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= Transaction exposure + Operating exposure arises because exchange rate changes alter the value of future revenue and costs |
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Arises when reporting and consolidating financial statements require conversion from subsidiary to parent currency |
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Alternative Currency Translation Methods (4) |
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Current/Non-Current Method Monetary/Non-Monetary Method Temporal Method Current Rate Method |
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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 |
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Additional Items to Study |
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Definition
Sample Problem, FASB 52 Hedging Methods Exhibit 10.6, 10.7, 10.8 in notes |
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IASB: International Accounting Standards Board |
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London based entity with mission to create globally accepted accounting standards. Adopted by EU, 2005 |
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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. |
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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. |
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There is always a cost incurred with Hedging. Should be looked at like purchasing insurance. |
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If "long" a foreign currency, Sell the foreign currency forward. If "short" a foreign currency, buy the foreign currency forward |
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Involves simultaneously borrowing and lending activities in two currencies (A "homemade forward contract") |
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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.) |
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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. |
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The net gain or loss on the entire currency portfolio is what matters, not individual transactions. |
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Parties agree to share currency risk. Usually price adjustment clause in contract to reflect changing exchange rate |
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Currency Collars AKA Range Forward |
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Definition
Brings in 3rd parties. (Cheaper than a forward) Contract with third party purchased to protect movement of currency outside a specific range. |
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When forward contracts are not available in certain currency. Answer: Engage in a forward contract in a related, CORRELATED currency. |
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Basic Asset and Liability Strategy |
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Definition
Hard Currency (Likely to appreciate) VS Soft Currency (Likely to depreciate) |
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