ChoiSM_ch11 - Chapter 11 Financial Risk Management...

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Chapter 11 Financial Risk Management Discussion Questions 1. Enterprise risk management assesses individual risks in the context of a firm’s business strategy. Risks are viewed from a portfolio perspective with risks of various business functions, e.g., FX risk, interest rate risk, political risk and the like, being coordinated by a senior financial manager responsible for keeping top management apprised of critical risks that could interfere with the accomplishment of a firm’s strategic objectives and devising risk optimization strategies. The variables that management accountants must track include factors both external and internal to the firm and varies from company to company. 2. Market risk refers to the risk of loss due to unexpected changes in the prices of currencies, interest rates, commodities, and equities. It is not confined to price changes. Market risk also includes liquidity risk, market discontinuities, credit risk, regulatory risk, tax risk, and accounting risk. An example of a foreign exchange risk is a situation where an exporter invoices a credit sale to a foreign importer in foreign currency and foreign currency devalues prior to payment. 3. An FX risk management program includes the following processes: a. Forecasting the expected movement in the relation between the yuan and your domestic currency. b. Measuring on a periodic basis your firm’s exposure to fluctuations in the value of the yuan. c. Designing protection strategies that will minimize losses should the yuan revalue. d. Establishing internal controls to measure your performance in hedging the risk of loss from changes in the value of the yuan. 4. Translation exposure measures the impact of exchange rate changes on the domestic currency equivalents of a firm s foreign currency assets and liabilities. It is primarily concerned with currency restatement. Transaction exposure measures the cash flow impact of fluctuating currency values on the settlement of commercial transactions denominated in foreign currencies. Transaction exposure is concerned with a currency conversion (exchange) process. Economic exposure attempts to measure the impact of changing exchange rates on the future revenues, costs, and sales volume of a multinational entity. It is concerned with the temporal effects of exchange rate changes. Although FAS No. 52 attempts to mitigate concern with translation gains and losses (accounting exposure), it does not totally eliminate it. Companies choosing the U.S. dollar as their functional currency will still use the temporal translation method and report translation gains and losses in period income. Companies designating the local currency as the functional currency will find their asset exposures increased as inventories and fixed assets are translated using current exchange rates. While such translation gains and losses bypass income, the adverse effects of currency fluctuations on a company’s consolidated equity will still exist. This is especially likely where loan covenant and other contractual provisions specify minimum
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This note was uploaded on 04/07/2009 for the course ACT - taught by Professor Burks during the Spring '09 term at Troy.

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ChoiSM_ch11 - Chapter 11 Financial Risk Management...

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