Solutions Chapters 10 & 11 Transactions and Economic Exposure

Solutions Chapters 10 & 11 Transactions and Economic Exposure
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INSTRUCTORS MANUAL: MULTINATIONAL FINANCIAL MANAGEMENT , 9 th ED. 1 CHAPTER 10 SUGGESTED ANSWERS TO CHAPTER 10 QUESTIONS 1. What is translation exposure? Transaction exposure? ANSWER. Translation exposure equals the difference between exposed assets and exposed liabilities. A foreign currency asset or liability is exposed if it must be translated at the current exchange rate. Transaction exposure equals the net amount of foreign-currency denominated transactions already entered into. Upon settlement, these transactions may give rise to currency gains or losses. 2. What are the basic translation methods? How do they differ? ANSWER. The basic translation methods are the current/noncurrent method, monetary/nonmonetary method, temporal method, and current-rate method. The current/noncurrent method treats only current assets and liabilities as being exposed. The monetary/nonmonetary method treats only monetary assets and liabilities as being exposed. The temporal method translates assets and liabilities valued at current cost as exposed and historical cost assets and liabilities as unexposed. The current rate method treats all assets and liabilities as exposed. 3. What factors affect a company's translation exposure? What can the company do to affect its degree of translation exposure? ANSWER. The factors affecting a company's translation exposure under FASB-52 include the currency of the primary economic environment in which the company (or its affiliate) does business, the currency in which it invoices its sales, the currency in which it negotiates to buy, the currency denomination of its borrowings, the currency denomination of the securities in which it invests surplus cash, and the location of its customers. This list suggests the actions that a company can take to affect its degree of translation exposure: borrow, invest, and invoice both sales and purchases in the local currency. It also has some degree of control over which customers to serve--foreign or domestic--but this decision should be based on economic profitability rather than its impact on translation exposure. 4. What alternative hedging transactions are available to a company seeking to hedge the translation exposure of its German subsidiary? How would the appropriate hedge change if the German affiliate's functional currency is the U.S. dollar? ANSWER. As mentioned in the text, the parent has three available methods for managing its translation exposure: (1) adjusting fund flows, (2) entering into forward contracts, and (3) exposure netting. Direct funds-adjustment methods include pricing exports in hard currencies and imports in a soft currency, investing in hard-currency securities, and replacing hard-currency borrowings with local currency loans. The indirect methods (see Chapter 20), include adjusting transfer prices on the sale of goods between affiliates; speeding up or slowing down the payment of dividends, fees, and royalties; and adjusting the leads and lags of intersubsidiary accounts. The standard techniques for responding to anticipated currency changes are summarized in Exhibit 10.1.
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