Transaction, Operating Accounting Exposures
Transaction, Operating, & Accounting (Translation) Exposures
Foreign Exchange Exposure – measures the potential for a firm’s profitability, net cash flow, and market value to alter because of a change in exchange rates.
Q: What are the three main foreign exchange exposures?
A: 1) Transaction Exposure 2) Operating Exposure 3) Accounting Exposure
Transaction Exposure – measures changes in the value of outstanding financial obligations incurred prior to a change in exchange rates.
Operating Exposure (Economic Exposure, Competitive Exposure, Strategic Exposure) – measures a change in the present value of a firm resulting from any change in future expected operating cash flows caused by unexpected changes in exchange rates.
Accounting Exposure (Translation Exposure) – measures accounting-derived changes in owner’s equity as a result of translating foreign currency financial statements into a single reporting currency.
Exhibit 8.1
[pic]
Note: In the fourth quarter of 2001 Amazon.com reported a net income of $5 million, due in part to a one-time foreign currency gain of $16 million.
Hedging – To take a position that will rise (or fall) in value to offset a change in value of an existing position.
|Benefits of Hedging |Costs of Hedging |
|Improved the planning capability of the firm. |Risk-averse strategy that benefits management more than |
|Reduced the likelihood of financial distress. (i.e. the risk that cash|shareholders. (i.e. shareholders can diversify currency risk on an|
|flows will fall below what is required for debt payments and continued|“as needed” basis) |
|operations) |Consumes the firm’s resources and expected cash flows to the firm |
|Management has a comparative advantage
Foreign Exchange Exposure – measures the potential for a firm’s profitability, net cash flow, and market value to alter because of a change in exchange rates.
Q: What are the three main foreign exchange exposures?
A: 1) Transaction Exposure 2) Operating Exposure 3) Accounting Exposure
Transaction Exposure – measures changes in the value of outstanding financial obligations incurred prior to a change in exchange rates.
Operating Exposure (Economic Exposure, Competitive Exposure, Strategic Exposure) – measures a change in the present value of a firm resulting from any change in future expected operating cash flows caused by unexpected changes in exchange rates.
Accounting Exposure (Translation Exposure) – measures accounting-derived changes in owner’s equity as a result of translating foreign currency financial statements into a single reporting currency.
Exhibit 8.1
[pic]
Note: In the fourth quarter of 2001 Amazon.com reported a net income of $5 million, due in part to a one-time foreign currency gain of $16 million.
Hedging – To take a position that will rise (or fall) in value to offset a change in value of an existing position.
|Benefits of Hedging |Costs of Hedging |
|Improved the planning capability of the firm. |Risk-averse strategy that benefits management more than |
|Reduced the likelihood of financial distress. (i.e. the risk that cash|shareholders. (i.e. shareholders can diversify currency risk on an|
|flows will fall below what is required for debt payments and continued|“as needed” basis) |
|operations) |Consumes the firm’s resources and expected cash flows to the firm |
|Management has a comparative advantage