Multinational financial management 7th CH10

Multinational Financial Management Alan Shapiro 7th Edition J.Wiley & Sons Power Points by Joseph F Greco, Ph.D California State University, Fullerton CHAPTER 10 MEASURING ACCOUNTING EXPOSURE CHAPTER OVERVIEW I ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE II.ALTERNATIVE CURRENCY TRANSLATION METHODS III STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO.52 CHAPTER OVERVIEW (con’t) IV TRANSACTION EXPOSURE V DESIGNING A HEDGING STRATEGY VI MANAGING TRANSLATION EXPOSURE VII MANAGING TRANSACTION EXPOSURE PART I ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE I ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE A Three Types of Exposure Accounting Exposure: when reporting and consolidating financial statements requires conversion from foreign to local currency ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE Transaction Exposure: occurs from changes in the value of foreign currency contracts as a result of exchange rate changes ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE Operating Exposure arises because exchange rate changes may alter the value of future revenues and costs ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE Economic Exposure = Transaction + Operating Exposures PART II ALTERNATIVE CURRENCY TRANSLATION METHODS I FOUR METHODS OF TRANSLATION A Current/Noncurrent Method Current accounts use current exchange rate for conversion Income statement accounts use average exchange rate for the period ALTERNATIVE CURRENCY TRANSLATION METHODS B Monetary/Nonmonetary Method Monetary accounts use current rate Pertains to - cash - accounts receivable - accounts payable - long term debt 10 MANAGING TRANSACTION EXPOSURE Managing transaction exposure: A transaction exposure arises whenever a company is committed to a foreign currency-denominated transaction Protective measures include using: forward contracts, price adjustment clauses, currency options, and HC 32 invoicing MANAGING TRANSACTION EXPOSURE A FORWARD MARKET HEDGE consists of offsetting a a receivable or payable in a foreign currency b using a forward contract: - to sell or buy that currency - at a set delivery date - which coincides with receipt of the foreign currency 33 MANAGING TRANSACTION EXPOSURE True Cost of Hedging: a The opportunity cost depends upon future spot rate at settlement b Shown as f1 - e e0 where f1 = forward rate e0 = spot rate e1 = future spot rate 34 MANAGING TRANSACTION EXPOSURE B MONEY MARKET HEDGE Definition: simultaneous borrowing and lending activities in two different currencies to lock in the dollar value of a future foreign currency cash flow 35 MANAGING TRANSACTION EXPOSURE C RISK SHIFTING home currency invoicing zero sum game common in global business firm will invoice exports in strong currency, import in weak currency Drawback: 36 it is not possible with informed MANAGING TRANSACTION EXPOSURE D PRICING DECISIONS general roles: on credit sales connect foreign price to home price using forward rate, but not spot rate if the dollar price is high/low enough the exporter/importer should follow through with the sale 37 MANAGING TRANSACTION EXPOSURE E EXPOSURE NETTING Protection can be gained by selecting currencies that minimize exposure Netting: MNC chooses currencies that are not perfectly positively correlated Exposure in one currency can be offset by the exposure in another 38 MANAGING TRANSACTION EXPOSURE F CURRENCY RISK SHARING Developing a customized hedge contract The contract typically takes the form of a Price Adjustment Clause, whereby a base price is adjusted to reflect certain exchange rate changes 39 MANAGING TRANSACTION EXPOSURE F CURRENCY RISK SHARING (con’t) Parties would share the currency risk beyond a neutral zone of exchange rate changes The neutral zone represents the currency range in which risk is not shared 40 MANAGING TRANSACTION EXPOSURE G CURRENCY COLLARS Contract bought to protect against currency moves outside the neutral zone Firm would convert its foreign currency denominated receivable at the zone forward rate 41 MANAGING TRANSACTION EXPOSURE H CROSS-HEDGING Often forward contracts not available in a certain currency Solution: a cross-hedge - a forward contract in a related currency Correlation between currencies is critical to success of this hedge 42 MANAGING TRANSACTION EXPOSURE I Foreign Currency Options When transaction is uncertain, currency options are a good hedging tool in situations in which the quantity of foreign exchange to be received or paid out is uncertain 43 MANAGING TRANSACTION EXPOSURE I Foreign currency options A call option is valuable when a firm has offered to buy a foreign asset at a fixed foreign currency price but is uncertain whether 44 MANAGING TRANSACTION EXPOSURE The firm can lock in a maximum dollar while price for its tender offer, limiting its downside risk to the call premium in the event its bid is rejected 45 MANAGING TRANSACTION EXPOSURE A put option allows the company to insure its profit margin against adverse movements in the foreign currency fixed prices to while guaranteeing foreign customer 46 ... STANDARDS NO 52 Reporting currency the currency the parent firm uses to prepare its financial statements 18 STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO 52 If foreign subsidiary’ operations are direct... EXCHANGE EXPOSURE A Three Types of Exposure Accounting Exposure: when reporting and consolidating financial statements requires conversion from foreign to local currency ALTERNATIVE MEASURES OF... average rate during period or The rate in effect when revenue and expenses incurred 15 STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO 52 D Translation Gains or Losses Recorded in separate equity account