Translation risk

Definition

Translation risk, also known as accounting exposure, is the risk that a company's financial statements will be affected by changes in exchange rates. This occurs when a company consolidates its foreign subsidiaries' financial statements into its own reporting currency.

5 Must Know Facts For Your Next Test

1. Translation risk arises from the need to convert financial statements of foreign operations into the parent company's reporting currency.
2. It affects reported earnings and can impact key financial ratios.
3. Translation methods include current rate method and temporal method.
4. Hedging strategies such as forward contracts can mitigate translation risk.
5. Companies with significant international operations are more exposed to translation risk.

Review Questions

• What is translation risk and how does it affect a company's financial statements?
• Name two methods used to convert foreign subsidiaries' financial statements into the parent company's reporting currency.
• How can companies hedge against translation risk?

Related terms

transactionRisk: Risk arising from fluctuations in exchange rates between the time a transaction is initiated and settled.

economicRisk: The potential impact on a company's market value due to long-term effects of exchange rate movements.

forwardContract: A derivative instrument used to lock in an exchange rate for a future date, helping mitigate translation or transaction risks.