FOREIGN EXCHANGE EXPOSURE AND RlSK MANAGEMlNT Homework Help

FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 

INTRODUCTION

Foreign exchange risk management (FIRM) constitutes an ‘integral part of all major corporate decisions to manage foreign  change exposure, given the global business scenario In which business firms (in particular International companies and  multinational companies) operate, forefront, it is imper:.initiative corporate firms are in the know of the various types of the   reign . exchange tsarists they are exposed to’ as well as are fully conversant with the various important Fermat techniques to deal  it such tsarists. THis Chapter discusses both these aspects. Section I describes the major exposures faced by bu eds firms In their   enter operations.techniques to hedF cover foreign exchange risk, namely, currency market hedges and Inanimate  techniques are dealt In Sections 2 and 3 respectively  The major ~ are surprised In

TYPES OF EXPOSURE

Oiliness fums, having international business operations, primarily encounter three types of expo didgeridoo,  nationalism exponent and  precook ponderer. This Ejection briefly explains them.

Transaction Exposure  

Tummy iota ex e is Inherent In all foreign currency denominated contractual obligations! impositions’.This involves gain  r  oz arising out of the various types of transactions that require  ..semester In a foreign currency. Hale transactions may relate to  Ross-border trade In terms of  iIpon or export of goods, the borrowing or lending in foreign currencies, domestic purchases and  of goods ~ services of the foreign subsidiaries and the purchase of assets or take over Of liability involving foreign cum ency. Hale  actual profit the farm earns or loss it suffers, of course, known only at the time of settlement of these transactions.  A firm’s  Once  heet already contains several items reflecting transaction exposure, the notable  ‘Beijing debtors receivable in foreign  Currency,creditors payable In foreign currency, foreign . and foreign Investments. While it is true that’ transaction expo Sure~ is  applicable to all these transactions, it .is usually employed In connection WI ad, that is, specific:  or expos on open  ~.credit. Example trillionths expos~. an Indian Import firm produces goods from the US, invoiced in ~,$.1 million.   t the time 01 the US dollar exchange rate was Is 47.4513. The payment is due after 4 months. Duran. the  t Ions period. the  Indian Rupee weak island the exchange rate of the dollar appreciates to Is 47.9824.  • resell. the Incineration has a transaction  oz 10 the. extent ciC excess rupee payment required to US $1 million.Now the firm has to pay US $1 million Is 41.4513  Is    million. After 4 from now when it is to make payment on maturity, it will have to make higher payment at Rs.7.9824

Translation Exposure

Translation exposure rescues to the’ channel’ an accounting’ come and balance sheet inducements caused ht the changes In exchange    rattly'” These changes rake place ht tar the emu (.f nullification of accounts compared h) the rime:’ when the  purchased or liability es assumed. . In other words, translation exposure re-lust from the need to translate foreign currency   sets or philistines to the local Circuit(y :11 the rime of finalist accounts, Example 35.2 illustrates the impact of translation   exposure,  Suppose, an Ind,an corporate has it’d.-n • loan from a bank in the LIST to import plant and machinery worth LEES HO   gillion Ht In the import materialist, the exchange rate was Rs 47,0. The imported plant and machinery in the hooks. of the  corporate would be shown at Rs ,P x US $10 hormonal = R~ 47 crore and loon  at R, 47 crore. Slamming no change in the exchange  ate, the corporate at the time of preparation of final accounts, will  provide depreciation (say at 25 per cent) of R< 11.75 crore on  he hook value of Rs 47 crore. Let us assume further that the dollar exchange rare appreciates 10 R< 4. As a result. the book   slue of plant and machinery  change to Rs 48 crore (Rs 1st US $10 million); depreciation will increase to Rs 12 crore (Rs 48  tore x 0,25), and the ion amount will also be revised upwards- 10 Rs 48 crore. Thus, there is a  translation loss’ of Rs I crore due  o the increased value of loan, Besides, the higher book value of the plant and machinery causes higher depreciation. reducing the  ET prof translation losses (or gains) m~y not he reflected in the income statement. They may be shown  separately   nuder the held of ‘translation adjustment’ in the balance sheet, without affecting accounting income. This translation loss  adjustment is to be carried out in the owners’ equity account, The adjustment made to the owners’ equity account is a better   approach as  accounting income would not be diluted on account of translation 105. sore gains, ‘ On account of varying ways of   dealing with translation losses or gains, accounting practices vary in different countries and among business firms Within a  country, Which”qr method is adopted to deal with  translation losses/gains. a marked Impact on both the income sacrament and  he balance sheet.

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