FINANCIAL RISK MANAGEMENT
Main Components of Foreign Currency Risk
a.
Accounting risk
(the risk of accounting): The risk that the preferred accounting treatment of a
transaction are not available.
b.
Balance sheet
hedge (balance sheet hedging): Reducing foreign exchange exposure faced by
differentiating the various assets and liabilities of a company abroad.
c.
Counterparty (the opponent): Individuals /
organizations who are affected by a transaction.
d.
Credit risk
(credit risk): The risk that the opponent had failed to pay its obligations.
e.
Derivatives:
the contractual agreement creating rights or obligations specific to the value
derived from other financial instrument or commodity.
f.
Economic exposure (economic exposure):
Effect of changes in foreign exchange rates against the cost
and revenue in the
future.
g.
Exposure management (exposure management): Preparation of the corporate structure to
minimize the adverse effect of exchange rate changes on earnings.
h.
Foreign currency commitment (commitment
to a foreign currency): Commitment to
the sale / purchase
of the company denominated
in foreign currencies.
i.
Inflation differential (difference of inflation):
The difference in the rate of inflation between two
countries or more.
j.
Liquidity risk (liquidity risk): The
inability to trade a financial instrument in
a timely manner.
k.
Market discontinuities (discontinuities market): Changes in market
value suddenly and significantly.
l.
Market risk
(market risk): risk of losses due to unexpected changes in foreign exchange
rates, commodity loans, and equity.
m.
Net exposed
asset position (the net asset position of the potential risk): Excess assets
position of the position of liabilities (also referred to as a positive
position).
n.
Exposed net
liability position (potential risk of the net liability position): Excess
liability position to the position of the asset (also referred to as a negative
position).
o.
Net investment
(net investment): An asset or net liability position that happens to a company.
p.
National amount
(national number): Total principal amount stated in the contract to determine
the settlement.
q.
Operational hedge (hedging operations):
foreign exchange risk Protection that
focuses on variables that affect a company's revenues
and expenses in foreign currency.
r.
Option (option): The right (not
obligation) to buy
or sell a financial contract at
a specified price before or during a specific date in the future
s.
Regulatory risk (regulatory risk): The risk that
a law limiting the public will mean
the use of a financial
product.
t.
Risk mapping (risk mapping): Observing the temporal relationship
with the market risks
of financial reporting variables that affect the value of the company and analyze the possibility of occurrence.
u.
Structural hedges (hedge structural):
Selection or relocation
of operations to reduce the overall foreign
exchange exposure of a company.
v.
Tax risk (the risk of tax): The risk that the absence of the desired tax treatment.
w.
Translation exposure (translation exposure):
Measuring the effect in the currency of the parent company of
the change in foreign
exchange for the assets, liabilities, revenues, and
expenses in foreign currencies.
x.
Transaction risk potential (the
potential risks of the transaction):
Foreign exchange gains or losses arising
from the settlement or conversion
of foreign currency transactions.
y.
Value at risk (the value of the
risk): Risk of loss
on trading portfolio of a company which is
caused by changes in market
conditions.
z.
Value drivers (trigger value):
The accounts of the balance sheet
and income statement which affects
value of the company.
Duties Manage Risk In Foreign Currency
The
growth of risk management
services that quickly shows
that management can enhance shareholder value by controlling
the financial risk. If the value of the company to match the present value of future cash flows, active
management of potential risks can be justified by
several reasons.
Exposure management helped in
stabilizing the company's cash flow expectations. Flow is
more stable cash flows that can minimize
earnings surprises thus increasing the present value of expected cash flows. Active
exposure management allows companies to concentrate
on the major business risks.
Lenders, employees and customers also benefit from exposure
management. Finally, because of losses caused by price and interest rate risk of certain transferred
to the customer in the form of higher prices, limiting exposure management of risks
faced by consumers.
Calculating the Risk of Translation
The process of
re-presentation of financial information from one currency to another currency
is called translation. Translation is not equal to the conversion.
Conversion is
the exchange of one currency to another currency physically. Translation is
just a change of monetary units, such as only a balance sheet re-expressed in
GBP are presented in U.S. dollar equivalent value. Potential risk of these
measuring translational effects of changes in foreign exchange against domestic
currency equivalent value of assets and liabilities denominated in foreign
currency held by the company.
Translational
gauge potential risk of exchange rate changes impact on the domestic currency
equivalent value of assets and liabilities denominated in foreign currency held
by the company. Because the amount of foreign currency is generally translated
into domestic currency equivalent value for purposes of monitoring or management
of external financial reporting, translational effects that pose an immediate
impact on the desired profit. Excess of assets exposed to liability risk
exposure (ie items in foreign currencies are translated based on the present
exchange rate) led to the position of net assets are exposed. This position is
often called the potential positive risks. Devaluation of foreign currencies
relative to the reporting currency translation losses caused. Revaluation of
foreign currency translation profits. Conversely, if the company has a net
liability position or potential exposure to downside risk if liabilities exceed
assets exposed exposed. In this case, the devaluation of foreign currency
translation gains cause. Revaluation of foreign currency translation losses
caused.
Calculating Risk Transactions
Potential risk of the transaction, gains and losses related to foreign exchange rates arising from the
settlement of transactions denominated
in foreign currencies. Transaction
gains and losses
have a direct impact on cash flow. Potential risks of the transaction report contains
items that generally do not appear in conventional financial statements, but it raises transaction gains and losses as foreign currency forward
contracts, purchase commitments and
future sales and long-term lease.
To minimize or
eliminate the potential risks, it takes a strategy that includes the balance
sheet hedging, operational, and contractual. Balance sheet hedging can reduce
the potential risks facing the company by adjusting the level and
value-denominated monetary assets and liabilities are exposed. Focusing on
operational hedging variables affecting revenues and expenses in foreign
currencies. Structural hedging include relocation of manufacturing to reduce
the potential risks facing the company or changing the State which is a source
of raw materials and component manufacturing. Contractual hedging was developed
to provide greater flexibility for managers to manage the potential risks faced
by foreign exchange.
The risk difference of Accounting
and Economic Risk
Differences
in the basic financial
instrument such as repurchase agreements (accounts),
bonds, and capital stock, meet the
definition of conventional accounting
for assets, liabilities,
and owner's equity While the derivative instruments are contractual
agreements that give special
rights or obligations and obtain the value
of financial instruments or commodities other.
In our
opinion, the difference lies in a different perspective because of reports of potential risks
in light of the translation of the parent company.
Forward exchange contract is
a contract between two parties to exchange
a certain amount of currency with another currency at
a certain date in the future. While the futures contract
is an exchange-traded
contracts that specify
delivery of a specific
currency at a date that has been
ensured in the future.
Because
when we handle the design
of a program to
hedge the market risks faced by customers
and how we handle
it, and it requires a lot of knowledge about
accounting management accounting in particular.
Actively hedge against the
potential financial risks are not generally accepted
among financial managers around
the world. Some argue that financial
management alone will not able to increase the value of the company and that
company better manage its core business risks and allowed himself to be
exposed by some (if not, all) financial risk.
Protection Strategy Exchange Rate
and Accounting Treatment of the
required
After
identifying potential risks, the next is designing
hedging strategies to minimize or even eliminate the potential risk. This can be done with
balance sheet hedging, operational, and contractual.
a.
Balance Sheet Hedging
Protection strategy by adjusting the level and value of monetary assets and
liabilities denominated exposed companies, which will reduce the potential
risks facing the company. Example of a hedging method subsidiaries located in
countries that are vulnerable to devaluation is:
·
Maintain cash
balances in local currency at the minimum level needed to support current
operations.
·
Restore the
earnings above the amount required for expansion capital to the parent company.
· Speeding
(ensure-leading) the receipt of outstanding trade receivables denominated in
local currency.
·
Delay
(slow-lagging) the payment of debt in local currency.
·
Accelerate the
payment of debts in foreign currencies.
·
Invest surplus
cash into the stock of debt assets of other funds in local currency which was
less affected by devaluation losses.
·
Invest in
assets outside the country with a strong currency.
b.
Operational Hedging
Focusing on operational hedging variables affecting revenues and expenses
in foreign currencies. More stringent cost control allows a greater margin of
safety against potential currency losses. Structural hedging include relocation
of manufacturing to reduce the potential risks facing the company or changing
the state is the source of raw materials and component manufacturing.
c.
Contractual Hedging
One
form of hedging with financial instruments, both the derivative instrument and the basic instrument.
This instrument products
include forward contracts,
futures, options, and the mix of all
three are developed. To provide greater flexibility for managers to manage the
potential risks faced by foreign exchange.
Accounting and Control Problems,
related to Risk Management
Foreign Exchange
Examples of accounting
and control issues associated with the risk management of foreign exchange can
be seen in the following cases:
These companies
continuously create and implement new strategies to improve their cash flow in order
to increase shareholder wealth. It does require some expansion strategy in the local
market. Other strategies require penetration into foreign markets. Foreign
markets can be very different from the local market. Foreign markets creates opportunities
increased incidence of corporate cash flow.
The
number of barriers to entry into foreign markets that
have been revoked or reduced, encouraging companies
to expand international trade. Consequently, many
national companies become multinational companies (multinational corporation) that are defined as
companies engaged in some form of international
business.
MNC own purpose
generally is to maximize shareholder wealth. Goal setting is very important for
an MNC, as all decisions must be made to contribute to the achievement of these goals. Any corporate policy
proposals not only need to consider the potential return, but also its risks. An
MNC must make decisions based on the same goal with the goal of purely domestic
firms. But on the other hand, MNC companies have a much wider opportunity, which
makes the decision became more complex.
There
are several constraints
faced by MNC companies
such as, environmental constraints, regulatory
constraints, and ethical
constraints. Environmental constraints
can be seen from the different characteristics of each country.
Regulatory constraints of each country regulatory differences that
exist such as, taxes, currency conversion rules,
as well as other regulations that may affect the
cash flows of subsidiaries. Constraint itself is
described as an ethical business practices vary in each country.
MNC, in doing international business, in general can use
the following methods:
o
International trade
o
Licensing
o
Franchising
o
The joint venture
o
Acquisition of companies
o
Establishment of new subsidiaries abroad
International business methods require
direct investments in operations abroad,
or better known as the Direct Foreign Investment (DFI).
International trade and licensing is usually not considered a DFI
because they do
not involve direct investment in overseas
operations. Franchising and
joint ventures tend to ask for direct investment, but
in relatively small amounts. The acquisition and establishment of new
subsidiary is the largest element of DFI.
Various opportunities
and advantages of a MNC is not free from risks that would arise. Although international
business can reduce the exposure of an MNC to the economic conditions of their
home country, international business usually also increase the MNC's exposure to
exchange rate movements, economic conditions abroad, and political risk. The
businesses Sebagian exchange of one currency International is calling others to
the currency of payment. Because the exchange rate continues to fluctuate, the
amount of cash required to make payments is also uncertain. Consequently, the
number of currency units of country of origin is required to pay may change even
if its suppliers do not change the price. In addition, when multinationals enter
foreign markets to sell products, the demand for such products depends on economic
conditions in those markets. Thus, the multinational company's cash flow is
affected by economic conditions overseas.
Management
can use the controls on
foreign currency exchange rates by hedging. However, any
financial risk management
strategy should evaluate
the effectiveness of the hedging program. Feedback
from the evaluation system
that is running will
help to develop
the institutional experience in the practice of risk menajamen. Performance assessment of risk management program
also provides information about when the current strategy is no longer appropriate to use. So basically,
effective financial control is a system of performance evaluation.
In many organizations,
foreign exchange risk management is centralized at corporate headquarters. This
allows the managers of subsidiaries to concentrate on its core business. However,
when comparing the actual and expected results, the evaluation system must have
a reference that is used to compare the success
of the company's risk protection.
TRANSFER PRICING AND TAXATION INTERNATIONAL
Basic Concepts of International
Taxation
The
complexity of the laws and rules that determine
the tax for foreign companies and the profits generated
abroad actually derived from some basic concepts:
a.
Tax neutrality is that the tax has no effect (or neutral)
of the resource allocation
decisions.
b.
Tax equity is that taxpayers who
are facing similar situations should
pay similar taxes
and the same thing but on disagreements between how to implement this concept.
With the use of tax Profit From Foreign Sources
Each country claims the right to impose taxes on income generated
within its borders. However, the national philosophy on the
taxation of resources from abroad
is different and this is important from the
perspective of a tax planner.
Most countries (including
Australia, Brazil, China, Czech Republic, Germany,
Japan, Mexico, Netherlands,
United Kingdom, and United States) to apply
the principles throughout the world
and impose taxes on profits or income of
the company and the
citizens in it without looking at
the territory of the State. The
underlying idea is that a foreign subsidiary
of a local company
is a local
company that happens to operate overseas.
Foreign Tax Credit
Foreign
tax credit can be counted
as a direct credit on income tax paid on earnings
branch or subsidiary and any tax withheld
at source such as dividends, interest, and royalties are sent
back to domestic
investors. The tax credit can also estimated if
the amount of foreign income tax paid is not too clear.
Tax Credit Restrictions
Foreign tax credit limitation applies
separately to U.S.
tax on foreign source income tax for
each of the following types of income:
1. passive income
2.
Financial services revenue
3.
Income levy high taxes
4.
transportation revenue
5. Dividend for each of the foreign
company with a share of ownership by 10% to 50%.
Tax treaty
Tax
treaties affect the tax levy on dividends,
interest and royalties paid by companies in the country to foreign
shareholders. These agreements
typically provide a reciprocal reduction of tax levies on dividends and royalties
are often exempt from
taxes and interest
charges.
International Tax Planning in Multinational Corporations
At the time
of the tax planning
of multinational companies have certain
advantages over a purely domestic firm
because it has a greater geographic flexibility in
determining the location of production
and distribution systems.
This flexibility would give opportunity to
utilize a separate juridical differences
between national tax so as to lower the overall
corporate tax burden.
The observation of these tax planning
issues at the start with two basic things:
a.
Tax considerations should never mengandalikan business strategy
b. Constant changes in tax laws
limit the benefits of tax planning in the
long term.
Variables in International Transfer Pricing
Transfer prices set a monetary
value on the exchange between firms that take place between the operating unit and
is a substitute for market prices.
Often the transfer price is recorded as
revenue by one
unit and the unit
cost by others.
Cross-border transactions of multinational corporations are also open to a number of
environmental influences that created the same time destroying the opportunity to increase profits through transfer pricing.
A number of variables in the transfer pricing separti tax
rate competition infalsi
rates, currency values, limitations on the transfer of funds, political risk and the interests of joint
venture partners are very complicated transfer pricing
decisions.
Transfer Pricing
Set prices on barangú and services
transferred between corporations within a group for the purpose of minimizing the overall corporate tax.
for example:
-
Establish a high transfer price
at which the
components are shipped from the subcontractor
in countries with
relatively low tax
rates.
-
On high transfer price at
which the components are shipped from the subsidiary
in the country which
is relatively high tax rates.
Factors underlying the Establishment of Policy D (Methods)
TRANSFER PRICING:
a.
Size (size of
the company).
Large companies
tend to use market-based transfer pricing policy
b.
Organizational
Design (design organization)
Centralized
operations, then the transfer price set center manager. Instead of
decentralization gives maximum autonomy to the manager of the subunits in
transfer pricing.
c.
Degree of
International Movement (the level of international involvement)
Transfer pricing in multinational companies is more influenced by environmental considerations.
Transfer pricing in multinational companies is more influenced by environmental considerations.
d.
Cultural influences
(cultural influences)
U.S. companies,
Canada, France and Italy as the main factors to consider tax rates that affect
the transfer. The Japanese company is considering the environmental effects
(such as inflation and currency revaluation) than U.S. firms.
e. Legal obligations
prevent conflicts dg taxation
officials, government antitrust
authorities and market regulators in both the home
or host country.
sources:
Choi, Frederick
D.S., and Gerhard D. Mueller, 2005., Akuntansi Internasional – Buku 1, Edisi
5., Salemba Empat, Jakarta.
Choi, Frederick
D.S., and Gerhard D. Mueller, 2005., Akuntansi Internasional – Buku 2, Edisi
5., Salemba Empat, Jakarta.
