbers as well as their
business, they have two methods for
dealing with translation exposure.
Balance Sheet Hedge
Derivatives Hedge

10-21

Balance Sheet Hedge


Eliminates

the mismatch between net


exposed assets and net exposed liabilities
denominated in the same currency.

Take

10-22

euro as an example

Assets
Cash
AR
Inventory
N FA
Exposed A
Liabilities
Accounts .P
Notes P
Long term D
Exposed L
Net exposure

Mexican
peso

Spanish euro

Ps 3000
9000
15000
46000
PS 73000

E 550
1045
1650
4400

PS 7000
17000
27000
PS 51000
PS 22000

E1364
935
3520

E7645

E 5819
E1826

Derivatives hedge
An

example would be the use of forward


contracts with a maturity of the reporting
period to attempt to manage the accounting
numbers.
Using a derivatives hedge to control
translation exposure really involves
speculation about foreign exchange rate
changes, however.
10-24

Example
Net exposed Euro 1826000
Euro depreciate from 1.1000/$1 to 1.1788/$1
Loss : $ 110704
Assume forward rate at the date of
consolidation is euro 1.1393/$1
Expected spot rate euro 1.1786/$1
Forward sale of euro 3782468 will hedge this
risk

Continued
Potential translation loss
f (R/F)-E[S( R/F)]
= 110704
1/(euro 1.1393/$1)-1/(euro 1.1786/$1)
= euro 3782468
Purchase of 3782468 at spot rate will
cost$3209289
Delivery of 3782468 at forward will yield $3319993
Profit $110704

Translation Exposure versus


Operating Exposure
The

effect that unanticipated changes in exchange


rates has on the firms ongoing operations.
a U.S. company that gets about 50% of its
revenues from overseas markets has factored in a
gradual decline of the U.S. dollar against major
global currencies say 2% per annum into its
operating forecasts for the next few years

10-27

If the U.S. dollar appreciates instead of


declining gradually in the years ahead, this
would represent economic exposure for the
company.
The dollars strength means that the 50% of
revenues and cash flows the company
receives from overseas will be lower when
converted back into dollars, which will have a
negative effect on its profitability.
.

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