Translation exposure is a type of foreign exchange exposure that causes the domestic currency value of foreign subsidiary assets, liabilities, equity, income and expenses to fluctuate due to changes in foreign exchange rate between two reporting dates. There are two main methods for translation exposure: current method and temporal method. Translation exposure can be hedged using balance sheet hedge.
Transaction exposure is a type of foreign exchange risk that results from the difference in the final settlement value of foreign-currency denominated assets and liabilities due to changes in exchange rate between the date those assets or liabilities arose and their settlement date. It can be hedged using futures contracts, money market hedge and options.
There are two approaches to evaluate a foreign project: home currency approach and foreign currency approach. The first involves converting the foreign project cash flows to local currency based on expected forward exchange rates and discounting them based on home country cost of capital. The second requires calculating NPV based on foreign country cost of capital and then converting the foreign-currency NPV to local currency at the spot exchange rate.
Interest coverage ratio is a measure of a company’s ability to pay interest. It equals operating cash flows before interest and taxes divided by total interest payments. A higher ratio is better because it indicates availability of enough operating cash flows to meet the interest payment obligations.
A floating-rate note (FRN) or a floater is a bond whose coupon rate changes with changes in market interest rates. The coupon rate on an FRN has a floating component which is based on some reference rate such as LIBOR and a spread component which represents the credit risk of the issuer.
Bond discount amortization is the process through which bond discount written off over the life of the bond. There are two primary methods of bond amortization: straight-line method and effective interest rate method. An amortization schedule lists bond payments, bond discount amortization and interest expense for each period.
When a bond’s coupon rate is lower than the market interest rate, the bond sells at a price lower than its face value. The difference is called bond discount. Similarly, when a bond’s coupon rate is higher than the market interest rate, the bond sells at a price higher than the face value and the difference is called bond premium.
Debt ratio (i.e. debt to assets (D/A) ratio) can be calculated directly from debt-to-equity (D/E) ratio or equity multiplier. It equals (a) debt to equity ratio divided by (1 plus debt to equity ratio) or (b) (equity multiplier minus 1) divided by equity multiplier.
An amortizing bond is a bond that pays both principal and interest through periodic payments while the bullet bond is a bond that pays interest through periodic payments and the principal amount at maturity through a single payment.
Discount rate is the rate of interest used to determine the present value of the future cash flows of a project. For projects with average risk, it equals the weighted average cost of capital but for project with different risk exposure it should be estimated keeping in view the project risk.