Question

1.) In the U.S. when does a company use the current rate method as opposed to the temporal method?

2.) What is an interest rate swap?

Please help me answer these international financial management questions. Thank you!

Answer 1

1) If the functional currency and the parent's presentation currency are different, the current rate method is used to translate the foreign currency financial statements. This usually happens when the subsidaries operating investing and financing activities are decentralized from the parent, in other words the subsidaries are self contained and independent.

For eg. A US company has a Indian subsidary. The subsidary's functional currency is Indian Rupee. the subsidary's books and records are maintained in Indian Rupee. the parents presentation currency is U.S dollars. in this case we will use current rate method as the functional currency and presentation currency are different.

2) Interest rate swap is a type of a forward contract between two parties to exchange all the future interest rate payments.

The most comman interest rate swap is the plain vanilla interest rate swap. In this swap company A agrees to pay company B a periodic fixed rate on a notional principal over the tenor of the swap.In return company B agrees to pay company A a perodic floating rate on the same notional principal.

Only net payment in exchanged.

E.g . If company A wants to convert a floating rate debt into a fixed rate debt as it expects the interest rate to go up can enter into a interest rate swap with company B to receive a floating rate of interest and pay a fix rate of interest, thereby converting its debt from a floating rate debt into a fixed rate debt.