GB525 Unit 4 Currency Exposure Memo Example

Sterling Receivables, Rupee Wages and a Translated Subsidiary: A Unit 4 Currency Exposure Memo

[Student Name]

Purdue University Global

GB525: Global Business Environment

Unit 4 Currency Exposure Memo

[Instructor Name]

[Date]

The manufacturer, its subsidiary and every amount and rate are composite and illustrative; the accounting standard and sources cited are real.

To: Chief Financial Officer, Wethersfield Instruments

From: Treasury Analyst

Subject: Our three currency exposures and the one action I recommend

Summary

We carry three different currency exposures: sterling receivables from UK customers, rupee operating costs at the Pune plant, and the translation of the Indian subsidiary's net assets into dollars. Only the first threatens near-term cash in a way we can hedge cheaply and precisely. I recommend selling sterling forward each month to cover 75 percent of expected receivables. The rupee cost exposure should be managed through pricing and sourcing, and the translation exposure should be monitored but not hedged.

The Exposure Table

Transaction exposure. Currency: pounds sterling. Amount: about £5.4 million of receivables outstanding at any time, on 60-day terms, worth about $6.9 million at 1.27 dollars to the pound. Horizon: 60 days, turning over continuously. Response: rolling forward contracts covering 75 percent.

Operating exposure. Currency: Indian rupees. Amount: about INR 420 million a year of wages, rent and local parts at the Pune plant, about $5.0 million at 84 rupees to the dollar. Horizon: years, since the costs recur. Response: pricing and sourcing, reviewed annually.

Translation exposure. Currency: rupees. Amount: the subsidiary's net assets of about INR 1.1 billion, about $13.1 million. Horizon: each quarter's reporting. Response: monitor and disclose; no hedge.

Two of the exposures share a currency, but all three differ in what they threaten: cash in 60 days, margins over years, and reported equity each quarter.

Transaction Exposure: Hedge It

When a UK utility pays its invoice in 60 days, we receive pounds and convert them to dollars at whatever the rate is then. A 5 percent fall in sterling between invoice and payment would cut the dollar value of outstanding receivables by about $343,000. The exposure is known in amount and timing, which makes it the easiest to hedge. Madura (2021) describes forward contracts as the standard tool for known foreign currency receivables, locking in a rate for a future date.

I recommend selling pounds forward each month for the receivables we expect to collect 60 days later, covering 75 percent. Hedging the full amount would leave us over-hedged if a customer paid late or disputed an invoice; 75 percent covers most of the risk while leaving room for timing differences. The cost is the forward points plus a small bank spread, which have recently been modest for sterling at this horizon.

Operating Exposure: Manage It Through the Business

The Pune plant's costs are in rupees, while the meters it builds are sold in dollars and pounds. If the rupee strengthened 8 percent against the dollar, our dollar cost for the plant would rise by about $400,000 a year, a cut in margin that no single forward contract would cover, because the exposure continues year after year.

Lessard and Lightstone (1986) argue that this kind of exposure belongs to operations rather than treasury, because it depends on where a firm makes and sells its products and how its competitors' costs move. For us, three levers matter: price adjustments in contracts longer than a year, sourcing more components locally in India so that some rupee costs are matched by rupee sales to Indian customers, and keeping the option of shifting some assembly between Pune and Connecticut. Financial hedges can smooth the coming year's costs, but they cannot change the exposure itself.

Translation Exposure: Monitor It

Each quarter we translate the subsidiary's balance sheet from rupees into dollars for our consolidated statements. A weaker rupee shrinks what Pune's net assets are worth once restated in dollars. Under US accounting rules, the resulting adjustment is reported in other comprehensive income as a cumulative translation adjustment, not in net income, and it is released into earnings only if we sell or liquidate the subsidiary (Financial Accounting Standards Board, 2013). A 6 percent fall in the rupee would reduce reported equity by about $786,000, but it would not change our cash.

Hedging translation exposure would mean taking on cash payments in the hedge to offset an accounting change that has none. Unless a lender's covenant were tied to reported equity, which ours is not, the cost of hedging would buy only a smoother balance sheet. I recommend disclosing the exposure and its sensitivity to the board each quarter instead.

Next Steps

If you agree, I will set up the forward program with our bank for the next month's invoices, prepare a one-page monthly report of hedged and unhedged sterling, and ask operations to review rupee-based sourcing in the annual plan. The program should be reviewed after six months.

References

Financial Accounting Standards Board. (2013). Foreign currency matters (Topic 830): Parent's accounting for the cumulative translation adjustment upon derecognition of certain subsidiaries or groups of assets within a foreign entity or of an investment in a foreign entity (Accounting Standards Update No. 2013-05).

Lessard, D. R., & Lightstone, J. B. (1986). Volatile exchange rates can put operations at risk. Harvard Business Review, 64(4), 107-114.

Madura, J. (2021). International financial management (14th ed.). Cengage.