MaxMark_Ch17_Correct_Answers

MaxMark_Ch17_Correct_Answers - MaxMark-Viney MenuItem 17:...

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MaxMark—Viney MenuItem 17: (Topic 17)Foreign exchange: Risk identification and management Question 1: Multinational Limited is an Australian company with subsidiary operations in several international markets. In conducting an audit of its risk exposures, Multinational’s board is advised that the company has a potential exposure to translation risk. Which of the following relates to its exposure to translation risk? A: the company will receive USD over the next twelve months from existing export contracts B: loan repayments on euromarket funding are payable in JPY C*: assets and liabilities of its subsidiaries are denominated in foreign currencies D: all of the above Feedback: Translation risk is the risk that conversion of foreign currency assets and liabilities to domestic currency will adversely affect the balance sheet. Answers A and B relate to transaction exposure and C is the only answer that relates to translation exposure, so it is the correct answer. MORE: Financial Institutions, Instruments and Markets 5/e , p. 662. Translation exposure, or accounting exposure, measures the impact of exchange rate changes on the consolidated financial statements of a firm. That is, the accounting consolidation and reporting of a firm’s financial position requires the financial statements of foreign operations or subsidiaries to be converted from local foreign currencies into the home currency of the parent company. For example, if a company accumulates assets or liabilities overseas, these items will usually be denominated in a foreign currency. If the company later translates the value of those items onto its consolidated balance sheet at anything other than the original exchange rate, their value in local currency terms will be affected by fluctuations in the exchange rate. Corporations need to consider the accounting standards of the country of the company’s incorporation to ascertain specific translation requirements. Question 2: An Australian company is preparing to export wine to France in direct competition with local vineyards. The wine will be sold through an importer who will act as an agent for the Australian company. There is some concern within the company that it will be exposed to foreign exchange risk. Which type of foreign exchange risk best describes the risk to which the company is exposed? A*: economic risk B: sovereign risk C: translation risk D: transaction risk Feedback: The company will be exposed to transaction risk and may have operating FX exposure as well. Economic exposure is a broader concept that encompasses these exposures, so A is the correct answer. MORE: Financial Institutions, Instruments and Markets 5/e , p. 663. Economic FX exposure is a broad measure that attempts to capture the impact of unexpected exchange rate fluctuations on the net present value of the firm’s future cash flows. Economic exposure combines both transaction exposures and operating FX exposures, but extends further to recognise the impact of FX risk on the future value of a firm. For example, an Australian and a
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MaxMark_Ch17_Correct_Answers - MaxMark-Viney MenuItem 17:...

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