On Schweser P.125, they say that when a subsidiary has a net asset position, which is the portion exposed to FX change under the current rate method, a local currency appreciation leads to a gain.
In my understanding, it would be the other way around, leading to a loss, no?
E.g. Imagine a Brazilian parent company with an US subsidiary. Let’s say the real appreciates (local currency) from BRL 3.0 per USD to BRL 2.5 per USD, and that net assets in USD of the subsidiary were 100 million initially. At the first FX rate, it would become BRL 300 million , but at the second FX rate (real appreciated), it would only be BRL 250 million.
I don’t know if its necessary to know the translation method being used to answer my question above, but anyway. Below is the original text from Schweser on the matter:
Current rate method
So, if the subsidiary has a net asset exposure and the local currency is appreciating, a gain is recognized. Conversely, a net asset exposure in a depreciating environment will result in a loss.
Temporal method
If the parent has a net monetary liability exposure when the foreign currency is appreciating, the result is a loss. Conversely, a net monetary liability exposure coupled with a depreciating currency will result in a gain.
I think “local currency” means the subsidiary’s currency, not the parent’s. So this would suppose a gain, because the subsidiary currency (US$) worths more in terms of the parent’s currency (BRL).
Well. The commentaries from Schweser are posted above. I guess its just a matter of terrible wording. Its obviously not clear. But anyway, thanks, I guess you could be right.
I have checked the book. Local currency is the currency of the country we refer to (in this case the subsidiary). In your example, the local / functional currency is US$, not BRL. There is your mistake.
Sounds like you got it figured out, but to echo Harrograth, if the subsidiary’s local currency is the functional currency, then that is also the presentation currency, and thus then current rate method is used.
After translating the income statement and moving down to the balance sheet (and remembering to follow this order for current rate method helps me to distinguish between the two methods), if there’s a net asset position in the subsidiary, then strengthened BRL (less of them per USD) means relatively more net USD will appear thanks to the new FX rate. This will show up on the balance sheet in equity as an increase in the CTA.
It reminds me of how a weaker dollar is usually good for blue-chip companies with lots of overseas businesses usually benefit from that fact (at least in terms of their financial statements).
Yeah, but you kind of got me confused again. Hehehe
The conclusions you are drawing are only correct if you’re assuming a different starting point than the one I suggested (Brazilian parent and US subsidiary). Please clarify that.