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Exam 10: Management of Translation Exposure

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Question 21

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Which of the following are true statements?

A) Since translation exposure does not have an immediate direct effect on operating cash flows,its control is relatively unimportant in comparison to transaction exposure,which involves potential real cash flow losses.
B) Since it is generally not possible to eliminate both translation exposure and transaction exposure,it is more logical to effectively manage transaction exposure.
C) Two ways to control translation risk are: a balance sheet hedge and a derivatives hedge.
D) all of the options

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Question 22

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A highly inflationary economy is defined in FASB 52 as

A) one that has cumulative inflation of approximately 100 percent or more over a 3-year period.
B) one that has current inflation of approximately 40 percent per year.
C) one that has going-forward expected inflation of approximately 40 percent per year.
D) none of the options

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Question 23

Multiple Choice

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The sensitivity of "realized" domestic currency values of the firm's contractual cash flows denominated in foreign currency to unexpected changes in the exchange rate is

A U.S.parent firm,as result of its business activities in Germany,has a net exposure of €1,000,000.The consolidated reports were prepared at the year-end for the last two successive years.If the exchange rates on these reporting dates changed from $1.00 = €1.10 to $1.00 = €1.00,then the translation exposure report will indicate a "reporting currency imbalance" of

Under which accounting method are most income statement accounts translated at the average exchange rate for the period?

The source of translation exposure

Assume that the balance sheet and income statement of a French subsidiary,which keeps its books in euro,is translated into U.S.dollars,the reporting currency of the U.S.MNC. The table presents the balance sheet and income statement in euro.The subsidiary is at the end of its first year of operation.The historical exchange rate is $1.60/€1.00 and the most recent exchange rate is $2.00/€. Fill out the 20 missing entries that translate the balance sheet and income statement for this French subsidiary using the Current/Noncurrent Method,the Monetary/Nonmonetary Method,the Temporal Method,and the Current Rate Method.

	Local Currency	Current/Non current	Monetary/Non monetary	Temporal	Current Rate
Balance Sheet
Cash	€ 2,100
Inventory (current Value = €1,800)	€ 1,500
Net fixed assets	€ 3,000	______	______	______	______
Total Assets	€ 6,600
Current liabilities	€ 1,200
Long-term debt	€ 1,800
Common stock	€ 2,700
Retained earnings	€ 900
CTA	______	______	______	______	______
Total L&E	€ 6,600
Income Statement
Sales Revenue	€ 10,000
COGS	€ 7,500
Depreciation	€ 1,000
NOI	€ 1,500	______	______	______	______
Tax(40%)	€ 600
Profit after tax	€ 900	______	______	______	______
Foreign Exchange gain (loss)
Net income	€ 900	______	______	______	______
Dividends	€ 0
Addition to Retained Earnings	€ 900

Under which method does the gain or loss due to translation adjustment not affect reported cash flows,as it does with the other three translation methods?

With regard to translation exposure versus operating exposure

Find the foreign currency gain or loss for this U.S.MNC translating the balance sheet and income statement of a French subsidiary,which keeps its books in euro,then is translated into U.S.dollars using the current/noncurrent method-the reporting currency of the U.S.MNC. The subsidiary is at the end of its first year of operation.The historical exchange rate is $1.60/€1.00 and the most recent exchange rate is $1.50/€. $\begin{array}{lccccc}&&&\text { Curent/Nor }\\&\text { Local Currency }&&\text { current }\\\text { Balance Sheet }\\\text { Cash } & € 2,100 & & \$ 3,150 \\\text { Inventory (current Value }=€ 1,800) & € 1,50 \mathrm{C} & & \$ 2,250 \\\text { Net fixed assets } & € 3,000 & & \$ 4,800 \\\text { Total Assets } & € 6,600 & & \$ 10,200 \\\text { Current liabilities } & € 1,200& & \$ 1,800 \\\text { Long-term } & € 1,800& & \$ 32,880 \\\text { Common stock } & € 2,700 & & \$ 3,320 \\\text { Retained earnings } & € 900& &\\\text { Total L\&E } & € 6,600 & &\$ 10,200 \\\text { Income Statement } & & & & \\\text { Sales Revenue } & € 10,000 & & \$ 15,484 \\\text { COGS } & € 7,500 & & \$ 11,613 \\\text { Depreciation } & € 1,000 & & \$ 1,600 \\\text { NOI } & € 1,500& & \$ 2,271 \\\text { Tax }(40 \%) & € 600 & & \$ 908 \\\text { Profit after tax } & € 900 & & \$1,363\\\text { Net income } & € 900 \\\text { Dividends } & €0 && \$0\\\text { Addition to Retained Earnings }& € 900 \end{array}$

The underlying principle of the current rate method is

Under the current/noncurrent method

When using the current/noncurrent method,current assets are defined as

A translation exposure report shows,for each account that is included in the consolidated balance sheet,

Consider a U.S.-based MNC with manufacturing activities in Japan.The result of a change in the ¥-$ exchange rate on the assets and liabilities of the consolidated balance sheet is $\begin{array} { l l l } \text { Exposed assets } & \text { ¥ } & 700,000,000 \\\text { Exposed liabilities } & \text { ¥ } & 500,000,000\end{array}$ Ignoring transaction exposure in the yen,the translation exposure will indicate a possible need for a "balance sheet hedge" of

With regard to research on the stock price reaction to mandated accounting changes,such as FASB 52,

When exchange rates change

The sensitivity of the firm's consolidated financial statements to unexpected changes in the exchange rate is

The underlying principle of the current/noncurrent method is that assets and liabilities should be translated based on their maturity.

XYZ Corporation,a U.S.parent firm,has a wholly owned sales affiliate,ABC Ltd.,in the United Kingdom.The affiliate was established to service the local market. Assume that 1.the functional currency of ABC is the pound. 2.the reporting currency is the dollar. 3.the initial exchange rate $1.00 = £0.67. ABC's nonconsolidated balance sheets and the footnotes to the financial statements indicate that ABC owes the parent firm £200,000.Assume that,XYZ had made an investment of $500,000 in the affiliate.Under FASB 52,the intercompany debt and investment will appear on the consolidated balance sheet as