![]() ![]() Of course, if the A$ strengthened over the three months, more than £55,556 would be received. If, however, the A$ weakened over the three months to become worth only A$/£2.00, then the amount received would be worth only £50,000. The exchange rate at the date of the contract is A$/£1.80 so the company is expecting to receive 100,000/1.8 = £55,556. For example, in June a UK company agrees to sell an export to Australia for 100,000 Australian $ (A$), payable in three months. If the exchange rate moves between agreeing the contract in a foreign currency and paying or receiving the cash, the amount of home currency paid or received will alter, making those future cash flows uncertain. ![]() This arises when a company is importing or exporting. If the US$ weakens, only the net US$1m becomes less valuable. The holding company’s investment is only US$1m and the company’s net assets in US$ are only US$1m. Its statement of financial position would look something like this: For example, take a US subsidiary that has been set up by its holding company providing equity finance. It can be partially overcome by funding the foreign subsidiary using a foreign loan. However, the term ‘translation risk’ is usually reserved for consolidation effects. It also becomes important if the subsidiary pays dividends. However, it would be important if the holding company wanted to sell the subsidiary and remit the proceeds. Usually, this effect is of little real importance to the holding company because it does not affect its day-to-day cash flows. If the subsidiary is in a country whose currency weakens, the subsidiary’s assets will be less valuable in the consolidated accounts. This affects companies with foreign subsidiaries. Although raw materials might still be imported and affected by exchange rates, other expenses (such as wages) are in the local currency and not subject to exchange rate movements.
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