Deck 11: Managing Translation Exposure and Accounting for Financial Transactions

Question 1

Information-based reasons for hedging translation exposure include each of the following EXCEPT

A) The quality of accounting information can be improved.
B) Meeting profit forecasts retains management's credibility in the marketplace
C) Information costs can be reduced in a perfect market.
D) Credit ratings are tied to accounting performance rather than cash flow.
E) Loan covenants are tied to accounting income.

Answer 1

Information costs can be reduced in a perfect market.

Question 2

Accounting standard setters have failed to respond to the recent growth in derivatives usage for risk management purposes.

Answer 2

False

Question 3

Finance theory states that the firm should only consider hedging risk exposures that are related to firm value.

Answer 3

True

Question 4

To maximize shareholder wealth, managers should only hedge translation exposure if it ______.

A) affects the total risk of the firm
B) involves accounting profits
C) involves cash flows
D) is convenient
E) None of the above

Question 5

When market prices are unavailable, historical cost accounting is more reliable than market value accounting.

Question 6

According to FAS #52, all income statement items are translated at the current exchange rate.

Question 7

Translation exposure is defined as change in the value of contractual cash flows due to unexpected changes in currency values.

Question 8

Empirical studies have found that non-U.S. firms are less willing than U.S. firms to hedge translation exposure.

Question 9

Translation exposure refers to the impact of exchange rate changes on the parent firm's consolidated financial statements.

Question 10

FAS #52 specifies each of the following rules EXCEPT

A) all assets and liabilities (including common equity) are translated at the current exchange rate
B) dividends paid are translated at the current exchange rate
C) income statement items are translated at an exchange rate (or an exchange rate average) from the reporting period
D) All of the above are elements of FAS #52
E) None of the above are elements of FAS #52

Question 11

Under FAS #52, translation gains and losses are not flowed through the income statement. Instead, they are accumulated in an account in the equity portion of the balance sheet.

Question 12

Historical cost accounting is reliable, but is less relevant than fair value accounting.

Question 13

According to FAS #52, translation gains or losses are reported on the balance sheet as a cumulative translation adjustment.

Question 14

Translation exposure is far more important than economic exposure to the value of the multinational corporation.

Question 15

Most businesses maintain positive net working capital, so a foreign currency appreciation is more likely to be associated with a translation gain than a translation loss.

Question 16

Net exposed assets equal ______.

A) assets less liabilities
B) exposed assets less exposed liabilities
C) shareholders' equity
D) More than one of the above
E) None of the above

Question 17

FAS #52 assumes the domestic currency values of the real assets of foreign subsidiaries are ______.

A) fully exposed to currency risk
B) negative related to the domestic currency
C) not exposed to currency risk
D) partially exposed to currency risk
E) positively related to the domestic currency

Question 18

According to FAS #52, all assets and liabilities are translated at the current exchange rate.

Question 19

Under the current rate method of FAS #52, changes in the translated value of balance sheet items are placed in a contra account on the asset side of the balance sheet.

Question 20

The response of accounting standard setters to derivatives-related losses in the 1990s was to place a moratorium on corporate reporting of derivatives transactions.

Question 21

In the United States, FAS #133 "Accounting for Derivative Instruments and Hedging Activities" requires each of a) through d) EXCEPT

A) Derivatives are assets and liabilities that should be reported in financial statements.
B) Market value is the most relevant measure of value.
C) Only assets and liabilities should be reported as such. Income and expenses should be reported on the income statement.
D) Hedge transactions should be fully capitalized on the balance sheet.
E) FAS #133 requires all of the above

Question 22

Which of a) through d) is a reasonable guideline for currency risk management?

A) All noncash currency risk exposures should be hedged with currency derivatives.
B) Do not hedge unless the purpose is to reduce translation exposure to currency risk.
C) Treasury should hold the managers of individual operating units responsible for the consequences of unexpected changes in currency values.
D) Treasury should quote market prices for currency hedges to the individual units.
E) None of the above

Question 23

Bodnar, Hayt, and Marston's "1998 Wharton Survey of Financial Risk Management by U.S. Non-Financial Firms" in Financial Management found that financial officers' biggest concern regarding derivatives was ______.

A) accounting treatment
B) credit risk
C) reaction by analysts or investors
D) SEC disclosure requirements
E) secondary market liquidity

Question 24

In the United States, FAS #133 "Accounting for Derivative Instruments and Hedging Activities" values financial derivatives at ______.

A) book value
B) historical cost
C) historical exchange rates
D) market
E) None of the above

Question 25

Adverse selection costs arise from ______.

A) differential taxes
B) information asymmetries
C) large bid-ask spreads
D) the perfect market assumptions
E) None of the above

Question 26

According to studies cited in the text, increased disclosure about financial price risks and risk management activities results in each of the following EXCEPT

A) higher trading volumes
B) increased risks of litigation over accounting disclosure practices
C) increased share price sensitivity to underlying financial prices
D) lower trading volume sensitivity to changes in underlying financial prices
E) lower bid-ask spreads