Foreign Currency Risk Mitigation Essay
Albert, CEO of XYZ, Inc., desires to expand the company’s sales through exports to three foreign subsidiaries. Albert knows that the target subsidiaries’ countries require transactions to be denominated in the local currencies. Albert has researched foreign currency risk and knows that there is accounting exposure in accounting statements, operating exposure in future cash flows, and transaction exposure in outstanding obligations. Albert does not understand how these risks apply to XYZ, Inc. under his proposal or if there are any mitigating risk strategies available.
Albert requests you, as head of the risk management division, to prepare a report that he can present to the board of directors on the potential foreign currency risk if XYZ, Inc. expands sales into these markets. XYZ, Inc.’s reporting currency is the U.S. dollar and the subsidiaries would purchase the merchandise as inventory items.
For more information on corporate strategies regarding hedging foreign exchange risk, refer to Chapter 9 of Advanced Accounting.
Write a paper in which you:
Specify accounting exposure, operating exposure, and transaction exposure.
Determine the main financial statement effects of each type of exposure if XYZ, Inc. expands as proposed.
Determine two types of hedges regarding foreign exchange risk in general and recommend the most advantageous risk mitigation strategy for XYZ, Inc.
Provide support for your rationale.
Determine the main accounting assumptions underlying each currently used method (e.g., current rate method and temporal method).
Determine the fundamental differences in balance sheet exposure from the application of each method.
Suggest the translation method that XYZ, Inc. should use to minimize balance sheet exposure. Provide support for your choice.
Compare the U.S. GAAP approach to the IFRS approach of translating foreign currency financial statements.
Determine the main similarities and differences between the two methods of translation.
Assuming one of the subsidiaries of XYZ, Inc. is in a highly inflationary country, determine the appropriate translation method under FASB and provide the theoretical justification for your response.
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