Institute of Chartered Financial Analysts of India (ICFAI) University 2006 Certification Finance International and Trade – II - Question Paper

Effective cost of the loan in rupee term is provided by ‘r’ in the subsequent formula.

204.05 = 3.1335 PVIF (r/2, 1) + 3.2033 PVIF (r/2, 2) + 3.2753 PVIF (r/2, 3) + 3.3488 PVIF (r/2, 4) + 3.4245 PVIF (r/2, 5) + 3.5010 PVIF (r/2, 6) + 3.5798 PVIF (r/2, 7) + 125.66 PVIF (r/2, 8) + 1.8709 PVIF (r/2, 9) + 129.4379 PVIF (r/2, 10)

For r/2 = 4% R. H. S. = 200.6275

For r/2 = 3% R. H. S. = 217.7761

\ = =

= 3.8004%

\ r = 7.60%.

Though the effective interest rate on yen borrowing is lower than dollar borrowing, SSIL is advised to borrow in Eurodollar since yen is a very much volatile currency which may increase the cost of borrowing in yen.

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5. SSIL will face transaction and translation exposure if it borrows in dollar.

Transaction Exposure

Transaction exposure is the exposure that arises from foreign currency denominated transactions which an entity is committed to complete. In other words, it arises from contractual, foreign currency, future cash flows. For example, if a firm has entered into a contract to sell computers to a foreign customer at a fixed price denominated in a foreign currency, the firm would be exposed to exchange rate movements till it receives the payment and converts the receipts into the domestic currency. The exposure of a company in a particular currency is measured in net terms, i.e. after netting off potential cash inflows with outflows.

Translation Exposure

Translation exposure is the exposure that arises from the need to convert values of assets and liabilities denominated in a foreign currency, into the domestic currency. For example, a company having a foreign currency deposit would need to translate its value into its domestic currency for the purpose of reporting at the time of preparation of its financial statements. Any exposure arising out of exchange rate movement and the resulting change in the domestic-currency value of the deposit would classify as translation exposure. It needs to be noted that this exposure is mostly notional, as there is no real gain or loss due to exchange rate movements since the asset or liability does not stand liquidated at the time of reporting. Hence, it is also referred to as accounting exposure. This fact makes the measurement of translation exposure dependent on the accounting policies followed for the purpose of converting the foreign-currency values of assets and liabilities into the domestic currency.

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