3. Transaction exposure
ā¢ It stems from transactions that give rise to known contractually
determined future foreign-currency denominated cash inflows or
outflows
ā¢ Examples: cross border trade, borrowings and lending's in foreign
currency, and the local purchases and the sales of foreign
subsidiaries
ā¢ If exchange rates changes between time of transaction and time of
settlement, the value associated foreign currency cash flow
changes, resulting in currency gains and losses.
ā¢ Example: If an Indian exporter has a receivable of $100000 due
three months hence in the meanwhile the dollar depreciates
relative to the rupee, a cash loss occurs.
ā¢ Similarly if the dollar appreciates relative to the rupee, a cash gain
occurs.
ā¢ Where in case of payable it is opposite
ā¢ Appreciation=loss
ā¢ Depreciation=profit
4. Where it is should be recorded and at
what rate???
ā¢ These foreign currency transactions are recorded in
books of account at average rate for the month. And the
difference between rates of payable and receivable
country are accounted in profit and loss account.
ā¢ At each balance sheet date
ā¢ A) foreign currency monetary items should be reported
using the closing rate.
ā¢ B) non monetary items which are carried at historical cost
should be reported using the exchange rate.
ā¢ C) non monetary items which are carried at fair value or
other similar valuation should be reported using the
exchange rates that existed when the values were
determined.
5. ā¢ Exchange differences arising on the settlement of
monetary items should be recognized as income or as
expenses in the period in which they arise.
ā¢ Forward exchange contract is entered in to as a hedge,
the premium or discount arising at the inception of the
contract should be amortized as expense or income over
the life of the contract.
6. Translation exposure(Accounting Exposure)
ā¢ It stems from the need to convert the financial statements
of foreign operations from foreign currencies to domestic
currency for purposes of reporting and consolidation.
ā¢ If the exchange rate is changed in comparison with
previous reporting period then the translation of foreign
currency will result in foreign exchange gains or losses.
ļ¶ translation gains does not involve cash flow as they are
purely paper gains/losses except when they have some
tax implications.
7. ā¢ The method used for translating foreign currency statements
depends on the nature of relationship between the parent and the
foreign operations.
Foreign operations
Integral foreign
operations
It carries out business as
it is an extension of
operation of the parent
Independent
foreign operations
It runs as a separate
enterprise
8. Where to record and at which rate?
Integral Foreign operations
ā¢ Monetary assets and liabilities are translated at the
exchange rate.
ā¢ Non monetary assets are translated at the historical rates.
ā¢ The items in the profit and loss account are translated at
the average exchange rate.
ā¢ The difference arising out of the translation are
recognized in the profit and loss account.
9. Where to record and at which rate?
Non-Integral Foreign operations
ā¢ The assets and liabilities ,both monetary and non integral
foreign operation should be translated at a closing rate.
ā¢ Income and expense item should be translated at exchange
rate at the dates of the transaction,
ā¢ All exchanges difference should be accumulated in foreign
currency translation reseve until the disposal of the net
investment.
ā¢ The income tax requires that foreign currency liabilities are
āmarked to marketā at the exchange rate prevailing on the date
of casting the balance sheet.
ā¢ If the foreign currency liability increases( decreases) on such
revaluation the value of the fixed asset is correspondigly
increased (decreased).
ā¢ Depericiation is admissible on such revalued assets.
10. Operating Exposure
ā¢ It is similar to transaction exposure
ā¢ It involves an actual or potential gain or loss.it is realted to
entire investment.
ā¢ The essence is that exchange rate changes significantly
alter the cost of a firmās inputs and the prices of its output
and thereby influence its competitive position
substantially.
11. Example of Volkswagen
ā¢ Volkswagen had a highly successful export market for its
āBeetleā model in the us before 1970
ā¢ With the break down of the Bretton wood system of fixed
exchange rates, the deutschemark appreciated
significantly against the dollar.
ā¢ This created problem for Volkswagen as its expenses
were mainly in Deutschemark but its revenues in dollars.
ā¢ However in a highly price-sensitive us market such an
action caused a sharp decrease in sales volume from
600000 vehicles in 1968 to 200000 in 1976
12. Example of east Asian crises
ā¢ East Asian crises was in 1997
ā¢ Currencies of several east Asian countries fell sharply
ā¢ Exports from these countries very competitive in
advanced markets.
ā¢ As a consequence, gems and jewelry exports from India
suffered competitive disadvantages vis-Ć -vis their rivals
from south east Asian.