Deck 10: Translation Exposure

Question 1

The biggest advantage of the current rate method of reporting translation adjustments is the fact that the gain or loss goes directly to the reserve account on the consolidated balance sheet and does not pass through the consolidated income statement.

Answer 1

True

Question 2

According to your authors, the main purpose of translation is

A) to prepare consolidated financial statements.
B) to help management assess the performance of foreign subsidiaries.
C) to act as an interpreter for managers without foreign language skills.
D) none of the above.

Answer 2

to prepare consolidated financial statements.

Question 3

Translation exposure may also be called ________ exposure.

A) transaction
B) operating
C) accounting
D) currency

Answer 3

accounting

Question 4

Under the current rate method, specific assets and liabilities are translated at exchange rates consistent with the timing of the item's creation.

Question 5

Gains or losses caused by translation adjustments when using the current rate method are reported separately on the

A) consolidated statement of cash flow.
B) consolidated income statement.
C) consolidated balance sheet.
D) none of the above

Question 6

The current rate method is the most prevalent method today for the translation of financial statements.

Question 7

If the same exchange rate were used to remeasure every line on a financial statement, then there would be no imbalances from remeasuring.

Question 8

Under the temporal rate method, specific assets and liabilities are translated at exchange rates consistent with the timing of the item's creation.

Question 9

The temporal rate method is the most prevalent method today for the translation of financial statements.

Question 10

Functional currency is

A) the currency of the primary economic environment in which the subsidiary operates and generates cash flows.
B) the currency of the country where the corporation is incorporated.
C) the weighted average of the currencies of all foreign subsidiaries.
D) the currency proscribed by the national laws of the subsidiary's country of incorporation.

Question 11

A foreign subsidiary's ________ currency is the currency used in the firm's day-to-day operations.

A) local
B) integrated
C) notational dollar
D) functional

Question 12

The basic advantage of the ________ method of foreign currency translation is that foreign nonmonetary assets are carried at their original cost in the parent's consolidated statement while the most important advantage of the ________ method is that the gain or loss from translation does not pass through the income statement.

A) monetary; current rate
B) temporal; current rate
C) temporal; monetary
D) current rate; temporal

Question 13

Historical exchange rates may be used for ________, while current exchange rates may be used for ________.

A) fixed asses and current assets; income and expense items
B) equity accounts and fixed assets; current assets and liabilities
C) current assets and liabilities; equity accounts and fixed assets
D) equity accounts and current liabilities; current assets and fixed assets

Question 14

Cumulative Translation Adjustment (CTA) is

A) a separate line on the consolidated income statement stating the FX effect on the company's earnings.
B) a separate equity reserve account stating translation gains or losses over time.
C) a separate margin added to the sale price once the subsidiary is liquidated.
D) a separate account on the subsidiary cash flow statement that needs to be adjusted.

Question 15

Translation exposure measures

A) changes in the value of outstanding financial obligations incurred prior to a change in exchange rates.
B) the potential for an increase or decrease in the parent company's net worth and reported net income caused by a change in exchange rates since the last consolidation of international operations.
C) an unexpected change in exchange rates impact on short run expected cash flows.
D) none of the above.

Question 16

Exchange rate imbalances that are passed through the balance sheet affect a firm's reported income, but imbalances transferred to the income statement do not.

Question 17

________ exposure is the potential for an increase or decrease in the parent company's net worth and reported net income caused by a change in exchange rates since the last transaction.

A) Transaction
B) Operating
C) Currency
D) Translation

Question 18

The two basic methods for the translation of foreign subsidiary financial statements are the ________ method and the ________ method.

A) current rate; temporal
B) temporal; proper timing
C) current rate; future rate
D) none of the above

Question 19

The current rate method of foreign currency translation gains or losses resulting from remeasurement are carried directly to current consolidated income and thus introduces volatility to consolidated earnings.

Question 20

The temporal method of foreign currency translation gains or losses resulting from remeasurement are carried directly to current consolidated income and thus introduces volatility to consolidated earnings.

Question 21

A Canadian subsidiary of a U.S. parent firm is instructed to bill an export to the parent in U.S. dollars. The Canadian subsidiary records the accounts receivable in Canadian dollars and notes a profit on the sale of goods. Later, when the U.S. parent pays the subsidiary the contracted U.S. dollar amount, the Canadian dollar has appreciated 10% against the U.S. dollar. In this example, the Canadian subsidiary will record a

A) 10% foreign exchange loss on the U.S. dollar accounts receivable.
B) 10% foreign exchange gain on the U.S. dollar accounts receivable.
C) since the Canadian firm is a U.S. subsidiary neither a gain nor loss will be recorded.
D) any gain or loss will be recorded only by the parent firm.

Question 22

A balance sheet hedge is the main technique for managing

A) transaction.
B) operating.
C) translation.
D) money market.

Question 23

If a firm's subsidiary is using the local currency as the functional currency, which of the following is NOT a circumstance that could justify the use of a balance sheet hedge?

A) The foreign subsidiary is about to be liquidated, so that the value of its Cumulative Translation Adjustment (CTA) would be realized.
B) The firm has debt covenants or bank agreements that state the firm's debt/equity ratio will be maintained within specific limits.
C) The foreign subsidiary is operating in a hyperinflationary environment.
D) All of the above are appropriate reasons to use a balance sheet hedge.

Question 24

The two methods for the translation of foreign subsidiary financial statements are the current rate and temporal methods. Briefly, describe how each of these methods translates the foreign subsidiary financial statements into the parent company's consolidated statements. Identify when each technique should be used and the major advantage(s) of each.

Question 25

The main technique to minimize translation exposure is called a/an ________ hedge.

A) balance sheet
B) income statement
C) forward
D) translation

Question 26

Balance sheet hedge is justified if

A) the management wants to boost the income statement metrics.
B) the foreign subsidiary country has high country risk and is facing potential hyperinflation.
C) the parent is planning equity injection to develop foreign subsidiary operations.
D) the subsidiary accounts receivable are denominated in parent's home currency.

Question 27

Balance sheet hedge requires an equal amount of exposed foreign currency assets and liabilities. A German company's subsidiary in Poland has Zloty as its functional currency. To hedge its translational exposure the company should

A) issue 10 year Eurobond guaranteed by the parent matching the amount of subsidiary's assets.
B) obtain 5 year zloty loan in Poland.
C) start rolling over 1 year forward contracts.
D) start rolling over 3 month zloty loans, repatriate and convert the proceeds in euro.

Question 28

Most managers would prefer to be protected against transaction rather than translation losses because

A) transaction loses are realized cash loses.
B) Wall-street analysts do not account for CTA.
C) potential transaction loses are bigger than the translational loses.
D) translation losses are not recognized in the consolidated financial statements.

Question 29

If a European subsidiary of a U.S. firm has net exposed liabilities of euro 500,000, and the euro drops in value from $1.40/euro to $1.30/euro then the U.S. firm has a translation

A) gain of $50,000.
B) loss of $50,000.
C) gain of $450,000.
D) loss of euro 450,000.

Question 30

If a European subsidiary of a U.S. firm has net exposed liabilities of euro 500,000, and the euro increases in value from $1.30/euro to $1.35/euro then the U.S. firm has a translation

A) gain of $25,000.
B) loss of $25,000.
C) gain of $525,000.
D) loss of euro 525,000.

Question 31

A balance sheet hedge requires that the amount of exposed foreign currency assets and liabilities

A) have a 2:1 ratio of assets to liabilities.
B) have a 2:1 ratio of liabilities to assets.
C) have a 2:1 ratio of liabilities to equity.
D) be equal.

Question 32

If the European subsidiary of a U.S. firm has net exposed assets of euro 500,000, and the euro increases in value from $1.30/euro to $1.35/euro the U.S. firm has a translation

A) gain of $25,000.
B) loss of $25,000.
C) gain of $525,000.
D) loss of euro 525,000.

Question 33

If a firm's balance sheet has an equal amount of exposed foreign currency assets and liabilities and the firm translates by the temporal method, then

A) the net exposed position is called monetary balance.
B) the change of value of liabilities and assets due to a change in exchange rates will be of equal but opposite direction.
C) both A and B are true.
D) none of the above.

Question 34

Using the table below, estimate the net exposure for Souris River Manufacturing of it's wholly-owned Canadian subsidiary. Souris River Manufacturing (Canada)
Balance Sheet December 31 200X

A) C$40,000
B) C$160,000
C) C$166,000
D) C$200,000

Question 35

Describe a balance sheet hedge and give at least two examples of when such a hedge could be justified.

Question 36

________ gains and losses are "realized" whereas ________ gains and losses are only "paper."

A) Translation; transaction
B) Transaction; translation
C) Translation; operating
D) None of the above

Question 37

If the European subsidiary of a U.S. firm has net exposed assets of euro 500,000, and the euro drops in value from $1.40/euro to $1.30/euro the U.S. firm has a translation

A) gain of $50,000.
B) loss of $50,000.
C) gain of $450,000.
D) loss of euro 450,000.