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FRM Part I · FRM Exam Part I · How Do Firms Manage Financial Risk?

A US multinational has a UK subsidiary with net assets of GBP 40 million. Under the current-rate translation method, the subsidiary's net assets are translated at the closing rate. The GBP/USD rate moves from 1.25 to 1.20 over the year. Which statement about the resulting translation effect is correct?

Net assets of GBP 40 million fall from USD 50 million to USD 48 million, a USD 2 million translation loss. It is an unrealized accounting effect with no immediate cash flow, typically recorded in equity rather than realized as a cash loss.

  1. AThe parent records an unrealized translation loss of USD 2 million, with no immediate cash flow effectCorrect
  2. BThe parent records a realized cash loss of USD 2 million
  3. CThe parent records a translation gain of USD 2 million because net assets rose in GBP terms
  4. DThe parent records a translation loss of USD 2.4 million because the GBP fell by 4 percent of USD 60 million

Explanation

Net assets in USD fall from 40 x 1.25 = 50 million to 40 x 1.20 = 48 million, a USD 2 million loss. Translation adjustments are non-cash accounting effects, usually reported in equity (other comprehensive income), not realized cash losses. The USD 2.4 million option uses an invalid base.

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