Answer to Question 1
Currency fluctuations result in three types of exposure for the firm: transaction exposure, translation exposure, and economic exposure.
Transaction exposure is currency risk firms face when outstanding accounts receivable or payable are denominated in foreign currencies.
Translation exposure results when an MNE translates financial statements denominated in a foreign currency into the functional currency of the parent firm, as part of consolidating international financial results. Consolidation is the process of combining and integrating the financial results of foreign subsidiaries into the parent firm's financial records. Accounting practices usually require the firm to report consolidated financial results in the functional currency.
Economic exposure (also known as operating exposure) results from exchange-rate fluctuations that affect the pricing of products and inputs, and the value of foreign investments. Exchange rate fluctuations help or hurt sales by making the firm's products relatively more or less expensive for foreign buyers.
The consolidation of financial statements provides benefits to an international firm. A critical task in international accounting is foreign currency translation, or translating data denominated in foreign currencies into the firm's functional currency. Each of the firm's subsidiaries abroad normally maintains its financial records in the currency of the country where it is located. When subsidiary results are consolidated into headquarters' financial statements, they must be expressed in the parent's functional currency. Consolidation also facilitates headquarters efforts to plan, evaluate, and control the firm's activities around the world.
Answer to Question 2
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