FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT
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.
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 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.