US-CN Companies & Securities Law Assignment

Derivatives and Foreign Currency 1. Define the term derivative and provide examples of risks that derivative contracts are designed to reduce. Derivative is the name given to a broad range of financial securities. Their common characteristic is that the derivative contract’s value to the investor is directly related to fluctuations in price, rate, or some other variable that underlies it. Interest rate, foreign currency exchange rate, commodity prices and stock prices are common types of prices and rate risks that companies hedge. 2. Explain the differences between forward contracts and futures contracts and the potential benefits and potential costs of each type of contract. A forward is negotiated directly with a counterparty, while a future is a standard contract traded on an exchange. The exchange traded instrument has less risk of non-performance, and is commonly cheaper to transact. But standard contracts might not fit all companies’ needs. The forward carries th...

Foreign Currency Financial Statements 1. Define the functional currency concept and briefly describe how a foreign entity’s functional currency is determined. Why is this definition critical from a financial reporting perspective? A company’s functional currency is the currency of the primary economic environment in which it operates. It is normally the currency in which it receives most of its payments from customers and in which it pays most of its liabilities. Other factors that are considered in determining the functional currency include whether its sales prices are determined primarily by local competition or local government regulation instead of short-run exchange rate changes or worldwide markets. The functional currency determination (local currency or parent currency or some other currency) is critical in determining what approach to converting financial statements to the ultimate reporting currency is used: the current rate or the temporal method. If the functi...