Question

How have changes in exchange rates impacted receivables, payables, and other items on the financial statements of the company you are researching? Describe the company’s (automobile manufacturer) exposure to exchange rate risk. That is, describe the exchange rate conditions affecting the performance of your business. Is the company (automobile manufacturer) business subject to transaction exposure? Economic exposure? Translation exposure? Explain why the company you are researching is or is not subject to each of these types of exposure.   What type policies does the company use to insulate itself from exchange rate risk?

Answer 1

Impact of changes in exchange rates on receivables, payables, and other items on the financial statements of the company is as follows in case of following cases:

Exchange rate/Elements of financial statement	If Domestic currency appreciates	If Domestic currency depreciates
Receivables	Receivables becomes more valuable with respective foreign country	Receivables becomes less valuable with respective foreign country
Payables	Payables becomes less valuable with respective foreign country	Payables becomes more valuable with respective foreign country
Loans (Borrowed money)	Loan amount decreases as interest payment reduces	Loan amount increases as interest payment increases
Asset	Asset becomes more valuable	Asset becomes less valuable
Liability	Liability becomes less valuable	Liability becomes more valuable

Transaction exposure results from the business transactions. Transaction exposure is actual loss (or gain) for companies whose payables and receivables are denominated in foreign currencies due to change of foreign exchange rate.

Translation exposure, also termed as accounting exposure, arises when financial statements of a foreign subsidiary are translated into the parent company’s domestic currency for the purpose of consolidating the financial reporting. The company’s liabilities, revenues, expenses, gains and losses which are denominated in foreign currencies will therefore vary because of the exchange rate fluctuations.  

Economic exposure is a possibility of benefit change in a specific future period due to the change of foreign exchange rates.

As fluctuation in currency does affect the performance of the company in positive and negative way depending on the appreciation or depreciation of the domestic and foreign currency

As automobile industry is cyclical kind of industry which is effected by economic cycles hence it would have effect of transaction,translation and economic exposure risk

Many methods have been used in order to effectively manage the currency risk including multi-currency diversification, currency swaps, and hedging via forwards, futures and options. Choosing an appropriate hedging tool depends upon a number of factors including the type of currency exposure (transaction, translation or economic risk) the size of the firm, the industry effect, the risk preference of the manager or the firm and his/her familiarity with the available financial instruments and techniques and also by moving production to foreign markets the company not only reduces its foreign exchange exposure but also benefits from being close to its customers.