Foreign Currency Exposure And Risk

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Brahma Kumaris

Risk and exposure out of international trade and business due to change in foreign currency rate

Foreign Exchange Exposure and Risk. World is changing faster than human Endeavor

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The foreign exchange market or forex market as it is often called is the market in which currencies are traded. Currency Trading is the world’s largest market consisting of almost trillion in daily volumes The market continues to rapidly grow. Not only is the forex market the largest market in the world, but it is also the most liquid, differentiating it from the other markets. There is no central marketplace for the exchange of currency, but instead the trading is conducted over-the-counter. This decentralization of the market allows traders to choose from a number of different dealers to make trades with and allows for comparison of prices. Typically, the larger a dealer is the better access they have to pricing at the largest banks in the world, and are able to pass that on to their clients. The spot currency market is open twenty-four hours a day, five days a week, with currencies being traded around the world in all of the major financial centers. All trades that take place in the foreign exchange market involve the buying of one currency and the selling of another currency simultaneously. This is because the value of one currency is determined by its comparison to another currency. The first currency of a currency pair is called the “base currency,” while the second currency is called the counter currency. The currency pair shows how much of the counter currency is needed to purchase one unit of the base currency. Currency pairs can be thought of as a single unit that can be bought or sold. When purchasing a currency pair, the base currency is being bought, while the counter currency is being sold. Forex Capital Markets (FXCM) is an online currency trading firm that offers a free demo account to traders who are new and interested in the foreign exchange market. It allows you to experience every step of currency trading including choosing currency pairs, deciding how much risk to take, tracking the time and dates of placed trades, deciding how long to stay in the trade, and when to exit the trade. It also allows the placing of stop and limit orders on trades. Information about trading and specifically about how to use the online trading platform can be found on the FXCM webpage. In addition, FXCM offers FREE interactive online seminars that are extremely useful to both new and experienced currency traders. Characteristics of foreign exchange Its huge trading volume representing the largest asset class in the world leading to high liquidity; Its geographical dispersion; Its continuous operation: 24 hours a day except weekends, i.e., trading from 20:15 GMT on Sunday until 22:00 GMT Friday; The variety of factors that affect exchange rates; The low margins of relative profit compared with other markets of fixed income; The use of leverage to enhance profit and loss margins and with respect to account size.

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Question 12 20 pts Explain five criteria of Statement No. 52 in determining the foreign currency as the functional currency. HTML Editor Paragraph ? Solution Answer) Application of this Statement will affect financial reporting of most companies operating in foreign countries. The differing operating and economic characteristics of varied types of foreign operations will be distinguished in accounting for them. Adjustments for currency exchange rate changes are excluded from net income for those fluctuations that do not impact cash flows and are included for those that do. The requirements reflect these general conclusions: The economic effects of an exchange rate change on an operation that is relatively self-contained and integrated within a foreign country relate to the net investment in that operation. Translation adjustments that arise from consolidating that foreign operation do not impact cash flows and are not included in net income. The economic effects of an exchange rate change on a foreign operation that is an extension of the parent\'s domestic operations relate to individual assets and liabilities and impact the parent\'s cash flows directly. Accordingly, the exchange gains and losses in such an operation are included in net income. Contracts, transactions, or balances that are, in fact, effective hedges of foreign exchange risk will be accounted for as hedges without regard to their form. More specifically, this Statement replaces FASB Statement No. 8, Accounting for the Translation of Foreign Currency Transactions and Foreign Currency Financial Statements, and revises the existing accounting and reporting requirements for translation of foreign currency transactions and foreign currency financial statements. It presents standards for foreign currency translation that are designed to (1) provide information that is generally compatible with the expected economic effects of a rate change on an enterprise\'s cash flows and equity and (2) reflect in consolidated statements the financial results and relationships as measured in the primary currency in which each entity conducts its business (referred to as its \"functional currency\"). An entity\'s functional currency is the currency of the primary economic environment in which that entity operates. The functional currency can be the dollar or a foreign currency depending on the facts. Normally, it will be the currency of the economic environment in which cash is generated and expended by the entity. An entity can be any form of operation, including a subsidiary, division, branch, or joint venture. The Statement provides guidance for this key determination in which management\'s judgment is essential in assessing the facts. A currency in a highly inflationary environment (3-year inflation rate of approximately 100 percent or more) is not considered stable enough to serve as a functional currency and the more stable currency of the reporting parent is to be used instead. The functio.

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Examine the importance for business financial leaders to recognize the firmâ€™s foreign currency exposure. Solution Foreign currency exposure means the financial risk that exists when a financial transaction is denominated in a currency other than that of the base currency of the firm. It is important for the business financial leaders to recognize the firmâ€™s foreign currency exposure so as to see the possible opportunities of arbitrage by holding one currency and releasing other. If a firm has to involve in the international trade (exports / imports) then it should be having an idea about the advantages and disadvantages of functioning in the currencies of the particular markets. Foreign exchange exposure is classified into three types viz. Transaction, Translation and Economic Exposure. Transaction Exposure also referred to as conversion exposure or cash flow exposure. It concerns the actual cash flows involved in setting transactions denominated in a foreign currency. These could include : sales receipts, payments for goods and services, receipt and/or payment of dividends, servicing loan arrangements as regards interest and capital . Translation exposure is also referred to as accounting exposure or balance sheet exposure. The restatement of foreign currency financial statements in terms of a reporting currency is termed translation. The exposure arises from the periodic need to report consolidated worldwide operations of a group in one reporting currency and to give some indication of the financial position of that group at those times in that currency. Economic exposure or operational exposure moves outside of the accounting context and has to do with the strategic evaluation of foreign transactions and relationships. It concerns the implications of any changes in future cash flows which may arise on particular transactions of an enterprise because of changes in exchange rates, or on its operating position within its chosen markets. Its determination requires an understanding of the structure of the markets in which an enterprise and its competitors obtain capital, labour, materials, services and customers. Identification of this exposure focuses attention on that component of an enterprise\'s value that is dependent on or vulnerable to future exchange rate movements. This has bearing on a corporation\'s commitment, competitiveness and viability in its involvement in both foreign and domestic markets. Thus, economic exposure refers to the possibility that the value of the enterprise, defined as the net present value of future after tax cash flows, will change when exchange rates change. .

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Translation of Foreign Currency in Financial Statements And Preparation of Journal Entries This week’s focus is on the translation of foreign currency financial statements for the purpose of preparing consolidated financials and also posting journal entries. When preparing consolidated financial statements on a worldwide basis, the foreign currency financial statements prepared by foreign operations must be translated into the parent company’s reporting currency. Issues related to this translation: 1. Which method should be used, and 2. Where should the resulting translation adjustment be reported in the consolidated financial statements. Translation methods differ on the basis of which accounts are translated at the current exchange rate and which are translated at historical rates. Accounts translated at the current exchange rate are exposed to translation adjustment (balance sheet exposure). Different translation methods give rise to different concepts of balance sheet exposure and translation adjustments of differing sign and magnitude. There are four major methods of translating foreign currency financial statements: 1. current/noncurrent method 2. monetary/non-monetary method 3. temporal method 4. current rate We will be focusing on the temporal and current rate methods. CURRENT RATE METHOD All assets and liabilities are translated at the current exchange rate giving rise to a balance sheet exposure equal to the foreign subsidiary’s net assets. Stockholders’ equity accounts are translated at historical exchange rates. Income statement items are translated at the average exchange rate for the current period. Appreciation of the foreign currency results in a positive translation adjustment Depreciation of the foreign currency results in a negative translation adjustment Translating all assets and liabilities at the current exchange rate maintains the relationships that exist in the foreign currency financial statements. Translating assets carried at historical cost at the current exchange rate results in amounts being reported on the parent’s consolidated balance sheet that have no economic meaning. TEMPORAL METHOD A method of foreign currency translation that uses exchange rates based on the time assets and liabilities are acquired or incurred. The exchange rate used also depends on the method of valuation that is used. Assets and liabilities valued at current costs use the current exchange rate and those that use historical exchange rates are valued at historical costs. Source: INVESTOPEDIA With the temporal method assets are carried at current or future value (cash, marketable securities, receivables) and liabilities are re-measured at the current exchange rate. Assets carried at historical cost and stockholders’ equity accounts are re-measured at historical exchange rates. Expenses related to assets re ...

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