Managing Translation Exposure
If a man will begin with certainties, he will end with doubts, but if he will be content to begin with doubts, he shall end in certainties.
Multinational corporations are required to report periodically their worldwide performance from both parent and foreign subsidiaries in the form of simple statistics such as consolidated earnings and the much awaited and closely studied earnings per share (EPS). This chapter examines how this periodic consolidation process requires the parent firm to translate the assets and liabilities of its foreign subsidiaries into its reporting currency. Thus translation exposure refers to the impact of exchange rate fluctuations on the parent firm's consolidated financial statements. After reviewing translation methods and conditions warranting the hedging of translation exposure, basic hedging techniques are analyzed; specifically, contractual hedging with forward contracts or currency options is compared with financial hedging through local borrowing.
After reading this chapter you should understand:
- Translation exposure and when it should be hedged.
- How translation exposure is measured under alternative methods.
- When hedging translation exposure is warranted.
- How to hedge translation exposure with forward and currency options.
- How to hedge translation exposure through borrowing in the exposed currency.
- The true cash flow cost of hedging.
WHAT IS TRANSLATION EXPOSURE?
Translation exposure to ...