InvestorQ : How important are currency markets in impacting the performance of global companies and how do they impact?
Debbie Mascarenhas made post

How important are currency markets in impacting the performance of global companies and how do they impact?

Crowny Pinto answered.
3 years ago

A globally diverse company typically conducts material volumes of routine business in dozens of currencies throughout the year. As a result, its business operations and balance sheet may be subject to significant currency market effects, and these could have strong influences on performance. For example, from 1971 to 2013, the daily average year-on-year change in the value of the US dollar relative to the Canadian dollar was a small fraction of 1%. But there were one-year periods where there were substantial swings up and down. Moreover, the standard deviation of the values is many times the average value. Standard deviation measures the amount of dispersion seen among the individual one-year results. A relatively large standard deviation implies that the chance of randomly finding average or near-average results in any particular one-year period is relatively small.

Let us now look at how currency changes can impact a company's reported financial performance. The details of every company’s accounting practices are determined by law and company policy, and each company faces unique individual circumstances. But multicurrency business dealings are subject to common forces. Financial statements to shareholders are generally compiled in the currency of the country where the corporation is domiciled and its shares have their primary listing.

Assets and liabilities on the balance sheet that are not denominated in the home currency are typically translated into home-currency values using a specified exchange rate. Asset purchases and sales not denominated in the home currency are typically translated at the exchange rates prevailing at the time of the transaction.

Year-to-year changes in foreign currency-based balance sheet values reflect both changes in the underlying asset/liability and changes in the exchange rate used for the translation. Gains or losses attributable to currency moves may be disclosed separately. If not, you can estimate underlying changes by translating each value in a time series back into its local currency using prevailing exchange rates for its period.

International operations are generally conducted in local currencies, with net operating results consolidated into the base currency periodically. As with assets and liabilities, the translated net operating results may reflect both operationally based and exchange rate-based changes.

Major foreign companies that list their shares in the United States through ADRs generally translate their foreign currency statements into US dollars using an exchange rate prevailing at the time of the statement. A US investor evaluating currency effects would have to first consider the translation effects into the base currency of the foreign company, and then the added effects of translation from that base currency into US dollars.

Currency considerations for fixed income investors

Investments in bonds denominated in foreign currencies pose complex accounting and performance issues for their holders. For a US investor, the effective interest payments and principal values from a foreign currency-denominated bond can be reduced if that currency weakens against the US dollar. That would lower the value of future interest payments and redemption amounts when translated back into dollars. Conversely, the net US dollar returns from any particular foreign bond could be enhanced if that bond's base currency strengthens.