ch10 - INSTRUCTORS MANUAL: MULTINATIONAL FINANCIAL...

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INSTRUCTORS MANUAL: MULTINATIONAL FINANCIAL MANAGEMENT , 9 th ED. CHAPTER 10 MEASURING AND MANAGING TRANSLATION AND TRANSACTION EXPOSURE This chapter introduces the concept of accounting exposure and describes the various alternatives available to measure accounting exposure and to manage it. A key point is the wide disparity in results possible for similarly situated firms when using different measures of translation exposure. Although the material is fairly mechanical, financial officers of MNCs should understand how companies measure exposure, at least for reporting purposes. When it comes to managing accounting exposure, companies have a number of different alternatives. Before deciding on which hedging alternatives to use, however, companies must first decide what they are trying to accomplish through their hedging program. K EY P OINTS ON M EASURING A CCOUNTING E XPOSURE 1. Accountants are concerned with the appropriate way to translate foreign currency-denominated items on financial statements to their home currency values. If currency values change, translation gains or losses may result. 2. There are four principal translation methods available: the current/noncurrent method, the monetary/nonmonetary method, the temporal method, and the current-rate method. 3. The past and present mandated translation methods are FASB-8 and FASB-52, respectively. 4. Regardless of the translation method selected, measuring accounting exposure is conceptually the same. It involves determining which foreign currency-denominated assets and liabilities will be translated at the current (postchange) exchange rate and which will be translated at the historical (prechange) exchange rate. The former items are considered to be exposed, while the latter items are regarded as not exposed. Translation exposure is just the difference between exposed assets and exposed liabilities. 5. By far the most important feature of the accounting definition of exposure is the exclusive focus on the balance sheet effects of currency changes. This focus is misplaced since it has led firms to ignore the more important effect that these changes may have on future cash flows. K EY P OINTS ON M ANAGING A CCOUNTING E XPOSURE 1. Hedging cannot provide protection against expected exchange rate changes . Firms ordinarily cope with anticipated currency changes by engaging in forward contracts, borrowing locally, and adjusting their pricing and credit policies. However, there is reason to question the value of much of this activity. Several empirical studies indicate that forward rates provide an unbiased estimate of future spot rates. Furthermore, according to the international Fisher effect, interest differentials between currencies equal anticipated currency devaluations or revaluations. This proposition is also supported by empirical research. What this means is that gains or losses on contractual flows in hard currencies (those likely to revalue) will be
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ch10 - INSTRUCTORS MANUAL: MULTINATIONAL FINANCIAL...

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