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Q. What is Translation risk?
This risk occurs on consolidation of financial statements prior to reporting financial results and for this reason is as well known as accounting exposure. Consider an asset worth €14 million obtained when the exchange rate was €1.4 per $. One year later while financial statements are being prepared the exchange rate has moved to €1.5 per $ and the statement of financial position value of the asset has changed from $10 million to $9.3 million resulting an unrealised (paper) loss of $0.7 million. Translation risk doesn't involve cash flows and so doesn't directly affect shareholder wealth. But investor perception may be affected by the changing values of assets and liabilities and consequently a company may choose to hedge translation risk through for instance matching the currency of assets and liabilities (example a Euro-denominated asset financed by a Euro-denominated loan).
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