chapter 12 foreign exchange risk and exposure. copyright 2010 mcgraw-hill australia pty ltd ppts...
TRANSCRIPT
![Page 1: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/1.jpg)
Chapter 12
Foreign Exchange Risk and Exposure
![Page 2: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/2.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Objectives
• To define risk and exposure• To elaborate on the concept of value at risk (VAR)• To distinguish among transaction, economic and
translation exposure
12-2
![Page 3: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/3.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Definitions of risk
• The chance of bad consequence, loss, etc. (The Concise Oxford Dictionary)
• The possibility of loss, injury, disadvantage or destruction (Webster’s Dictionary)
12-3
(cont.)
![Page 4: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/4.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Definitions of risk (cont.)
• The origin of the word ‘risk’ is either the Arabic risq or the Latin risicum
12-4
(cont.)
![Page 5: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/5.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Definitions of risk (cont.)
• In finance, a distinction is made between risk and uncertainty
• In finance, risk is measured by the dispersion around the mean value of the rate of return, the cost of borrowing, the value of assets and liabilities, etc.
12-5
![Page 6: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/6.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
FX risk
• FX risk arises because of uncertainty about the future spot exchange rate
• It refers to the variability of the domestic currency value of certain items resulting from the variability of the exchange rate
12-6
![Page 7: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/7.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Rate of return
1)1)(1(
11
VSR
SVV
VV
VRt
t
12-7
![Page 8: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/8.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Measuring risk: probability distribution
21
2
1
)()(
)()(
RERpR
RpRE
i
n
ii
i
n
ii
12-8
![Page 9: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/9.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Measuring risk: historical data
2
1
2
1
1
1
1
)RR(n
)R(
Rn
R
n
tt
n
tt
12-9
![Page 10: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/10.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Measurement of VAR
• Measurement unit (e.g. AUD)• Time horizon (one day, one week, etc.)• Probability (1-5%)
12-10
![Page 11: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/11.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Implementation of VAR analysis
• Parametric (analytical) approach• Historical approach• Simulation approach
12-11
![Page 12: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/12.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
The parametric approach
• The approach is based on the assumption of the normality of rates of return
12-12
(cont.)
![Page 13: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/13.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
The parametric approach (cont.)
Per cent of
Observations Lowest r Highest r Probability VAR
68 r r 16.0 )( rK 90 65.1r 65.1r 5.0 )65.1( rK 95 96.1r 96.1r 2.5 )96.1( rK 98 33.2r 33.2r 1.0 )33.2( rK 99 3r 3r 0.5 )3( rK
12-13
![Page 14: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/14.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
The historical approach
• VAR with a certain probability is calculated from the lower nth percentile of historical observations on the rate of return
12-14
![Page 15: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/15.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
The simulation approach
• VAR with certain probability is calculated from the lower nth percentile of simulated observations on the rate of return
• Observations are generated from Monte Carlo simulation by specifying a probability distribution and its parameters
12-15
![Page 16: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/16.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
VAR: pros
• It is simple• It is suitable for risk-limit setting and performance
measurement• It can take account of complex movements
12-16
![Page 17: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/17.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
VAR: cons
• It can be misleading• VAR estimates are highly sensitive to the underlying
assumptions• It cannot cope with sudden or sharp changes
12-17
![Page 18: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/18.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
VAR: conclusion
• VAR is useful but it should be handled with care and used in conjunction with other measures of risk
• Confidence in VAR has been undermined by the global financial crisis as the VAR models used by financial institutions failed to predict the losses that they actually endured
12-18
![Page 19: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/19.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Exposure
• Risk measures the probability and magnitude of deviation from some expected outcome
• Exposure is a measure of the sensitivity of what is at risk to the source of risk
12-19
![Page 20: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/20.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
FX exposure
• Exposure to FX risk is a measure of the sensitivity of the domestic currency value of FX items to changes in the exchange rate
• Sometimes it is defined as the amount at risk
12-20
![Page 21: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/21.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
The slope of the exposure line
SV β
where is the slope of the exposure line. is positive (negative) for assets (liabilities)
12-21
![Page 22: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/22.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Long and short exposures
• Long exposure assets • Short exposure liabilities
12-22
![Page 23: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/23.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Combined exposure
• A combined exposure arises when a firm holds both foreign assets and foreign liabilities
12-23
![Page 24: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/24.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
The relation between FX risk and exposure
)(σβ)(σ 222 SV
12-24
![Page 25: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/25.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Multiple exposure
• Exposure to more than one currency:
)/()/( 01010 nn xxSxxSV
12-25
![Page 26: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/26.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
The volatility of the AUD exchange rates
• The standard deviations of monthly percentage changes in exchange rates
USD/AUD JPY/AUD EUR/AUD GBP/AUD 2004 2.88 3.38 1.70 2.11 2005 1.71 2.03 2.12 2.04 2006 2.62 2.18 2.30 1.74 2007 3.41 4.29 2.74 3.01 2008 6.44 7.93 3.62 5.41
12-26
![Page 27: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/27.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Transaction exposure
• Transaction exposure arises if payables and receivables are denominated in foreign currencies. It is a cash flow exposure associated with trade and capital flows
12-27
![Page 28: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/28.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Transaction exposure (examples)
• Foreign assets or liabilities that are already recorded on the balance sheet
• A contract or an agreement involving a future foreign currency cash flow
12-28
![Page 29: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/29.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Volatility and correlation
• Exposure to a currency that fluctuates sharply is more of a source of concern
• Exchange rate correlations are important
12-29
![Page 30: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/30.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Economic exposure
• Changes in exchange rates affect the firm’s non-contractual or unplanned cash flows
• It refers to future changes in earning power as a result of changes in exchange rates
12-30
![Page 31: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/31.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Measurement of economic exposure
• Economic exposure cannot, in general, be known accurately in advance
• It can be estimated from a regression equation relating changes in cash flows to changes in exchange rates
12-31
![Page 32: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/32.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Translation (accounting) exposure
• Translation exposure arises from the consolidation of foreign currency assets, liabilities, net income and other items
• Conversion may produce gain or loss
12-32
![Page 33: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/33.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Translation rates
• Closing (current) rate• Average rate• Historical rate
12-33
![Page 34: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/34.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
The closing rate
• The closing rate (or current rate) is the rate prevailing at the end of the accounting period (that is, coinciding with the balance sheet date)
12-34
![Page 35: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/35.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
The average rate
• The average rate is the average value of the exchange rate over the accounting period
• The simplest procedure is to take a simple average of the closing rate and the rate prevailing at the beginning of the period. Otherwise, a time-weighted average may be used
12-35
![Page 36: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/36.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
The historical rate
• The historical rate is the rate prevailing on the date when an asset is acquired or a liability is committed
• The historical rate may therefore fall outside the current accounting period. In fact, this is invariably the case for long-term assets and liabilities
12-36
![Page 37: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/37.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Translation methods
• Current/non-current method• Closing (current) rate method• Monetary/non-monetary method• Temporal method
12-37
![Page 38: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/38.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Current/non-current method
• According to this method, current items are translated at the closing rate, whereas long-term items are translated at the historical rate
12-38
![Page 39: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/39.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Closing (current) rate method
• Assets and liabilities are translated at the exchange rate prevailing at the end of the accounting period
12-39
![Page 40: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/40.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Monetary/non-monetary method
• Monetary items (such as bonds) are translated at the closing rate, whereas non-monetary items (such as real estate) are translated at the historical rate
12-40
![Page 41: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/41.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Temporal Method
• According to the temporal method, the use of the closing rate or the historical rate is determined by the valuation of the underlying item
• The closing rate is used for items stated at replacement cost, realisable value or market value
• The historical rate is used for all items stated at historical cost
12-41
![Page 42: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/42.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Some principles
• Translation of balance sheet items is based on the closing rate
• Transaction gains and losses are accounted for in the income statement
12-42
(cont.)
![Page 43: Chapter 12 Foreign Exchange Risk and Exposure. Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e](https://reader038.vdocuments.net/reader038/viewer/2022103122/56649f565503460f94c7a458/html5/thumbnails/43.jpg)
Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Some principles (cont.)
• Non-transaction gains and losses are represented by changes in reserves
• Transaction gains and losses from a hedge are accounted for by movements in reserves or are reported on the income statement
12-43