A:

Any company that does a substantial amount of business in foreign countries, and is therefore subject to foreign currency exchange risk, may likely benefit from reporting results using constant currency figures. The likelihood that a company benefits from using constant currency numbers is increased if the company does a lot of business with a country with a currency increasingly valued higher respective to the company's home country currency. Using constant currency numbers is also of particular benefit when currency exchange rates are more highly volatile.

Adjustments for Exchange Rate Changes

The use of constant currency calculations is a way for a company to show its financial performance without the effect of currency exchange rate fluctuations. A common means of doing this is to report financial performance and profitability using the exchange rates that existed at the beginning of a company's fiscal year. Alternately, a company may simply report all sales denominated in the currency of the country where the sales were made or in its home country currency, without reference to exchange rates.

If a company does a large amount of business in a lot of different foreign countries, using constant currency numbers may not reflect an attempt to adjust its financial statements to make the company's performance look better. Rather, it may just result from the company trying to simplify its reporting. Some analysts question the validity of using constant currency figures, but the fact is, since exchange rates are constantly fluctuating, there is no choice of exchange rate figures that is perfectly accurate.

The use of constant currency numbers does not completely eliminate the effect of changes in interest rates from a company's financial reporting. Using constant currencies is merely a means of smoothing out the impact of changes in exchange rates that commonly occur from one year to the next. Constant currency values reflect the average exchange rate for the year. For example, if the exchange rate between the British pound (GBP) and the U.S. dollar (USD) traded during the year in a range from 1.5100 to 1.5500, then a U.S.-based company using constant currency numbers might report its earnings from business done in the United Kingdom assuming an exchange rate for GBP/USD of 1.5300. Some adjustments to the simple arithmetic average may be made if, for example, the trading range for the year was between 1.5100 and 1.5500, but the exchange rate was between 1.5400 and 1.5500 for 10 months of the year.

Hedging Against Currency Risk

Currency risk is an important factor for businesses operating in foreign countries to take into account, since significant changes in the exchange rate between two currencies can have a major impact on a company's profitability. In an extreme case, a large, unfavorable shift in exchange rates might completely eliminate a company's net profits from sales.

To protect themselves from potential adverse changes in foreign exchange rates, many companies hedge their exposure to currency risk, either through the use of forward contracts that lock in an agreed-upon exchange rate prior to the time a sale actually takes place or through hedging investments in the foreign exchange market. Foreign currency transactions can be hedged using forex market investments, options, currency exchange-traded funds (ETFs) or currency futures.

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