Question

Identify whether the following create substantial transaction, operating, and/or translationexposure (or no exposure at all) for a U.S. company, and how the company will be affected if theforeign currency depreciates. The examples will typically create more than one type of exposure.

c) IBM issues Swiss franc-denominated bonds in Zurich.

Answer 1

Solution:-

If IBM issues Swiss franc-denominated bonds in Zurich, it will bring the company transaction and translation exposure due to the following reasons:

• The bonds will stand on the company's balance sheet and will have to be repaid in Swiss francs at the time of maturity. Thus, it is a transaction related foreign currency exposure that the business will carry for the period of bond issue
• The value of swiss bonds liability standing in the balance sheet will have to be translated in US dollars at the date of balance sheet (as balance sheet will be in USD), which will expose company to profit or loss due to change in the exchange rates. Further, the company exposes itself on the foreign exchange risk on the interest payments to be made in foreign currency, thus exposing firm to translation exposure

If the Swiss francs depreciates against USD, it will have the following implications for IBM:

• It will reduce the interest expense in terms of USD and thus improve the company's bottom line
• It will reduce the liability of the company at the balance sheet as stated in terms of USD, and thus will create a stronger balance sheet
• The company will have a gain at the time of repayment of the bonds as depreciation of Swiss francs against USD would mean lesser USD required to repay the loan