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Question;Essay Questions;10.1 Types of Foreign Exchange Exposure;1) List and;define the three types of foreign exchange exposure presented by your authors.;Answer: Transaction exposuremeasures changes;in the value of outstanding financial obligations incurred prior to a change in;exchange rates but not due to be settled until after the exchange rates change.;Thus, it deals with changes in cash flows that result from existing contractual;obligations.;Translation exposureis the potential for;accounting-derived changes in owner's equity to occur because of the need to;translate" foreign currency financial statements of foreign;subsidiaries into a single reporting currency to prepare worldwide consolidated;financial statements.;Operating exposure, also called economic;exposure, competitive exposure, or strategic exposure;measures the change in the present value of the firm resulting from any change;in future operating cash flows of the firm caused by an unexpectedchange;in exchange rates. The change in value depends on the effect of the exchange;rate change on future sales volume, prices, and costs.;10.2 Why Hedge?;1) Does foreign;currency exchange hedging both reduce risk and increase expected value?;Explain, and list several arguments in favor of currency risk management and;several against.;Answer: Foreign exchange currency hedging can reduce;the variability of foreign currency receivables or payables by locking in a;specific exchange rate in the future via a forward contract, converting;currency at the current spot rate using a money market hedge, or minimizing;unfavorable exchange rate movement with a currency option. None of these;hedging techniques, however, increases the expected value of the foreign;currency exchange. In fact, expected value should fall by an amount equal to;the cost of the hedge.;Generally, those;in favor of currency risk management find value in the reduction of variability;of uncertain cash flows. Those opposed to currency risk management argue the NPV;of such activities are $0 or less and that shareholders can reduce risk;themselves more efficiently. For a more complete answer to this question, see;page 4 where the author outlines several arguments for and against currency;risk management.;?;10.3 Trident's Transaction Exposure;1) Currency risk;management techniques include forward hedges, money market hedges, and option;hedges. Draw a diagram showing the possible outcomes of these hedging;alternatives for a foreign currency receivable contract. In your diagram, be;sure to label the X and Y-axis, the put option strike price, and show the;possible results for a money market hedge, a forward hedge, a put option hedge;and an uncovered position. (Note: Assume the forward currency receivable is;British pounds and the put option strike price is $1.50/?, the price of the;option is $0.04 the forward rate is $1.52/? and the current spot rate is;$1.48/?.);Answer: The student should draw and label a diagram;that looks similar to the one found in exhibit 10.4.;10.4 Translation Exposure;1) The two;methods for the translation of foreign subsidiary financial statements are the;current rate and temporal methods. Briefly, describe how each of these methods;translates the foreign subsidiary financial statements into the parent;company's consolidated statements. Identify when each technique should be used;and the major advantage(s) of each.;Any gains or;loses caused by translation adjustments are typically placed into a special;reserve account (such as a CTA). Thus, gains or losses do not go through the;income statement and do not increase the volatility of net income. This is;perhaps the biggest advantage to using the current rate method.;By contrast, the;temporal method assumes that several individual financial statement items are;periodically restated to reflect their market value. The temporal method;translates individual line items based on monetary/nonmonetary criteria where;monetary assets such as cash and marketable securities are translated at;current exchange rates, but nonmonetary assets such as fixed assets are;translated at historical rates. The gains or losses that result from;translation remeasurement are recorded on the consolidated income statement and;impact upon the volatility of net income. The temporal method of using;historical costs may be more consistent with the practice of carrying domestic;items at cost on the financial statements.;10.5 Trident Corporation's Translation Exposure;1) There are no;essay questions for this section.;10.6 Managerial Implications;1) Describe a;balance sheet hedge and give at least two examples of when such a hedge could;be justified.


Paper#51183 | Written in 18-Jul-2015

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