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FIN 456, Chapter 10
Finance 456, Chapter 10
18
Finance
Undergraduate 4
11/22/2009

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Term
Economic Exposure
Definition
= Transaction exposure + Operating exposure
arises because exchange rate changes alter the value of future revenue and costs
Term
Accounting Exposure
Definition
Arises when reporting and consolidating financial statements require conversion from subsidiary to parent currency
Term
Alternative Currency Translation Methods (4)
Definition
Current/Non-Current Method
Monetary/Non-Monetary Method
Temporal Method
Current Rate Method
Term
FASB Rule 52
Definition
Mandates the use of the Current Rate method to translate foreign currency denominated assets and liabilities into dollars
Distinction created between functional and reporting currency.
Transaction gains or losses appear on foreign unit income statement and recorded in separate equity account on balance sheet called Cumulative Translation Adjustment Account
Term
Additional Items to Study
Definition
Sample Problem, FASB 52
Hedging Methods
Exhibit 10.6, 10.7, 10.8 in notes
Term
IASB: International Accounting Standards Board
Definition
London based entity with mission to create globally accepted accounting standards.
Adopted by EU, 2005
Term
Norwalk Agrreement
Definition
Memorandum of understanding with FASB to coordinate and remove differences between FASB and IASB.
Barriers to achieving conversion are great, and complex.
PHILOSOPHY is greatest complexity: FASB has rules for everything, IASB morality driven.
Term
Hedging
Definition
Establishing an offsetting currency position. Whatever is lost or gained by the original position is offset by the hedge.
Alternative Definition: To Lock in Home currency value
Basic Intention: Reduce/eliminate volatility of earnings.
Term
Hedging Costs
Definition
There is always a cost incurred with Hedging. Should be looked at like purchasing insurance.
Term
Forward Market Hedge
Definition
If "long" a foreign currency, Sell the foreign currency forward.
If "short" a foreign currency, buy the foreign currency forward
Term
Money Market Hedge
Definition
Involves simultaneously borrowing and lending activities in two currencies (A "homemade forward contract")
Term
Risk Shifting
Definition
Eliminate transaction risk by pricing contracts in home currency (home currency invoicing)
* Common in global business: Firms will invoice exports in strong currency/Import in weak currency. (Not possible with informed customers.)
Term
Pricing Decisions
Definition
Foreign currency contract prices should factor in possible exchange rate changes.
(Home currency price on foreign sales should be converted at forward rate, not the spot rate.)
Build exchange rate fluctuations into price.
Term
Exposure Netting
Definition
The net gain or loss on the entire currency portfolio is what matters, not individual transactions.
Term
Currency Risk Sharing
Definition
Parties agree to share currency risk.
Usually price adjustment clause in contract to reflect changing exchange rate
Term
Currency Collars AKA Range Forward
Definition
Brings in 3rd parties. (Cheaper than a forward)
Contract with third party purchased to protect movement of currency outside a specific range.
Term
Cross Hedging
Definition
When forward contracts are not available in certain currency.
Answer: Engage in a forward contract in a related, CORRELATED currency.
Term
Basic Asset and Liability Strategy
Definition
Hard Currency (Likely to appreciate) VS Soft Currency (Likely to depreciate)
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