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GROUP: 09

TRANSLATION EXPOSURE

10-4A
DETERMINANTS OF TRANSLATION EXPOSURE
10-4B
EXPOSURE OF AN MNC’S STOCK PRICE TO TRANSLATION EFFECTS
 What is translation
exposure ?

Translation exposure is
the risk that a
company's equities,
assets, liabilities or
income will change in
value as a result
of exchange
rate changes
 The extent of an MNC translation
exposure depends mainly on three
factors:

DETERMINANTS  . The proportion of its business


OF TRANSLATION conducted by foreign
EXPOSURE subsidiaries
 . The locations of its foreign
subsidiaries
 . The accounting methods that it
uses
THE
PROPORTION • The greater the percentage of an MNC
OF ITS business conducted by its foreign
BUSINESS subsidiaries, the larger the percentage of a
CONDUCTED given financial statement item that is
BY FOREIGN susceptible to translation exposure
SUBSIDIARIES
 Thecountries in which subsidiaries are located can
also influence the degree of translation exposure
because the financial statement items of each
subsidiary are typically measured by the respective
subsidiary's home currency.

THE LOCATIONS OF ITS FOREIGN


SUBSIDIARIES
The • An MNC's degree of translation exposure is
strongly affected by the accounting
accounting procedures used to translate when
methods consolidating financial statement data.
4 methods and examples
Assets (millions) Liabilities & Equity (milions )
Cash 1000 Accts payable 47000

Account Rec. 50000 Long term debt 12000

Inventories 32000 Total liabilities 59000

Net fix asset 110000 Equity 135000


Asset 194000 L&E 194000
Method Example

Curent rate method: All assets and liabilities 194000-59000=135000


translated at curent exchange rate each report
period .exposure is net equity
Current / non-current method : only current CA-CL “1000+50000+32000-47000=36000
account translated at the exchange rate , the non –
current account was counted at the historical rate
Montary /non-montary medthod : Like the ways MA-ML”1000+50000-12000-47000=-8000
counting for Current method
Temporal method : Same as montary method MA-ML-inventory “-8000+32000=24000
except inventory included
Investor tend to valuing the stock of
MNCs by using:
 Earnings
 Deriving estimate of expected cash
flows from previous earnings
 Applying an industry P/E

The translation exposure of each MNC


affect its consolidated earnings, that
exposure can also affect the MNC's
valuation.
Signals that
complement
Translation Effects

The exchange rate conditions that


cause a translation effect can also
signal changes in expected cash flows
in the future year. Such changes could
also influence the stock price.
• Unfavorable translation effect that
reduces consolidated earnings may
also reduce the MNC’s stock price
• Favorable translation effect that
boosts consolidated earning could
boots the stock price.
Since an MNC’s stock may be subject to
translation effects and since managerial
compensation is often tied to the MNC’s stock
price, it follows that managerial compensation is
affected by translation effects.

Manages of one US-based MNC may receive more


compensation in a particular quarter because its
foreign subsidiaries are located in countries
where the local currencies appreciated against
the dollar over that quarter.

Managers of some US-based MNC may receive


low compensation because the currencies of their
foreign subsidiaries depreciated against the
dollar, thereby reducing earnings and stock price
performance
 Recall the previous example at 10.4a, in which Providence earned consolidated
earning of 17 million in year 1 but only 15 million in year 2. Providence has 10
million shares of stock outstanding. Suppose the P/E ratio was 20% in year 1
and also year 2.
In year 1, EPS is estimated to be $1.70, the stock valuation is $1.70x20= $34/share.
In year 2, EPS is only $1.50, the stock valuation is $1.50x20= $30/share.
Thus, its stock valuation declined over last year because consolidated earning declined
over that period.
Which in turn resulted from a decline in the exchange rate used to translate the British
pound earnings in to dollar earnings. These results hold regardless of whether the
subsidiary earnings are remitted to the US parent or reinvested by the subsidiary in the
UK.