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Explain how an unanticipated decline in value of the domestic currency affects the state of a...

Explain how an unanticipated decline in value of the domestic currency affects the state of a borrowing firm's balance sheet, and thus how it affects the severity of asymmetric information problem in the financial system?

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Answer #1

The decline in currency leads to depreciation of net assets of the company. The net assets of the company is constant, as a result of the deprecation of the domestic currency, the net asset value of the company depreciates. As a result this leads to losses, that is added on the debit side of the balance sheet.

It affects the severity of the asymmetric problems. Asymmetric problems means that the total net loss of the company in the balance sheet cannot be accurately calculated. There is an factor of currency depreciation that is not taken into consideration while formulating the balance sheet. The more the deviations of the currency, the more will be the asymmetric information biasedness.

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