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1、Chapter 6Foreign Currency TranslationDiscussion Questions Solutions 1. Foreign currency translation is the process of restating a foreign account balance from one currency to another. Foreign currency conversion is the process of physically exchanging one currency for another. 2. In the foreign exch
2、ange spot market, currencies bought and sold must be delivered immediately, normally within 2 business days. Thus a Singaporean tourist buying U.S. dollars at the airport before boarding a plane for New York would hand over Singapore dollars and immediately receive the equivalent amount in U.S. doll
3、ars. The forward market handles agreements to exchange a fixed amount of one currency for another on an agreed date in the future. For example, a French manufacturer exporting goods invoiced in euros to a Japanese importer on 60-day credit terms would buy a forward contract to sell yen for euros 2 m
4、onths in the future. Transactions in the swap market involve the simultaneous purchase (or sale) of one currency in the spot market and the sale (or purchase) of the same currency in the forward market. Thus, a Canadian investor wishing to take advantage of higher interest rates on 6-month Treasury
5、bills in the United States would buy U.S. dollars with Canadian dollars in the spot market and invest in the United States. To guard against a fall in the value of the U.S. dollar before maturity (when the U.S. dollar proceeds are converted back to Canadian dollars), the Canadian investor would simu
6、ltaneously enter into a forward contract to sell U.S. dollars for Canadian dollars 6 months in the future at today s forward exchange rate.3. The question refers to alternative exchange rates that are used to translate foreign financial statements. The current rate is the exchange rate at the financ
7、ial statement date. It is sometimes called the year-end or closing rate. The historical rate is the exchange rate at the time of the underlying transaction. The average rate is the average of various exchange rates during a fiscal period. Since the average rate normally is used to translate income s
8、tatement items, it is often weighted to reflect any seasonal changes in the volume of transactions during the period.Translation gains and losses do not occur if exchange rates do not change. However, if exchange rates change, the use of current and average rates causes translation gains and losses.
9、 These do not occur when the historical rate is used because the same (constant) rate is used each period. 4. In this example, the Mexican Affiliate s Canadian dollar loan is denominated in Canadian dollars. However, because the Mexican affiliates functional currency is U.S. dollars, the peso equiva
10、lent of the Canadian dollar borrowing would be remeasured in U.S. dollars prior to consolidation. If the Mexican affiliates functional currency were the peso, the Canadian dollar loan would be remeasured in pesos before being translated to U.S. dollars. 5. A transaction gain or loss occurs when a fo
11、reign currency transaction, e.g., a foreign currency borrowing, is settled at a different exchange rate than that which prevailed when the transaction was originally incurred. In this case there is an exchange of one currency for another. A translation gain or loss, on the other hand, is simply the
12、result of a restatement process. There is no physical exchange of currencies involved. 6. It is not possible to combine, add, or subtract accounting measurements expressed in different currencies; thus, it is necessary to translate those accounts that are measured or denominated in a foreign currenc
13、y into a single reporting currency. Foreign currency translation can involve restatement or remeasurement. In restatement, the local (functional) currency is kept as the unit of measure; that is, the translation process multiplies the financial results and relationships in the local currency account
14、s by a constant, the current rate. In contrast, remeasurement translates local currency results as if the underlying transactions had taken place in the reporting (functional) currency of the parent company; for example, it changes the unit of measure of a foreign subsidiary from its local (foreign)
15、 currency to the U.S. dollar. 7. Major advantages and limitations of each of the major translation methods follow.Current Rate MethodAdvantages:a. Retains the initial relationships in the foreign currency statements.b. Simple to apply.Limitations:a. Violates the basic purpose of consolidation, which is to present the results of a parent and its subsidiaries as if they were a single entity.b. Inconsistent with historical cost.c. Presumes that all local assets and liabilities are subject to exchange risk.d. While stockholders equity adjustments shield an MNC s bottom line from translatio
