FOREIGN EXCHANGE EXPOSURE

Prerna verma

Parth shah

Parth sheth

Anjali Ranjan

Kishore purohit

Foreign Exchange Exposure

Transaction exposure

Translation exposure

Operating exposure

Transaction exposure• It stems from transactions that give rise to known contractually

determined future foreign-currency denominated cash inflows or outflows

• Examples: cross border trade, borrowings and lending's in foreign currency, and the local purchases and the sales of foreign subsidiaries

• If exchange rates changes between time of transaction and time of settlement, the value associated foreign currency cash flow changes, resulting in currency gains and losses.

• Example: If an Indian exporter has a receivable of $100000 due three months hence in the meanwhile the dollar depreciates relative to the rupee, a cash loss occurs.

• Similarly if the dollar appreciates relative to the rupee, a cash gain occurs.

• Where in case of payable it is opposite• Appreciation=loss• Depreciation=profit

Where it is should be recorded and at what rate???• These foreign currency transactions are recorded in books

of account at average rate for the month. And the difference between rates of payable and receivable country are accounted in profit and loss account.

• At each balance sheet date• A) foreign currency monetary items should be reported

using the closing rate.• B) non monetary items which are carried at historical cost

should be reported using the exchange rate.• C) non monetary items which are carried at fair value or

other similar valuation should be reported using the exchange rates that existed when the values were determined.

• Exchange differences arising on the settlement of monetary items should be recognized as income or as expenses in the period in which they arise.

• Forward exchange contract is entered in to as a hedge, the premium or discount arising at the inception of the contract should be amortized as expense or income over the life of the contract.

Translation exposure(Accounting Exposure)

• It stems from the need to convert the financial statements of foreign operations from foreign currencies to domestic currency for purposes of reporting and consolidation.

• If the exchange rate is changed in comparison with previous reporting period then the translation of foreign currency will result in foreign exchange gains or losses.

translation gains does not involve cash flow as they are purely paper gains/losses except when they have some tax implications.

• The method used for translating foreign currency statements depends on the nature of relationship between the parent and the foreign operations.

Foreign operations

Integral foreign operations

It carries out business as it is an extension of

operation of the parent

Independent foreign operations

It runs as a separate enterprise

Where to record and at which rate?Integral Foreign operations

• Monetary assets and liabilities are translated at the exchange rate.

• Non monetary assets are translated at the historical rates.• The items in the profit and loss account are translated at

the average exchange rate.• The difference arising out of the translation are

recognized in the profit and loss account.

Where to record and at which rate?Non-Integral Foreign operations• The assets and liabilities ,both monetary and non integral

foreign operation should be translated at a closing rate.• Income and expense item should be translated at exchange

rate at the dates of the transaction,• All exchanges difference should be accumulated in foreign

currency translation reseve until the disposal of the net investment.

• The income tax requires that foreign currency liabilities are “marked to market” at the exchange rate prevailing on the date of casting the balance sheet.

• If the foreign currency liability increases( decreases) on such revaluation the value of the fixed asset is correspondigly increased (decreased).

• Depericiation is admissible on such revalued assets.

Operating Exposure• It is similar to transaction exposure• It involves an actual or potential gain or loss.it is realted to

entire investment.• The essence is that exchange rate changes significantly

alter the cost of a firm’s inputs and the prices of its output and thereby influence its competitive position substantially.

Example of Volkswagen • Volkswagen had a highly successful export market for its

“Beetle” model in the us before 1970• With the break down of the Bretton wood system of fixed

exchange rates, the deutschemark appreciated significantly against the dollar.

• This created problem for Volkswagen as its expenses were mainly in Deutschemark but its revenues in dollars.

• However in a highly price-sensitive us market such an action caused a sharp decrease in sales volume from 600000 vehicles in 1968 to 200000 in 1976

Example of east Asian crises• East Asian crises was in 1997• Currencies of several east Asian countries fell sharply• Exports from these countries very competitive in

advanced markets.• As a consequence, gems and jewelry exports from India

suffered competitive disadvantages vis-à-vis their rivals from south east Asian.