Part 2: Management of Translation Exposure |English| #InternationalFinance| M. Com|MBA
Summary
TLDRThis video delves into translation exposure, a financial risk faced by multinational corporations (MNCs) due to currency fluctuations during financial statement consolidation. It explains the concept, types of exposure, and introduces four translation methods: current/non-current, monetary/non-monetary, current rate, and temporal. The video concludes with strategies for hedging translation exposure, including balance sheet hedging and derivative hedging, to mitigate risks associated with exchange rate changes.
Takeaways
- 🌐 Translation exposure is the financial risk faced by multinational corporations (MNCs) due to changes in exchange rates when consolidating financial statements of subsidiaries in different countries.
- 💼 The value of a subsidiary's holdings needs to be converted into the home country's currency, which can be affected by exchange rate fluctuations, also known as accounting exposure.
- 🏢 An example is given where an Austrian subsidiary of an American company purchases a building, and the change in exchange rate affects the value recorded in the parent company's financial statements.
- 📈 There are various methods to translate financial statements, including current/non-current method, monetary/non-monetary method, current rate method, and temporal method.
- 💰 The current/non-current method differentiates between current assets/liabilities (translated at current exchange rates) and non-current assets/liabilities (translated at historical rates).
- 💵 Monetary assets and liabilities, which have a fixed amount of money, are translated at the current exchange rate, while non-monetary assets are translated at the historical rate.
- 🔄 The current rate method translates all items except for the stock of capital at the current exchange rate, with the capital being translated at the historical rate.
- 📊 The temporal method is similar to the monetary/non-monetary method but has different treatment for inventory, which is typically translated at the historical rate unless it's valued at market value.
- 🛡️ Two hedging strategies are discussed: balance sheet hedge, which aligns assets and liabilities to prevent mismatches, and derivative hedge, which uses financial instruments like forwards, options, and swaps.
- 📚 The presenter encourages viewers to check out previous videos for more detailed information on types of foreign exchange exposure and hedging strategies.
Q & A
What is translation exposure?
-Translation exposure is the financial exposure faced by multinational corporations (MNCs) that operate in various subsidiaries from different countries. It occurs when financial statements are consolidated from subsidiaries to the parent company and the exchange rate changes, affecting the value of the financial statements.
How does translation exposure affect the financial statements of a company?
-Translation exposure affects the financial statements of a company by causing changes in the value of the holdings of each subsidiary when they are converted into the currency of the home country due to fluctuations in the exchange rate.
What is the difference between current and non-current translation methods?
-In the current translation method, current assets and liabilities are converted at the exchange rate prevailing on the balance sheet date, while non-current assets and liabilities are converted at the historical exchange rate.
Can you provide an example to illustrate the current and non-current translation method?
-Yes, if a subsidiary purchases a building worth one lakh Euro on September 1, 2021, with an exchange rate of 1.20 (Euro to USD), it would be recorded as $120,000. If the financial statements are consolidated on March 31, 2022, with an exchange rate of 1.15, the building would then be recorded as $115,000.
What are monetary and non-monetary assets in the context of translation exposure?
-Monetary assets are fixed amounts of money, such as cash and accounts receivable, which do not change with exchange rates. Non-monetary assets are assets like machinery and buildings whose values can fluctuate with market value.
How does the current rate method differ from the monetary and non-monetary method?
-The current rate method values all assets and liabilities at the current exchange rate, except for the stock of capital, which is valued at the historical rate. In contrast, the monetary and non-monetary method values monetary accounts at the current rate and non-monetary accounts at the historical rate.
What is the temporal method of translation?
-The temporal method is similar to the monetary and non-monetary method, but it differs in how it treats inventory. Inventory is generally taken at the historical rate unless it is measured at market value, in which case it is converted at the current exchange rate.
What strategies can be used to hedge against translation exposure?
-Two common hedging strategies against translation exposure are balance sheet hedging and derivative hedging. Balance sheet hedging involves matching assets and liabilities to prevent mismatches in final values due to exchange rate changes. Derivative hedging uses financial instruments like forwards, options, and swaps to mitigate risk.
Why is it important for companies to manage their translation exposure?
-Managing translation exposure is important because it helps companies to predict and control the financial impact of exchange rate fluctuations on their consolidated financial statements, thereby reducing financial risk and uncertainty.
How can a company's decision to hedge its translation exposure affect its financial performance?
-Hedging translation exposure can stabilize a company's financial performance by reducing the volatility caused by exchange rate fluctuations. However, it may also involve costs and can sometimes limit potential gains if exchange rates move favorably.
What is the role of derivatives in managing translation exposure?
-Derivatives play a crucial role in managing translation exposure by providing a means to offset potential losses due to exchange rate changes. They allow companies to lock in exchange rates, thus reducing the risk associated with currency fluctuations.
Outlines
🌐 Introduction to Translation Exposure
The video begins with a discussion on translation exposure, a financial risk faced by multinational corporations (MNCs) with subsidiaries in different countries. When consolidating financial statements, fluctuations in exchange rates can affect the value of these statements, leading to translation exposure. The presenter clarifies that this exposure is also known as accounting exposure. An example is provided where an Austrian subsidiary of an American company purchases a building, and the change in exchange rate from the time of purchase to the time of financial consolidation affects the recorded value of the asset in USD.
📈 Methods of Translation and Hedge Strategies
The video script explains different methods for translating financial statements: the current/non-current method, the monetary/non-monetary method, the current rate method, and the temporal method. Each method has specific rules for converting assets and liabilities at either the current exchange rate or the historical rate. The script also discusses designing hedging strategies, such as balance sheet hedging to match assets and liabilities and derivative hedging using financial instruments like forwards and options. The presenter encourages viewers to check out previous videos for more details on these strategies and concludes by asking viewers to like, share, and subscribe if they found the content helpful.
Mindmap
Keywords
💡Translation Exposure
💡Consolidation
💡Exchange Rate
💡Hedge Strategy
💡Current and Non-Current Method
💡Monetary and Non-Monetary Method
💡Current Rate Method
💡Temporal Method
💡Balance Sheet Hedge
💡Derivative Hedge
Highlights
Translation exposure is the financial exposure faced by MNCs operating in various countries.
Translation exposure arises when consolidating financial statements of subsidiaries in different currencies.
The value of holdings of each subsidiary needs to be converted into the home country's currency.
Translation exposure is also known as accounting exposure.
An example of translation exposure involves an Austrian subsidiary of an American company purchasing a building in Euros.
The fluctuation in exchange rate affects the recorded value of the building in the parent company's currency.
There are various methods of translation: current/non-current, monetary/non-monetary, current rate, and temporal methods.
Current assets and liabilities are converted at the current exchange rate.
Non-current assets and liabilities are converted at the historical exchange rate.
Monetary assets and liabilities are fixed amounts that do not change with exchange rates.
Non-monetary assets fluctuate with market value and are converted at the historical rate.
The current rate method involves converting all items except stock capital at the current exchange rate.
The temporal method treats inventory differently based on whether it is recorded at historical or market value.
Designing a hedging strategy involves balance sheet hedging and derivative hedging.
Balance sheet hedging involves matching assets and liabilities to prevent mismatches in final values.
Derivative hedging can use forwards, options, or swaps to mitigate exposure.
The video provides a comprehensive overview of translation exposure and its management strategies.
Transcripts
hi guys welcome to my channel I hope you
guys are doing well
so in today's video we will be
discussing about translation exposure
in this we'll be covering about the
meaning methods of translation and
designing a hedge strategy right so
before we begin with I have already made
a video on the all the types of Foreign
Exchange exposure that is translation
exposure economic exposure and the
transaction exposure please go and check
that video I will provide you the video
in the description box all right
so let's just begin with what is the
translation exposure this is basically
the financial exposure that is being
faced by the mncs that operate in
various subsidiaries from different
countries say like India
or in Australia Europe so on and so
forth right so whenever the financial
statements are being Consolidated of the
subsidiaries
okay to the parent company then the
translation exposure comes into the
picture so let's understand the meaning
firms Consolidated financial statements
can be affected by changes in the
exchange rate right
so in the previous video I have already
explained you with the help of an
example supposedly there is a company
mncs that operates in U.S right it is a
parent company it has various
subsidiaries we are taking into
consideration the three subsidiaries say
one operating in UK one in Africa and
one in India right so whenever the
financial statements are being made of
these subsidiaries these will be in
their own home currency right however
when the final accounts will be made the
consolidation of the financial
statements will be done of the parent
company the all the financial statements
will be converted into the parent
company currency right so whatever is a
fluctuation in the exchange rate is
known as the translation exposure I hope
I have already cleared you this thing
right
so in this what happens is if the parent
company is situated in a country with a
different currency the value of the
Holdings of each subsidiary needs to be
converted into the currency of the Home
Country right this exposure is no also
known as the accounting exposure
so let's just take an example there is
an Austrian subsidiary of American
company what it does it it purchases a
building worth one lakh Euro on first of
September 2021
right on that date that is first
September the exchange rate that is Euro
euro to US dollar was 1.20
so they have recorded their building
that is in uh 120 000 uh dollars they
have already recorded in their books
however when the total the compilation
of these financial statements was done
the subsidiaries account was merged into
the consolidation on 31st March 2022 the
exchange rate went to
1.15 dollars
so now it has to be recorded into one
lakh fifteen thousand dollars in their
books right
now we have various methods of
translation first is it current or
non-current method then we have monetary
non-monetary current rate method and
temporal method we'll study all these
one by one first is the current and
non-current Method right we have current
assets we have non-current assets I hope
you know the meaning of current and
non-current you're going to comment this
in the comment section
right so whatever the current assets or
liabilities are there we take into
consideration there
there are converted into the
exchange rate that prevails on the date
of balance sheet right however for the
non-current assets or liability these
are being converted into historical rate
now if I say that my historical exchange
rate is 1.20 and the current rate is
1.15 now let's see how will we will
convert it
I told you that in current and
non-current Method what do we do all the
current
assets or liability are taken at current
rate whatever the exchange rate is
prevailing we take into consideration so
the uh sundry creditors right cash in
hand sanitary debtors these all have
been taken as a part of current
prevailing exchange rate
however others that is non-current long
term debt will be non-current capital
and then your buildings this has been
taken at the Historical rate right any
confusion till now please comment in the
comment section
then we have the monetary or
non-monetary method okay so what are
monetary assets basically monetary
assets or liability they have the fixed
amount of money that does not change for
example cash the amount of cash will be
the same the debtors whatever is a
liability from the debtors they are
going to pay you the same amount that
will not change with the exchange rates
the creditors and Loans right whatever
is fixed is known as the monetary assets
however whatever the value of the assets
such as Machinery buildings capitals
which fluctuates with the market value
is known as the non-monetary method thus
we can say that all the monetary
accounts are being converted at the
current rate of exchange whereas
non-monetary accounts are converted at
the Historical rate right
let's take an example
the example is the same that the
historical exchange rate is 1.12 and the
current rate is at 1.15
so we've already started that all the
monetary values will be taken at the
current rate and non-monetary at the
Historical rate so over here we can see
monetary is the current creditors
right then we have is the long term debt
cash in hand and Sundry debtors whereas
non-monetary will be the value the
market value of which it keeps on
changing capital and building has been
taken on the historical rate
next method is the current rate method
this is the simplest of all that you
take everything on the current rate of
exchange
except for the stock of capital right
except for stock of capital everything
has to be taken on the current rate of
exchange
over here what have we done we have
taken everything on the current rate
except for the capital that will be on
the historical rate easy
last method is the temporal method this
method is same as monetary and
non-monetary except for its treatment
about the inventory
now over here you guys need to note over
here is that value of the invert
inventory is generally taken at
historical rate but if in the books the
inventory is measured or taken on market
value then it is being converted into
the current rate right if I say that we
have taken the inventory of the books in
the books it has been recorded at 1000
Euro then the value of conversion will
be at the Historical rate
however if the prevailing if it is
prevailing on the market value then only
you take the current
exchange rate that is prevailing right
last is the designing of the hedging
strategy over here we have two
strategies basically first is the
balance sheet head and another one is
the derivative hedge in balance sheet
what do we do there are various items in
balance sheet we have liabilities and we
have the assets right so if there is any
mismatch
the assets and liabilities are actually
hedged so that they do not mismatch in
their final value
and about the derivative hedge what can
be the derivatives your forwards
then
options
swaps
right we've already discussed about the
derivatives hedge in the previous
lecture so you guys can go and check out
that in detail
so that is it for today guys I hope you
have learned something if yes then
please do like share and subscribe to my
channel thank you and have a nice day
Weitere ähnliche Videos ansehen
Part1: Management of Transaction Exposure in detail |English| #International Finance
Fundamentals of Accountancy, Business and Management 2 for Grade 12 - Module 1 (Chapter 1/Week 1)
Risk Hedging Supply Chain Strategy: L7
Cybersecurity Skills: Quantitative Risk Management
Macro and Flows Update: May 2023 - e17
Statement of Financial Position (SOFP) | Laporan Posisi Keuangan | Akuntansi Keuangan Menengah
5.0 / 5 (0 votes)