1. International Accounting and Multinational Enterprises 5/e
By Lee H. Radebaugh
and Sidney J. Gray
2/17/2019
PowerPoint Presentation
by Kent W. Meyer, PhD

2. Copyright © 2002 John Wiley & Sons, Inc. All rights reserved
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3. Foreign Currency Transactions
Chapter Nine

4. 1 Basic Markets 1. Over-the-Counter (OTC) 2. Exchanges:
Spot - Settled second day after agreement
Outright Forward - Three or more days after agreement
FX Swap - One currency swapped for another. First at spot then swapped back at future rate.
3. Options
4. Futures 1

5. 2 Spot Market 1. Rates quoted from trader’s perspective
2. Difference between bid and ask is trader’s profit
3. Exchange rate quotes are available in newspapers/ online
4. Quoted rates are Direct, Indirect, and Cross:
Direct - Local currency (usually $US) required to buy one unit of the foreign currency
Indirect - Foreign currency required to purchase one unit of local currency (usually $US)
Cross - Relationship between two non-$US currencies. 2

6. Outright Forward Market
Contract between currency trader and client for future purchase or sale of foreign currency. 3

7. Swaps
A simultaneous spot and forward transaction. 4

8. Options
The right but not obligation to buy or sell foreign currency at a given rate on or before a specific future date.
Terminology:
Put - Right to sell to the option writer
Call - Right to buy from the option writer
Option Cost - Premium and brokerage fee 4

9. Foreign Exchange Markets
1. Trades occur 24 hours a day at a rate of $1.5T a day;
2. The Interbank is the most important foreign exchange market, utilizing banks and non-bank financial institutions;
3. The $US is the most widely traded world currency;
4. Seven of the 10 largest currency pairs involve the $US;
5. The most important markets are in the United States, the United Kingdom, and Japan; and
6. The world’s dominant currencies are the dollar, euro, and yen. 5

10. Currency Convertibility
1. Not all currencies are convertible;
2. Non-convertible currencies are traded on the black market at significant discounts; and
3. Governments in weaker economies may regulate their currencies through licensing, multiple exchange rates, and rationing. 6

11. The International Monetary System
1. International Monetary Fund (IMF) created to promote exchange stability;
2. The initial fixed-rate system has been changed to provide more flexibility:
Some countries peg their currencies to one or several major currencies,
Some currencies adopt a free or managed float; and
4. Governments also may attempt to influence exchange rates. 7

12. The Determination of Exchange Rates
A number of factors influence exchange rates and relative value:
Purchasing Power Parity
Interest Rates
Trade Balances
Exchange Reserves
Economic and Political Stability 8

13. Foreign Currency Transactions
1. Transactions denominated in a currency other than the reporting currency (financial statement currency usually that of the corporate parent;
2. Transactions in firm’s domestic currency cause no accounting problems;
3. Transactions denominated in a foreign currency require resolution of four issues:
Initial Recording,
Recording foreign currency balances,
Treatment of foreign currency gains/ losses, and
Recording of foreign currency receivables/ payables at settlement date. 9

14. Foreign Currency Transactions (Cont.)
4. All foreign currency transactions have a non-monetary and monetary component;
5. Solution approaches include:
Two Transactions - Recognize gains and losses,
Two Transactions - Defer gains and losses
One Transaction - Recognize gains and losses as an asset, cost, or liability.
6. Two Transactions approach with immediate recognition of gains/ losses is the most common worldwide. 10

15. Hedging Strategies and Accounting for Derivatives
1. The impossibility of predicting foreign exchange rate changes puts corporations at risk for unacceptable losses.
2. Firms can use several financial instruments to minimize foreign exchange risk:
Forward contracts,
Swaps, and
Options
3. Accounting for these instruments may become extremely complicated when actual transactions have not yet been completed. 11