Fundamentals of Multinational Finance, 5e (Moffett et al.)
Chapter 10 Translation Exposure
Multiple Choice and True/False Questions
10.1 Overview of Translation
1) Translation exposure may also be called ________ exposure.
A) transaction
B) operating
C) accounting
D) currency
2) 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.
3) ________ 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
4) 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.
5) 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.
6) 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
7) 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.
10.2 Translation Methods
1) 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.
2) 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.
3) Under the current rate method, specific assets and liabilities are translated at exchange rates
consistent with the timing of the item’s creation.
4) Under the temporal rate method, specific assets and liabilities are translated at exchange rates
consistent with the timing of the item’s creation.
5) 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
6) 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.
7) 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.
8) 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
9) If the same exchange rate were used to remeasure every line on a financial statement, then
there would be no imbalances from remeasuring.
10) 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
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) 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
10.3 Trident Corporation’s Translation Exposure
1) 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.
2) ________ 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
3) 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.
4) 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.
5) 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.
6) 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.
10.4 Managing Translation Exposure
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 is the main technique for managing
A) transaction.
B) operating.
C) translation.
D) money market.
3) 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.
4) 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.
5) 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.
6) 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.
7) 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
8) 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.
9) 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.
10
Essay Questions
10.1 Overview of Translation
1) 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.
10.2 Translation Methods
1) There are no questions in this section.
10.3 Trident Corporation’s Translation Exposure
1) There are no questions in this section.
10.4 Managerial Implications
1) Describe a balance sheet hedge and give at least two examples of when such a hedge could be
justified.