Chapter 11 Notes

Chapter 11 Notes - Chapter 11 Transaction Exposure...

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Chapter 11 Transaction Exposure Questions 11-1. Foreign Exchange Exposure. Give a general definition of “foreign exchange exposure” as it relates to the operations of a multinational enterprise. In its most general sense, foreign exchange exposure is the possibility of either beneficial or harmful effects on a company caused by a change in foreign exchange rates. The effect on the company may be on its profits, its cash flows, or its market value. 11-2. Exposure Types. Explain the differences among transaction, operating, and translation exposure. a. Transaction exposure is the potential for a gain or loss in contracted-for, near-term cash flows caused by a foreign-exchange-rate-induced change in the value of amounts due to the MNE or amounts that the MNE owes to other parties. As such, it is a change in the home currency value of cash flows that are already contracted for. b. Operating exposure is the potential for a change in the value of an MNE, usually viewed as the present value of all future cash inflows, caused by unexpected exchange rate changes. As such, it is a change in expected long-term cash flows; i.e., future cash flows expected in the course of normal business but not yet contracted for. c. Translation exposure is the possibility of a change in the equity section (common stock, retained earnings, and equity reserves) of an MNE’s consolidated balance sheet, caused by a change (expected or not expected) in foreign exchange rates. As such it is not a cash flow change, but is rather the result of consolidating into one parent company’s financial statement the individual financial statements of related subsidiaries and affiliates. 11-3. Translation versus Transaction Exposure. How do translation exposures and a transaction exposures alter corporate cash flow? Translation exposure measures accounting (book) gains and losses from a change in exchange rates, and therefore does not alter corporate cash flows. Transaction exposure measures cash (realized) gains and losses from a change in exchange rates, and therefore does alter corporate cash flows. 11-4. Tax Exposure. What is tax exposure and how does it relate to the triumvirate of transaction, operating, and translation exposure? Tax exposure is separate from the triumvirate of transaction, operating, and accounting exposure because it is basically the tax consequences of a gain or loss caused by this triumvirate. Transaction exposure is a cash loss and so results in a tax savings—in the sense that a lowering of profits because of a transaction loss lowers income taxes, other things being equal. Any loss from operating exposure is difficult to measure; a resultant drop in market value of an MNE’s shares
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This note was uploaded on 12/06/2011 for the course FIN 536 taught by Professor Staff during the Fall '11 term at S.F. State.

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Chapter 11 Notes - Chapter 11 Transaction Exposure...

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