Foreign Currency Risk Research

Since foreign currencies are subject to fluctuations, if a country’s currency is devalued in a particular financial year, a company may either gain from the fluctuations or may lose as a result of disposing an item at the current exchange rate. Foreign exchange transactions occur in categories namely; spot transactions, forward transactions and future transactions (Ibrahim, Jibrin, et al. To be effective in the Foreign exchange market, the XYZ needs to hire a specialist in matters of international currency and a broker. The main players in the Foreign Exchange market are the hedgers and speculators who act as brokers. The spot exchange transaction takes place in a spot market. When consolidating their financial statements, the subsidiaries will have to use their reporting currency for the holding company.

For instance, assume that the company trade in with South Africa. If the exchange rate at 4th September 2014; 01:10 AM is 1USD= 14. 89 Rand and at the time of the exchange, the exchange rate is 1USD= 10. 89, this means that XYZ will have lost 4 Rand Operating exposure This type of risk affects the income flow of the company. However, before the lapse of the period, the currency exchange rate may have dropped drastically putting the seller in a risky position. To safeguard himself against such risk, he may hold is stock till maturity period. The buyer, on the other hand, may hold his money in the expectation that the exchange rates will favor him or invest in treasury bills. In the case of XYZ, the subsidiaries may use this method to raise revenue since it is unrestricted.

Accounting Assumptions in the Currency Exchange Current rate method The current exchange rate refers to the spot exchange rate used to present the company’s current assets and current liabilities in the financial statements. All revenues are recorded when earned not when received thus they are recorded at the spot rate. From our case study example XYZ, the company should adopt the temporal method to reduce the risk of exposure. The corporation needs to define its financial reporting dates to avoid confusing its subsidiaries. The temporal method is preferable in this case since assets both monetary and non-monetary are recorded at their actual cost. Revenues are recognized in the income statement when earned which is in conjunction with the matching approach.