Question

1. A US company designs its products in US but manufactures those products in

China.

a) What type of currency exposure the US Company will face?

b) List three strategies to manage the operation exposure, and explain how

they can be used to hedge the operation exposure.

2. A US company has a manufacturing subsidiary in Brazil and it categorizes

Brazilian Real as the functional currency.

a) Explains the concept of functional currency;

b) Under US accounting, what currency translation method it will use for this

subsidiary?

c) Explain the benefit of using this translation method.

3. Join a research team and the team decides on a topic. < don't bother

Answer 1

1 a) The company would face foreign currency exposure of payables in Chinese currency for purchasing the manufactured products from its subsidary in China.

b) The three strategies for managing the exposure is:-

i) The company can purchase forward contracts to hedge the variation in currency rates and thus reduce any impact due to fluctuation.

ii) The foreign subsidiary can also buy the design from the company in USA and thus exports of the design and imports of the manufactured products can nullify the net impact

iii) The company can also use options and futures and other derivatives to manage the foreign currency exposure.

2a) The functional currency is the currency of the economy in which the major business of the entity is conducted as well as the currency in which the major cash inflow and outflow would happen.

b) The foreign currency translation would happen at the current or market rate method.

c) The advantage of this method is that the assets and liabilities as well as the income are always marked to market and reflect the true realities of the economic and financial condition.