Examples of foreign currency exposures in the following topics:
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- Foreign currency exposures are categorized as transaction/ short-run exposure, economic/ long-run exposure, and translation exposure.
- Foreign currency exposures are generally categorized into the following three distinct types: transaction (short-run) exposure, economic (long-run) exposure, and translation exposure.
- A firm has transaction exposure/ short-term exposure whenever it has contractual cash flows (receivables and payables) whose values are subject to unanticipated changes in exchange rates due to a contract being denominated in a foreign currency.
- To realize the domestic value of its foreign-denominated cash flows, the firm must exchange foreign currency for domestic currency.
- As all firms generally must prepare consolidated financial statements for reporting purposes, the consolidation process for multinationals entails translating foreign assets and liabilities or the financial statements of foreign subsidiaries from foreign to domestic currency.
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- As a business invests or operates in a foreign country, a changing exchange rate causes gains or losses on international business activities.
- Firms are subjected to currency risk, called exposure.
- Transaction exposure comes from the risk of transactions denominated in different currencies.
- Economic exposure is how a firm's expected cash flows are affected by unexpected changes in currency exchange rates.
- Translation exposure, referred to as accounting exposure, is fluctuations in currency exchange rates affect a firm's consolidated statements.
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- Transaction exposure is the impact on current transactions, such as accounts receivable and accounts payable in a foreign country when the exchange rate changes.
- Economic exposure is fluctuating exchange rates affect expected cash flows over time.
- Translation exposure is the change in a company's consolidated financial statements because accountants use different exchange rates to convert accounts into the domestic currency.
- Thus, the transaction exposure is your costs rise while your revenues fall.
- Second, company can shift its production to low-cost countries, especially in countries that weaken its currency.
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- A firm must accurately forecast cash flows and exchange rates because the transaction exposure alters future cash flows as the currency exchange rates fluctuate.
- If a subsidiary sees positive cash flows after correcting for the currency exchange rates, then its net transaction exposure is low.
- Analysts can estimate economic exposure accurately if currency exchange rates display a trend, and they know future cash flows with certainty.
- Using a simple example, our home country is the United States while Europe is the foreign country.
- Thus, the price, P, is the foreign asset's price in U.S. dollars while S indicates the spot exchange rate, defined as U.S. dollars per euro.
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- In finance, an exchange rate (also known as the foreign-exchange rate, forex rate, or FX rate) between two currencies is the rate at which one currency will be exchanged for another.
- Conversely, if the foreign currency is strengthening, the exchange rate number increases and the home currency is depreciating.
- This is presented by a higher exchange rate if the exchange rate is quoted as home currency / 1 foreign currency.
- The balance of payment model holds that a foreign exchange rate must be at its equilibrium level, which is the rate which produces a stable current account balance.
- A nation with a trade deficit will experience a reduction in its foreign exchange rate reserves, which ultimately lowers (depreciates) the value of its currency.
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- When a central bank tries to control the foreign-exchange rate of its currency, economists call this foreign-exchange market intervention.
- The Fed will sell foreign currencies and buy U.S. dollars.
- Instead, the Fed could accept a check for the foreign-currency sales.
- For example, the Fed buys $30,000 of foreign currency.
- The Fed buys $30,000 in foreign currencies and sells $30,000 in U.S. currency, boosting the monetary base.
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- Foreign-currency exchange market is traders exchange currency of one country for another country's currency.
- Consequently, five parties need foreign currency.
- First, international banks specialize in foreign currencies.
- They transfer billions in foreign currencies with other banks.
- Third, international travelers need foreign currency to pay for food, lodging, and entertainment in a foreign country.
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- A central bank holds foreign currencies.
- If a central bank wants to strengthen its currency, it must buy its currency using a foreign currency.
- Consequently, a central bank's cache of foreign currencies would decrease.
- If a central bank weakens its currency, subsequently, it buys foreign currencies using its own currency.
- Hence, a central bank accumulates more foreign currencies.
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- Reason 3: An enterprise that moves its factories to a foreign country automatically avoids trade restrictions, like tariffs and import quotas.Government does not apply trade restrictions to products and services produced within a country.
- Reason 6: A company could diversify its business and manufacturing by expanding into foreign markets.Some foreign markets grow quickly, while other markets experience weak growth.Consequently, the business could earn a return on its investments.
- Reason 10: A company investing in a foreign market today may lead to future investments.For example, a company opens a subsidiary in Moscow, Russia.After establishing the subsidiary, the company can open branches in other Russian cities or enter other Russian speaking countries.
- Reason 11: A company that produces in a foreign market reduces economic exposure.Economic exposure is changes in economic factors, such as inflation, interest rates, and exchange rates affect a company's profits.One important factor is fluctuating exchange rates.A company could experience wide swings in profits if it produces in one country and exports to another.However, if the company produces and sells within the same country, fluctuating exchange rates would impact less because the company's revenues and costs are denominated inthe same currency.Thus, a company's profit could remain stable in a foreign market.
- Multinational enterprises are more complicated than businesses that remain in their home country.First, the businesses transfer resources, such as machines, equipment, and labor between different countries.Next, they ship products and services to other countries.Consequently, companies need excellent management in logistics, and specialists who monitors a country's different laws and regulations.Second, international enterprises are exposed to exchange rate risks and credit risks.Thus, a company's profit can quickly change due to fluctuations in currency exchange rates, or a company cannot get credit to finance operations in a specific country.Finally, enterprises have other exposures, such as country risk.For example, when Hugo Chavez became president of Venezuela, his government began nationalizing companies.Any international enterprise in Venezuela can experience the seizure of its assetswithout compensation.
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- The Fed's assets include securities, discount loans, Items in the Process of Collection (CIPC), Gold Certificates, Special Drawing Rights (SDRs), coins, buildings, and foreign currency reserves.
- It attracts foreign investors.
- A weak currency creates jobs and wealth.
- A weak dollar means $1 can purchase fewer foreign currencies, while a strong dollar means $1 can buy more foreign currencies.
- As the Federal Reserve buys or sells foreign currencies, the Fed's assets and liabilities change.