L . G AT T I S
T H E P E N N S Y LVA N I A S TAT E U N I V E R S I T Y
Poll
2
Caterpillar’s Japanese subsidiary has yen receivables of ¥100M, payables of ¥200M, and debt of ¥300M. The USD is designated the functional currency. The accounts are recorded on the balance sheet at a spot rate of ¥83.33. What is the translation gain or loss if the exchange rate is ¥85 at the end of the reporting period.
A. -$94,310 B. +$94,310 C. -$668M D. +$668M
Poll
3
Caterpillar’s Japanese subsidiary has yen receivables of ¥100M, payables of ¥200M, and debt of ¥300M due in 45 business days. The
USD is designated the functional currency. What is Caterpillars 95%, 45 day, EaR if the annualized volatility of the $/Yen daily returns is 10% and the spot price is $.012/¥ (¥83.33/$)? (Assume 260 business days in a year to compute daily standard deviation)
A. $.033M B. $.33M C. $3.3M D. $33M
E. $330M
Learning Objectives
4
Students understand and can recall
methods for measuring and managing transaction exposure
the definitions, implementation, and use of CaR to measure exchange rate risk
Students can calculate
transaction exposure/loss
Students can calculate CaR given cashflow information and exchange rate volatility
Forex Exposure
5
I. Translation “Accounting” Exposure arises when reporting and consolidating financial statements require conversion from foreign currency to home currency. It is a possible accounting gain/loss on foreign assets and liabilities which are reported as losses in income or adjustments to equity
(Translation exposures often lead to cashflow losses when accounts are liquidated)
II. Cashflow Exposures
1.
2.
Transaction Exposure: potential gains or losses on foreign transactions such as bond payments and receivables paid in the foreign currency. (Up until a payment is made, these are only translation exposures)
Competitive Exposure: long-term exposure to currency change on future business.
Translation and Transaction Risk
6
Translation gains and losses may or may not lead to actual cash
losses (Transaction Losses)
Example 1: Book value of Mexico City storage facility fluctuates with the exchange rate causing translation gains and losses, but the gains and losses are never realized because property is never sold.
Example 2: Book value of peso inventory fluctuates with the exchange rate causing translation gain and losses, and is realized as inventory is sold and proceeds converted into dollars.
Translation losses become transaction losses when the asset is
sold (inventory, property, cash) or comes due (receivables, payables, loans).
Transaction exposure is the net position (assets – liabilities) in foreign denominated accounts that are expected to come due.
(not just reported – translation exposure)
Transaction gains and losses are the difference between the expected domestic currency value (book value in some cases) and the actual domestic currency value of the position.
Rolls-Royce, the British jet engine manufacturer, sells engines to
U.S. airlines and buys parts from U.S. companies. Suppose it has accounts receivable of $1.5 billion and accounts payable of $740 million. It also borrowed $600 million. The current spot rate is $1.5128/£.
What is Rolls-Royce's dollar transaction exposure in dollar terms? Suppose the pound appreciates to $1.7642/£. What is RollsRoyce's gain or loss, in pound terms, on its dollar transaction exposure? A. -£40M
B. -£15M
C. £15M
D. £40M
7
Cashflow at Risk (CaR)
“Measuring Transaction Exposure”
8
CaR measures the risk that actual cashflows are
different than what is expected (or planned)
More technically, CaR is the level of cashflow loss that has a x% probability of being exceeded over the next n periods.
Example: Manager may have a
