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Fundamentals of Multinational Finance, 6e (Moffett et al.)
Chapter 11 Translation Exposure
11.1 Overview of Translation
1) Translation exposure may also be called ________ exposure.
A) transaction
B) operating
C) accounting
D) currency
2) ________ 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
3) 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
4) 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
5) Historical exchange rates may be used for ________, while current exchange rates may be
used for ________.
A) fixed assets 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
6) If an imbalance results from the accounting method used for translation, the imbalance is
taken either to ________ or ________.
A) the bank; the post office
B) depreciation; the market for foreign exchange swaps
C) current income; equity reserves
D) current liabilities; equity reserves
7) Generally speaking, translation methods by country define the translation process as a
function of what two factors?
A) size; location
B) a firm's functional currency; location
C) location; foreign subsidiary independence
D) foreign subsidiary independence; a firm's functional currency
8) A/An ________ subsidiary is one in which the firm operates as an extension of the parent
company with cash flows highly interrelated with the parent.
A) self-sustaining foreign
B) integrated foreign entity
C) foreign
D) none of the above
9) Consider two different foreign subsidiaries of Georgia-Pacific Wood Products Inc. The first
subsidiary mills trees in Canada and ships its entire product to the Georgia-Pacific U.S. The
second subsidiary is also owned by the parent firm but is located in Japan and retails tropical
hardwood furniture that it buys from many different sources. The first subsidiary is likely a/an
________ foreign entity with most of its cash flows in U.S. dollars, and the second subsidiary is
more of a/an ________ foreign entity.
A) domestic; integrated
B) self-sustaining; domestic
C) integrated; self-sustaining
D) self-sustaining; integrated
10) 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
11) The ________ determines accounting policy for U.S. firms.
A) Securities and Exchange Commission (SEC)
B) Federal Reserve System (Fed)
C) Financial Accounting Standards Board (FASB)
D) General Agreement on Tariffs and Trade (GATT)
12) It is possible to use different exchange rates for different line items on a financial statement.
13) If the same exchange rate were used to remeasure every line on a financial statement, then
there would be no imbalances from remeasuring.
14) A foreign subsidiary's functional currency is the currency of the primary economic
environment in which the subsidiary operates and in which it generates cash flows.
15) It is highly unusual for a multinational firm to have both integrated foreign entities AND
self-sustaining foreign entities.
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16) Most countries specify the translation method to be used by a foreign subsidiary based on its
business operations or the functional currency. Explain both subsidiary characterization criteria
and the one adopted in the United States.
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11.2 Translation Methods
1) 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
2) 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
3) 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
4) Under the U.S. method of translation procedures, if the financial statements of the foreign
subsidiary of a U.S. company are maintained in U.S. dollars:
A) translation is accomplished through the current rate method.
B) translation is accomplished through the temporal method.
C) translation is not required.
D) the translation method to be used is not obvious.
5) Under the U.S. method of translation procedures, if the financial statements of the foreign
subsidiary of a U.S. company are maintained in the local currency, and the local currency is the
functional currency, then:
A) the translation method to be used is not obvious.
B) translation is accomplished through the temporal method.
C) translation is not required.
D) translation is accomplished through the current rate method.
6) Under the U.S. method of translation procedures, if the financial statements of the foreign
subsidiary of a U.S. company are maintained in the local currency, and the U.S. dollar is the
functional currency, then:
A) translation is not required.
B) translation is accomplished through the current rate method.
C) translation is accomplished through the temporal method.
D) none of the above
7) Under U.S. accounting and translation practices, use of the current rate method is termed
________ while use of the temporal method is termed ________.
A) translation; the same
B) translation; remeasurement
C) remeasurement; the same
D) remeasurement; translation
8) Which of the following primary principles of U.S. translation procedures in NOT true?
A) If the financial statements of the foreign subsidiary of a U.S. company are maintained in U.S.
dollars, translation is not required.
B) If the financial statements of the foreign subsidiary are maintained in the local currency and
the local currency is the functional currency, they are translated by the temporal method.
C) If the financial statements of the foreign subsidiary are maintained in the local currency and
the U.S. dollar is the functional currency, they are remeasured by the temporal method.
D) All of the above are true.
9) ________ occur as a result of changes in the value of currency, whereas ________ occur as a
result of ongoing business activities.
A) Operating gains or losses; translation gains or losses
B) Swap losses; translation gains or losses
C) Translation gains or losses; operating gains or losses
D) all of the above
10) 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.
11) The current rate method is the most prevalent method today for the translation of financial
statements.
12) The temporal rate method is the most prevalent method today for the translation of financial
statements.
13) 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.
14) Under the temporal rate method, specific assets and liabilities are translated at exchange rates
consistent with the timing of the item's creation.
15) 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.
16) The current rate method and the temporal method are two basic methods for translation that
are employed worldwide
17) Under U.S. accounting and translation practices, use of the current rate method is termed
"translation" while use of the temporal method is termed "remeasurement."
18) If the financial statements of the foreign subsidiary are maintained in the local currency and
the U.S. dollar is the functional currency, they are remeasured by the temporal method.
19) Translation gains or losses can be quite different from operating gains or losses not only in
magnitude but also in sign.
20) 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.
1) If the European subsidiary of a U.S. firm has net exposed assets of €750,000, and the euro
drops in value from $1.30/euro to $1.20/€ the U.S. firm has a translation:
A) gain of $75,000.
B) loss of $75,000.
C) gain of $625,000.
D) loss of €576,923.
2) If the European subsidiary of a U.S. firm has net exposed assets of €200,000, and the euro
increases in value from $1.22/€ to $1.26/€ the U.S. firm has a translation:
A) gain of $8,000.
B) loss of $8,000.
C) gain of $252,000.
D) loss of €252,000.
3) If the British subsidiary of a European firm has net exposed assets of £125,000, and the pound
increases in value from €1.40/£ to €1.44/£, the European firm has a translation:
A) loss of €5,000.
B) gain of €5,000.
C) gain of £5,000.
D) loss of £5,000.
4) If the British subsidiary of a European firm has net exposed assets of £250,000, and the pound
drops in value from €1.35/£ to €1.30/£, the European firm has a translation:
A) gain of €12,500.
B) loss of €12,500.
C) loss of £12,500.
D) gain of £12,500.
5) The value contribution of a subsidiary of a multinational firm to the firm can be reported in
the income statement or balance sheet of the consolidated firm. Explain the reporting of the
changes in the value of a subsidiary as a result of the change in an exchange rate - changes to the
income and the assets of the subsidiary - in the consolidated financial statements of the parent
company.
1) The main technique to minimize translation exposure is called a/an ________ hedge.
A) balance sheet
B) income statement
C) forward
D) translation
2) 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.
3) 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 is 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
4) 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 is a hyperinflationary environment.
D) All of the above are appropriate reasons to use a balance sheet hedge.
5) If the parent firm and all subsidiaries denominate all exposed assets and liabilities in the
parent's reporting currency this will ________ exposure but each subsidiary would have
________ exposure.
A) maximize translation; no transaction
B) eliminate translation; transaction
C) maximize transaction; no translation
D) eliminate transaction; translation
6) 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.
7) ________ 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
8) It is possible that efforts to decrease translation exposure may result in an increase in
transaction exposure.
9) One possible reason for a balance sheet hedge could be because the foreign subsidiary is about
to be liquidated, so that value of its Cumulative Translation Adjustment (CTA) would be
realized.
10) One possible reason for a balance sheet hedge could be because the firm has debt covenants
or bank agreements that state the firm's debt/equity ratios will be maintained within specific
limits.
11) If management expects a foreign currency to depreciate, it could minimize translation
exposure by increasing net exposed assets.
12) If management anticipates an appreciation of the foreign currency, it should decrease net
exposed assets to benefit from a gain.
13) Describe a balance sheet hedge and give at least two examples of when such a hedge could
be justified.
